20 Aug 2015

Lessons for administrators: Avoid material omissions in a section 439A report and get the DOCA right

by Laura Hawes, Scott Sharry

A section 439A report must contain all material information which is known or reasonably ascertainable by administrators.

A recent decision, In the matter of Recycling Holdings Pty Limited [2015] NSWSC 1016, provides some guidance for administrators on what constitutes a material omission or misstatement in a section 439A report and second meeting of creditors, and what administrators can discuss, pre-appointment, with a director concerning potential terms of a DOCA before an apprehension of bias may arise.

The administrators are called to Recycling Holdings Pty Limited

Recycling Holdings Pty Ltd was in liquidation. At the director's suggestion, the liquidator appointed voluntary administrators to the company pursuant to section 436B of the Corporations Act 2001 (Cth).

The administrators' section 439A report included a proposal for a DOCA on the following terms:

  • the company would be returned to the control of the director;
  • a related entity would fund ongoing litigation by the company against certain creditors (defendant creditors);
  • the proceeds of the litigation would be paid into a DOCA fund;
  • creditors were expected to receive a dividend of 100 cents in the dollar if the litigation was successful;
  • the director was required to apply to have the winding up terminated under section 482 of the Act.

The administrators told the second meeting of creditors that, if the litigation didn't return sufficient money to pay them 100 cents in the dollar, they would be given the opportunity to vote to terminate the DOCA.

Creditors voted in favour of the proposal but the DOCA prepared did not include provision for creditors to vote to vary or terminate the DOCA if the litigation proceeds fell short ‒ merely that the administrators had a discretion to call such a meeting.

The defendant creditors applied to the Court to have the DOCA terminated under section 445D, or declared void under section 445G of the Act, on the basis that there were material omissions from, and misstatements made in, the information provided to creditors, both in the section 439A report and at the second creditors' meeting in relation to the litigation. They also applied, in the alternative, for removal of the deed administrators under section 449B of the Act.

Alleged material omissions from the section 439A report

Information about the litigation

The defendant-creditors complained that the administrators' report omitted a significant amount of material information about the litigation against them.

The Court dismissed this argument. It found that the creditors had been informed generally as to the nature of the cause of action, the estimated quantum of return, the funding arrangement, the director's belief that the action enjoyed good prospects of success and the likely timeframe for a trial. It noted that the administrators could only report on information available to them, taking into consideration the need to retain privilege in any legal advice (and not to disclose to the defendant creditors the strengths and weaknesses of the litigation).

However, the Court found that the creditors were not (and should have been) told that the director (along with the company) was personally a cross-defendant in the litigation, that this was a matter which was known to or reasonably discoverable by the administrators, and its omission was material.

Voidable transaction

The Court found that the administrators had failed to investigate or disclose in their section 439A report a potential unfair preference or uncommercial transaction of approximately $500,000 in value (as they did not realise that it had been made within the 6 month relation-back period) and the omission of that matter from the report was material.

Grounds for termination of the DOCA?

Material omissions

The Court's discretion to make an order terminating a DOCA is enlivened where it is established that material misleading information has been provided to creditors or there has been material omission under section 445D(1)(a), (b) or (c) of the Act.

The Court here declined to exercise that discretion given that the resolution approving the DOCA proposal was carried on the votes of creditors related to the director, such that the omitted matters, while material, would not have affected the votes of those creditors had they been disclosed to them prior to the second meeting.

The Court found that most of the opposition to the DOCA came from the defendant creditors and that, if the DOCA didn't pay 100 cents in the dollar, creditors could opt for a liquidation.

Unfairly prejudicial

The Court dismissed the argument that the DOCA was unfairly prejudicial to creditors or contrary to the interests of the creditors as a whole within the meaning of section 445D(1)(f) on the basis that:

  • in a liquidation, the liquidator might be able to pursue the potential voidable transaction but would require funding to do so, and the maximum net return would only be about $100,000 (the company's debts were over $2m);
  • under the DOCA, success in the litigation would produce sufficient funds to pay creditors 100 cents in the dollar and if it did not, creditors could opt for a liquidation.

Variation of the DOCA

The Court held that section 439C of the Act was not complied with because the DOCA did not reflect the proposal voted on at the second meeting (as it did not give creditors the opportunity to terminate the DOCA if it failed to pay them 100 cents in the dollar) and the appropriate remedy was to make an order under section 445G(4) of the Act to vary the DOCA to reflect that proposal.

Removal of the deed administrators

The defendant creditors argued that the deed administrators should be removed under section 449B of the Act, on the basis that their pre-appointment discussions with the liquidator and director, and their recommendation in favour of the DOCA, all indicated bias.

The Court dismissed that argument. It found that the administrators' pre-appointment discussions did not unreasonably involve discussion of the potential terms of a DOCA and, in the course of considering whether or not to accept an appointment, it is to be expected that administrators will consider and even form some preliminary views in respect of a DOCA.

Stay of the liquidation

While there was no certainty that the litigation would result in a recovery of funds sufficient to ensure that the company came out of insolvency, the Court ordered a stay of (but did not terminate) the winding up while the DOCA was in force.

Implications for administrators

The case serves as an important reminder to administrators:

  • to ensure that a section 439A report contains all material information which is known or reasonably ascertainable by them ‒ if it does not, the Court could exercise its discretion to terminate a DOCA under section 445D of the Act; and
  • when drawing up a DOCA, to take particular care to ensure that it accurately reflects and is in substantially in the same form as the proposal voted on at the second meeting of creditors.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.