Deeds of company arrangement: Buying of debts and unreasonable prejudice for the purposes of section 600A of the Corporations Act

Deeds of company arrangement: Buying of debts and unreasonable prejudice for the purposes of section 600A of the Corporations Act

Grocon Constructions Pty Ltd v Kimberley Securities Ltd [2009] NSWSC 541, New South Wales Supreme Court, Barrett J, 16 June 2009

(a) Summary

The proceedings were initiated by Grocon Construction Pty Ltd (Grocon) to challenge the adoption of the deed of company arrangement (DOCA) dated 21 April 2009 executed by the first defendant, Kimberley Securities Ltd (Kimberley).

Grocon’s challenge was based mainly on sections 600A and 445D of the Corporations Act 2001 (Cth) (Corporations Act). Ostensibly, Grocon was seeking an order from the court setting aside the resolutions of directors by which the DOCA was adopted on the basis that its adoption prejudiced a class of creditor.

The proceedings were brought against Kimberley (1st Defendant), John Vouris (2nd Defendant), Warren Panzer (3rd Defendant), Lohemi Pty Limited (4th Defendant), Gabriel Michael Lorentz (5th Defendant), Nathan Stoliar (6th Defendant) and Building Insurers’ Guarantee Corporation (Supporting Creditor).

The court found that the substantive elements of Grocon’s claim were made out.

It found that Kimberley (via related entity Selwan Property Holdings Pty Ltd (Selwan)), bought the debts of creditors and assigned those debts to third parties, in an attempt to control the meetings of creditors which led to adoption of the DOCA.  The effect was to force the creditors who voted against the DOCA (Opposing Creditors) to participate in the Deed Fund and have their debts extinguished, while allowing related party creditors to avoid participation in the Deed Fund and extinguishment of their debts.  It further prevented the Opposing Creditors from calling for Kimberley’s winding up.

The court found that the buying of debts by Kimberley/Selwan amounted to a class of equitable fraud and caused the outcome of the creditors meetings to favour the DOCA.  It found further that these actions prejudiced the Opposing Creditors in the sense relevant to section 600A(1)(c).  It therefore ordered the setting aside of the resolution of creditors, termination of the DOCA and winding up of the company.

(b)  Facts

Kimberley was a property development company that went into Part 5.3A administration on 19 December 2008.  By resolution of the directors, Mr Vouris and Mr Pantzer (who were also Kimberley Directors) were appointed administrators.

Several creditors’ meetings followed.  Relevantly, at a creditors’ meeting on 20 March 2009, the administrators expressed the opinion that it would be in the best interests of creditors to accept the proposal for the DOCA contained in a supplementary administrators’ report attached to the notice of meeting on the basis that “it may provide for a greater and more certain return to creditors than a winding up of the company”.

At a reconvened meeting on 30 March 2009, the following resolution was passed:

“That the company execute a deed of company arrangement as detailed in the administrators’ report to the creditors dated 20 March 2009.”

Of the 22 creditors who voted on a poll, 17 (accounting for $13,585,530.11) voted in favour of the DOCA (Approving Creditors) and there were five Opposing Creditors (accounting for $5,557,864.89).  As a result, the resolution was carried.

A Deed Fund was established by the “Secured Creditor” which required the deposit of $180,000 on or before 30 June 2009 and $180,000 on or before 30 June 2010.  The “Secured Creditor” was Lohemi Pty Ltd (Lohemi).

Grocon brought proceedings on the basis that, despite the resolution being carried, 11 of the Approving Creditors were related parties of Kimberley within the section 9 Corporations Act definition (thereby related creditors within the meaning of section 600A(3) Corporations Act) and their votes were therefore to be disregarded.  Having disregarded the 11 related creditor votes, there were still six Approving Creditor votes, resulting in a majority in number in favour of the DOCA but a majority in value against it.  Thus, under regulation 5.6.21(4), it would have been open to the chairperson to exercise the casting vote.

The remaining unrelated Approving Creditors were made up of the Creditors who had had debts assigned to them by Selwan (Assignee Creditors).  The Assignee Creditors each appointed a Kimberley/Selwan director as proxy to vote at the creditors’ meeting, thereby ensuring the adoption of the DOCA.

The question before the court was whether the prejudice operating against the Opposing Creditors was sufficient to allow the court to make an order under section 600A(2) settling aside the resolution.

To determine whether it was open to it to set aside the resolution, the court focussed on the effect of the purchase and assignment of the debts assigned to the Assignee Creditors.

(c) Decision

(i) Buying of debts

Each of the Assignee Creditors had been assigned a debt following the purchase of the debt from the original creditor and assignment of it by Selwan to the Assignee Creditor.  Selwan has the same directors and secretary as, and is a related party of, Kimberley.

The court found that the payments by Selwan to the creditors and the assignment of the debts was undertaken in an effort to ensure that the DOCA would be supported at least on the basis of a majority by number.  The court found that Selwan did not take the assignment of the debts itself, despite paying for them, as it was a related party.  If it had taken assignment of the debts, its vote would still have been disregarded on the basis that it is a related creditor and it would not have had the benefit of six seemingly unrelated votes.  The effect of purchasing and assigning the debts to six unrelated creditors was to control the meeting of creditors, at least to the extent that the vote would be in favour of the DOCA on numbers.

The Assignee Creditors were at no disadvantage, as they paid nothing for the assignment of the debt and incurred no financial risk.  Without exception, each unrelated Assignee Creditor had executed a proxy to one of the Kimberley/Selwan directors to vote at the Kimberley creditors’ meeting.  While not strictly within the section 9 definition of related entity, the Assignee Creditors were aligned with the directors of Kimberley/Selwan, devoid of interests of their own and were in substance related entities.  The court found that the transactions by which the Assignee Creditors acquired their debts were an “artifice to give an air of arm’s length independence to a device by which voting power by any meeting of creditors was put into the hands of the Kimberley directors, with mere nominees being made to appear to possess the voting power” [see paras 50 – 58].  In summary, “the directors and secretary of Kimberley, acting in the corresponding capacities within Selwan, implemented a strategy deliberately aimed at enhancing their changes of controlling, at the head count level, creditor voting that they already controlled at the value level because of the magnitude of the debt”.

The court found further that, had all of the supporting votes, whether by related parties or Assignee Creditors, been ignored as required by section 600A(3), there would have been no votes in favour of adopting the DOCA and five votes against it.  The five Opposing Creditors would have been counted as arm’s length creditors with substantial debts.

(ii) Unreasonable prejudice and the matters in section 600A(1)(c)

In applying section 600A(1)(c), the court likened the actions of the Kimberley/ Selwan directors to a species of equitable fraud.  It found that the passing of the resolution for the adoption of the DOCA entailed clear prejudice to the Opposing Creditors.  The Kimberley directors had exerted actual influence over the outcome of the resolution by masquerading as arm’s length parties having “engaged in private and undisclosed dealings with certain creditors.in the lead-up to the Part 5.3A administration for reasons which obviously included . the enhancement of the voting power . at the meetings of creditors which would inevitably be held in the course of the administration” [see paras 77 and 78].

Further prejudice came from the fact that the Deed Fund was not available to related parties.  To this end, the debts of all related entities were to remain unextinguished and continue as undiminished obligations of Kimberley while the debts of the unrelated and Opposing Creditors would, for their aggregate claims exceeding $5.5 million, be confined to participation in the Deed Fund and have their debts extinguished while being prevented from calling for Kimberley to be wound up.

The court then considered whether the identified prejudice inflicted on the Opposing Creditors was “unreasonable” having regard to the matters referred to in section 600A(1)(c)(ii)(A), (B), and (C).  The court noted that generally, the question of unreasonableness boils down to whether the creditors are better off with the deed or with the liquidation.  The court found that it was not really necessary to undertake this objective inquiry, because the Opposing Creditors made it clear by their votes that they preferred winding up and wanted to avoid extinguishment of their debts.  The related Creditors wanted precisely the opposite outcome, because they clearly saw benefits to themselves in standing aside from the scheme of debt extinguishment and Deed Fund participation and would not have caused the DOCA to be adopted had they not seen those benefits.

The court found that if the objective inquiry was needed, there was very little difference between winding up and the DOCA.  In this case, there was negligible difference between the financial outcomes, although the administrators’ report which detailed the likely outcomes of a DOCA and winding up did not include relevant information including amounts that might be recovered by a liquidator on account of unfair preferences, insolvent trading and other causes of action available to the liquidator alone.

The court also considered that certain undertakings made by Opportune Pty Ltd (Opportune) that Kimberley would remain a going concern (which may have induced creditors to rely on Kimberley’s solvency) and certain actions by Lohemi in repaying Kimberley debts to Alcany Pty Ltd (Alcany) prior to the commencement of the administration (and the assignment of securities to Lohemi by Alcany previously granted to Alcany by Kimberley) would not be investigated if Kimberley adopted the DOCA in the same way as if it were to be wound up.

The court found that, in addition to the other prejudices operating against the Opposing Creditors, it was prejudicial to their interests that the Opportune undertakings and Lohemi debts and securities were to be left unexplored without “the more rigorous and independent scrutiny that a liquidator could bring to bear” [see paras 88 – 102].

Having satisfied itself that the Opposing Creditors were prejudiced for the purposes of section 600A(1)(c), the court set aside the resolution of 30 March 2009 under section 600A(2)(a), terminated the DOCA under section 600A(2)(d) and section 445D(1)(g) (which provides for the court to terminate a DOCA if satisfied that it should be terminated for some other reason) and further ordered that Kimberley should be wound up pursuant to section 600A(2)(a).

 

Co-authored by Annabelle Wilson.

Published by SAI Global on behalf of Centre for Corporate Law and Securities Regulation, Faculty of Law, the University of Melbourne with the support of the Australian Securities and Investments Commission, the Australian Securities Exchange and the leading law firms.