Co-authored by Taline Chater, Partner and Joshua Kerr, Law Graduate

In the matter of Academy Construction & Development Pty Ltd (subject to Deed of Company Arrangement) [2024] NSWSC 808.

Key Takeaways:

1. Oppression, unfair prejudice or unfair discrimination in respect of a deed of company arrangement (DOCA), for purposes of section 445D of the Corporations Act 2001 (Cth) (Act), is often relied upon by genuinely aggrieved creditors or those wishing to seek leverage in commercial discussions during a restructure.
2. However, it ordinarily difficult to establish such grounds and achieve a termination of a DOCA, because:
   1. Part 5.3A of the Act contemplates that a DOCA can indeed treat different classes of creditors differently or prejudicially but dictates that treatment of creditors cannot be “unfairly prejudicial”;
   2. in the majority of situations, the aggrieved party may be treated differently to other creditors in the same ‘class’ but is not able to demonstrate that under the counterfactual of liquidation, they would be worse off.
3. This decision is instructive because it demonstrates the legal limits of the above position That is, where there lacks a rational or commercial basis for the differential treatment of creditors between the same class, although there may be a better return on a comparative counterfactual between a liquidation and DOCA, the deed may be set aside.
4. That is, a deed proponent is not free to determine, without any proper commercial basis, that one creditor should receive a reduced return so that other creditors may be paid in full. That approach is potentially oppressive, irrespective of whether it is directed to a majority or minority creditor and whether the majority of creditors vote in favour of the DOCA pursuant to the Administrators’ recommendation. That is, a DOCA cannot simply be used as a ‘strategy’ to cram out a disputed claim particularly in the absence of a proper adjudication of the claim by an Administrator. Accordingly, this decision has implications for disputed claims under building, construction and infrastructure as well as mining contracts, which would also need to be carefully considered in the context of their industry, statutory regimes.
5. Second, this decision confirms the established principle that third party releases in favour of directors and officers of a company cannot be effected upon under a DOCA noting section 444D of the Act, unlike in a scheme of arrangement.[1]
6. The Court will in particular circumstances exercise its discretion under s 445D(1)(g) of the Act where a DOCA erodes commercial morality or public confidence, in so far, a DOCA is inconsistent with the proper use of Part 5.3A of the Act, which in this case was found to be the case.
7. Third, the Court will not sever invalid clauses from a DOCA and will otherwise set aside the DOCA where:
   1. the offending clause/s are inextricably interconnected with elements of the DOCA; and
   2. the removal of the offending clause/s would affect the substantial purpose and effect of the DOCA and/or DOCA proposal.
8. Whilst the Court has the power to vary a DOCA under s 447A of the Act, the Court in the circumstances considered no utility in the severance of offending clauses where the DOCA otherwise remains oppressive, unfairly prejudicial and/or contrary to the public interest.

Background

1. In or around late December 2014 or January 2015, Academy Construction & Development Pty Ltd (Subject to Deed of Company Arrangement) (Company) – second defendant in the proceeding – finalised building works in respect of a strata property located in Botany in New South Wales for The Owners – Strata Plan 90889 (Owners Corporation), the plaintiff in the proceeding.
2. On 5 March 2021, the Owners Corporation commenced proceedings in the Supreme Court of New South Wales (Supreme Court Proceedings) against the Company who was responsible for designing and constructing the strata property, and the developer Great Tang Brothers Pty Ltd (Great Tang), alleging common property of the strata property had defects arising from residential building works performed by the Company when it constructed the building comprising the strata property. The Company denied those claims and pleaded the proceedings were commenced outside of the relevant statutory warranty period.[2]
3. On 9 June 2023, consent orders were made in the Supreme Court Proceedings requiring the Company to file lay and expert evidence on which it relied by 17 November 2023.[3]
4. Between the period 6 June 2023 and 30 August 2023, discussions transpired between the Company’s in-house legal adviser, the Company’s solicitors involved in the Supreme Court Proceedings, the Company’s accountant, and Mr Andrew Spring, acting at that time in what the Court understood to be an advisory capacity prior to later consenting to being appointed a voluntary administrator of the Company.[4]
5. On 31 August 2023, Messrs Andrew Spring and Peter Moore were appointed voluntary administrators to the Company under section 436A of the Act.
6. On 11 September 2023, the Owners Corporation submitted a proof of debt in the voluntary administration reflecting its debt owed as at 31 August 2023 in the amount of $7,127,600 (exc GST) plus legal and expert costs, with expert costs estimated at $500,000 plus GST.
7. On or around 25 and 26 September 2023, email exchanges take place between a former director of the Company, the Company’s in-house legal advisor, legal representatives of the Company and Mr Spring discussing the claims of creditors including the Owners Corporation under a DOCA proposal, and the desirability of including releases in favour of at least the Company’s director and former director in a DOCA proposal and the DOCA.[5]
8. On 26 September 2023, Mr Spring emailed a draft of the DOCA proposal to the Company’s in-house legal adviser and its former director, for consideration by the Company’s director, having been appointed in that capacity shortly prior to the Company being placed into voluntary administration. The DOCA proposal dated 26 December 2023 proposed the segregation of unsecured creditors of the Company into two classes, termed Class ‘A’ and Class ‘B’. Class ‘A’ represented all creditors other than the Owners Corporation, whilst Class ‘B’ solely included the Owners Corporation.
9. The DOCA proposal:
   1. provided a return to Class ‘A’ creditors of 100c/$ (i.e. payment in full) whilst Class ‘B’ creditors (i.e. the Owners Corporation) would receive a lump sum payment of $200,000 on its debt (estimated to be a dividend of 2.4c/$) following payment of the costs and expenses of the voluntary administration;
   2. sought to settle the Supreme Court Proceedings between the Company and the Owners Corporation and to impose an obligation on the Owners Corporation to provide third-party releases against associated entities of the Company (including but not limited to the Company’s director and former director); and
   3. involved related parties of the Company not participating in the deed fund and deferring their claims against the Company.[6]
10. On 27 September 2023, Messrs Spring and Moore (Administrators) in their capacities as Administrators of the Company, issued their second report to creditors pursuant to section 439A of the Act and Rule 75-225(3) of the Insolvency Practice Rules (Corporations) (439A Report). Section 9 to the 439A Report summarised the salient terms of the DOCA proposal (annexed to the 439A Report), advantages and disadvantages of the DOCA and . At paragraph 10.3 of the 439A Report, the Administrators recommended creditors resolve that the Company enter into a DOCA on materially similar terms to the DOCA proposal.[7]
11. Notably:
    1. the Administrators in formulating their recommendation, did not refer to or consider the differential treatment the DOCA proposal provided for between the Owners Corporation and all other creditors of the DOCA. The primary justifications in support of their recommendation included:
       1. a better return to creditors under the DOCA (Class ‘A’ creditors would receive 100c/$ compared to nil, and the Owners Corporation as a ‘Class B’ creditor would receive 2.4c/$ compared to nil in a liquidation) than what would otherwise be received in a liquidation scenario, and
       2. continuity of trading and employment.
    2. During the hearing, the Administrators conceded the counterfactual comparison conducted by them as to an estimated return to creditors under the DOCA and a liquidation had significantly understated the potential recoveries of a liquidation and accordingly, overstated the advantage under a DOCA .[8] The Court accordingly, found that the comparison undertaken by the Administrators was erroneous in that it understated the costs of adjudicating the Owners Corporations’ claim in a DOCA relative to undertaking that same task in a liquidation.[9]
12. On 6 October 2023, at a second meeting of creditors, six (6) creditors of the Company (including one (1) related creditor) voted in favour of the Company entering into a DOCA, whilst the Owners Corporation vetoed the resolution, causing a deadlock between a majority of creditors voting in favour by number but not by value, in light of the quantum of the Owners Corporation’s claim in the administration. As chair of the second meeting of creditors, Mr Spring exercised his casting vote in favour of the Company entering into a DOCA on substantially similar terms to the DOCA proposal of the Company’s director.[10]
13. On 23 October 2023, the Company and the Administrators entered into the DOCA on substantially similar terms to the DOCA proposal of the Company’s director.

Issues

1. Whether the resolution ought to be set aside? (Issue 1);
2. Were there alleged defects in information to creditors? (Issue 2);
3. Whether the DOCA was oppressive, unfairly prejudicial to, or unfairly discriminatory against the Owners Corporation? (Issue 3);
4. Whether the DOCA should be terminated for some other reason (Issue 4); and
5. Whether the offending clauses under the DOCA in respect of third-party releases may be severed from the DOCA (Issue 5).

Legal Analysis

Issue 1

1. The Administrators did not take a formal position in respect of the application brought by the Owners Corporation, but contended that the Administrator had exercised his casting vote appropriately, based on the following grounds:
   1. the Owners Corporation’s claim being disputed by the Company;
   2. the fact that creditors stood to receive a greater (even if nominal for the applicant) and swifter return under the DOCA as compared to a liquidation;
   3. the Administrators’ reference to the interests of creditors and the ARITA Code of Professional Practice in exercising his casting vote.[11]
2. The Owners Corporation argued that the DOCA:
   1. should be set aside;
   2. was oppressive or unfairly prejudicial to, or unfairly discriminatory against it (s 445(1)(f) of the Act);
   3. was against the public interest (s 445(1)(g) of the Act), for reasons that:
      1. there were significant defects in the information provided to creditors prior to the second meeting of creditors;
      2. there was no explanation, clarification or proper legal basis for the structure of the DOCA including as to the differential treatment of otherwise similar categories of unsecured creditors into two classes, with the effect that the Owners Corporation was in a class of its own and lower ranking as to the waterfall of funds to be paid out under the DOCA; and
      3. the Owners Corporation was the only creditor or party required to provide releases against related entities and/or parties under the DOCA.
3. Black J considered it unnecessary to decide this issue (i.e. whether to set aside the resolution on the basis of Mr Spring improperly exercised his casting vote in favour of the Company entering into the DOCA) on the basis that the DOCA would be set aside on other grounds including oppression, unfair prejudice or unfair discrimination (s 445D(1)(f) of the Act), and other reasons pursuant to s 445D(1)(g) of the Act.

Issue 2

1. The Administrators disputed the Owners Corporation’s position that there were significant defects in the information provided to creditors prior to the second meeting of creditors and the exercise of the Administrator’s casting vote passing the DOCA.
2. His Honour, Black J, considered this issue was not material to the determination of the proceedings in light of his views with other issues raised.[12]

Issue 3

1. Black J summarised the principles relevant to an application to set aside a deed of company arrangement under s 445D of the Act, as set out in his reasons in Re Citadel Financial Corporation Pty Ltd (subject to Deed of Company Arrangement) (2020) 146 ACSR 220 at [16]ff and Re ACN 613 909 596 Pty Ltd (formerly Minle Wine Negociants of Australia Pty Ltd) (subject to Deed of Company Arrangement) [2023] NSWSC 753 at [42]ff and [56]ff. Those principles are as follows:
   1. An order terminating a DOCA may be made under s 445D(1)(f) of the Act if that deed is oppressive or unfairly prejudicial to, or unfairly discriminatory against, one or more of the company’s creditors or is contrary to the interests of the creditors of the company as a whole.[13]
   2. Section 445D of the Act undertakes a two (2) step enquiry, namely, whether a ground under section 445D of the Act is established, and if that is answered in the affirmative, whether as a matter of discretion, the DOCA should be terminated.[14]
2. The factors informing the exercise of discretion for the Court to set aside a DOCA under s 445D(1)(f) include:
   1. the objects of Part 5.3A of the Act, which assumes creditors are best placed to determine their interests;
   2. interests of other creditors, the company and the public;
   3. comparable position of the creditor on a winding up compared with their position under the DOCA; and
   4. other relevant facts such as the relative position of all creditors under the DOCA, the existence of a collateral benefit to the shareholders and the whole of the effect of the DOCA.[15]
3. His Honour also noted the relevant propositions set out by McKerracher J outlined in respect of s 445D(1)(f) of the Act, as follows[16]:
   1. part 5.3A of the Act assumes creditors are best placed to judge their interests so a setting-aside will not be ordered lightly;[17]
   2. the fact that a creditor is prejudiced by the operation of the deed is not a sufficient reason to terminate a deed. It is a practical outcome of the deed procedure that some creditors stand to benefit whilst others do not;
   3. the test under s 445D(1)(f)(i) is not merely discrimination or prejudice, but unfair discrimination or unfair prejudice. Some degree of discrimination is not necessarily unfair. Thus, it is clear that a DOCA may provide for differential dividends among creditors;[18]
   4. part 5.3A does not require a pari passu What is required is a better return to creditors than an immediate winding up. That object is met if some creditors are better off than in a winding up and none are worse off under the DOCA than they would be under a winding up;[19]
   5. when deciding whether a deed unfairly prejudices or discriminates against a creditor or group of creditors, consideration must be given to what those purportedly prejudiced creditors would receive, or would be likely to receive, on a winding up, and the reasonableness of any conclusions reached by the administrator on that question;
   6. In respect of determining what is unfairly discriminatory, there must be reasonable grounds for differentiation between creditors of an equal class that accord with the object and spirit of Pt 5.3A. Exceptional circumstances may arise where differentiation is necessary;[20]
   7. where a DOCA proposes to preserve the company to achieve the objects of Part 5.3A of the Act, there should be no expectation of equal treatment of unsecured creditors where such treatment would defeat that purpose;[21] and
   8. if there is no prima facie evidence of misfeasance, concealment or a materially inadequate preliminary examination, and the DOCA offers both real financial benefits credibly estimated on preliminary investigation to exceed those available on liquidation, and indirect or collateral benefits from the survival of the company’s business; and no worthwhile avenues for further recovery in liquidation are identified, a major creditor’s curiosity or preference for further exploration of speculative claims is unlikely to render termination of the DOCA in the interests of the creditors as a whole.[22]
4. In respect of the present terms of the DOCA, Black J found that neither the Company or the Administrators had:
   1. made any attempt to establish that a pari passu distribution as between other creditors and the Owners Corporation would be achieved, after the Owners Corporation’s claim was properly adjudicated on by the Deed Administrators, which, would result in a distribution of $200,000 or less to the Owners Corporation;[23] and
   2. established any rational or commercial basis between the position of Class ‘A’ creditors whose claims were allowed in full, and the position of the Owners Corporation, where any uncertainty in the amount recoverable by the Owners Corporation would necessarily have been addressed in the valuation of that claim in the proof of debt process.
5. Black J further stated that the fact that a creditor’s claim is large and complex, and may be relatively costly to adjudicate, provides no basis for arbitrarily capping it to a figure chosen by a deed proponent to avoid or minimise the need for a proper adjudication of the claim; and such a cap does not avoid the need for an adjudication of that claim which is required to admit it under the DOCA. In the circumstances, there was no objective justification for the $200,000 cap of the Owners Corporation’s claim, which was an arbitrary amount chosen for the purposes of extinguishing the Owners Corporation’s claim.[24]
6. Black J concluded that he was satisfied a basis for termination of the DOCA under s 445D(1)(f) of the Act was established, on the ground that it was oppressive and unfairly prejudicial to or unfairly discriminatory against the Owners Corporation. This conclusion was reached (irrespective of the third party releases that were proposed in the DOCA and were found to be unauthorised by Part 5.3A of the Act), for the following reasons:[25]
   1. there was no objective or commercial basis for the DOCA to impose a cap of $200,000 for recovery by the Owners Corporation’s claim;
   2. there was a real risk that the Owners Corporation would not recover the amount of $200,000 to be made available to it, in light of the DOCA deferring the Owners Corporation’s claim to rank in priority behind the claims of all creditors(including the Administrators’ fees and expenses and the other creditors who would be paid in full); and
   3. significantly, there was no top-up obligation imposed upon by the deed proponent, so as to avoid any erosion of any amount available to the Owners Corporation from the Administrators’ further costs and expenses in attending to additional work.

Issue 4

1. The Owners Corporation also relied upon s 445D(1)(g) of the Act as justification for the termination of the DOCA on the basis that the DOCA was against the public interest and that the Court should therefore exercise its discretion and terminate the deed “for some other reason”.[26]
2. Black J found that there was a sufficient basis for the terminating the DOCA under s 445D(1)(g) of the Act, in light of the lack of a commercial basis for the differential treatment of the Owners Corporation as against other unsecured creditors under the DOCA.[27]
3. In exercising the Court’s discretion, Black J considered that where, in the present circumstances, a DOCA operates to the advantage of the majority of creditors, and the substantial disadvantage of a single creditor or minority creditors, then the advantage of the DOCA for creditors generally is of lesser relevance, and issues relating to the proper use of Part 5.3A of the Act pursuant to which a DOCA governed, are of greater significance.[28]
4. Counsel for the Administrators in assisting the Court, raised the possibility that the Court should not exercise its discretion in terminating the DOCA where the creditors other than the Owners Corporation would “definitely” be worse off in a liquidation than under the DOCA and the Owners Corporation will “likely” (but not definitively) be worse off under the DOCA, and where financial contributions to the deed fund had been made which exceed $500,000.[29]
5. Black J determined that such basis was not a justification for not exercising the Court’s discretion in terminating the DOCA where:
   1. the structure of the DOCA involved a high level of oppression and discrimination against the Owners Corporation;
   2. the factual inaccuracies as to the Administrators’ counterfactual comparison of estimated returns to creditors in a DOCA and/or liquidation scenario; and
   3. it would substantially undermine the public purpose served by Part 5.3A of the Act and specifically s 445D of the Act if the Court were to give substantial weight to the fact of a contribution to a deed fund having the effect of immunising a deed of company arrangement against being set aside for oppression, discrimination or abuse of Part 5.3A of the Act.

Issue 5

1. In circumstances where it was conceded that a DOCA cannot include third party release clauses, the deed proponent sought to severe the relevant clauses and otherwise maintain the balance of the proposed DOCA. In an amended defence filed by the Company and Company’s director, those parties sought an order under s 447A of the Act that the DOCA be varied by severing clauses 6.2 and 13.3 of the DOCA. His Honour was not satisfied that the Court ought to exercise such power and permit the severance of the clauses (and permit the balance of the proposed DOCA) where:
   1. the objective intent of the DOCA and subjective intent of the Company’s director was to include them, for the same reasons that those clauses would not be severed; and
   2. importantly, the DOCA would still be oppressive of the Owners Corporation and contrary to the public interest;
   3. there would be no utility in an order under s 447A of the Act to delete those clauses, where his Honour would terminate the DOCA, irrespective of its invalidity by reasons of those clauses.

[1] City of Swan v Lehman Brothers Australia Ltd (2009) 74 ACSR 191; Lehman Bros Holdings Inc v City of Swan (2010) 240 CLR 509 [50] – [53].

[2] In the matter of Academy Construction & Development Pty Ltd (subject to Deed of Company Arrangement) [2024] NSWSC 808 (‘ACD’) [1], [16] (Black J).

[3] Ibid [16].

[4] ACD (n 2) [17] – [24].

[5] ACD (n 2) [26] – [30].

[6] ACD (n 2) [31] – [34].

[7] ACD (n 2) [35] – [37].

[8] ACD (n 2) [38].

[9] ACD (n 2) [39].

[10] ACD (n 2) [42] – [43].

[11] ACD (n 2) [46].

[12] ACD (n 2) [51].

[13] ACD (n 2) [56].

[14] ACD (n 2) [86].

[15] ACD (n 2) [59]. See Britax Childcare Pty Ltd (ACN 006 773 600) v Infa Products Pty Ltd (ACN 092 222 994) (admins apptd) (2016) 115 ACSR 322 [115] (Burley J).

[16] Decon Australia Pty Ltd v TFM Epping Land Pty Ltd (No 2) [2021] FCA 32 [202] – [203] as cited in ACD (n 2) [60].

[17] University of Sydney v Australian Photonics Pty Ltd (2005) 53 ACSR 579 [34].

[18] Hamilton v National Australia Bank Ltd (1996) 66

[19] Fleet Broadband Holdings Pty Ltd v Paradox Digital Pty Ltd (2005) 228 ALR 598 [62].

[20] Lam Soon Australia Pty Ltd v Molit (No 55) Pty Ltd (1996) 70 FCR 34, 46-48.

[21] Commonwealth v Rocklea Spinning Mills Pty Ltd (2005) 145 FCR 220 [30] (Finkelstein J).

[22] Mediterranean Olives Financial Pty Ltd v Loaders Traders Pty Ltd (ACN 069 549 042) (subject to deed of company arrangement) (No 2) (2011) 82 ACSR 300 [195], 344 (Dodds-Streeton J).

[23] ACD (n 2) [64].

[24] ACD (n 2) [71], [73].

[25] ACD (n 2) [75] – [77].

[26] ACD (n 2) [80].

[27] ACD (n 2) [85].

[28] ACD (n 2) [86].

[29] ACD (n 2) [87].