Ashurst Restructuring Roundup

Terminating DoCA's (Part 4) – Exercise of Discretion

Sino Group International Limited v Toddler Kindy Gymbaroo Pty Limited [2023] FCAFC 110 (Toddler Kindy)

Canstruct Pty Limited v Project Sea Dragon Pty Limited (No. 4) [2024] FCA 112 (Canstruct)

Yan v The Won Capital Pty Limited [2024] NSWSC 758 (Won Capital)

Commissioner of State Revenue v McCabe (No. 2) [2024] FCA 662 (McCabe)

IMO Academy Construction & Development Pty Limited [2024] NSWSC 808 (Academy Construction)

When deciding an application under s 445D(1), Corporations Act 2001 (Cth) (CA) to terminate a DoCA, the court will first decide whether one of the grounds for which that subsection provides is satisfied, and second, whether the court should exercise its discretion to terminate. The exercise of that discretion is informed by considering whether it is in the interests of creditors as a whole to set aside a DoCA or whether allowing it to continue is contrary to the public interest.

There are a number of factors which have been identified as a basis for exercising that discretion.

It has also become common for applications to terminate a DoCA to rely on s 447A, CA in addition to s 445D(1), CA. Accordingly, the exercise of the discretion to terminate a DoCA, in the typical case, will also be informed by those matters to which the court will have regard when exercising its power under s 447A, CA.

Irrespective of the basis of the application, an overarching consideration when exercising the discretion involves a "balancing act" between the interests of creditors and the public interest. So much was explained in Academy Construction in which decision (at [81]) the following passage from an earlier judgment was adopted:

"…generally speaking, one should not terminate a DOCA and order a company to be wound up if the DOCA will restore the company to financial health and the DOCA does not have the purpose or effect of unjustifiably quarantining third parties from investigations. If the company is trading and it is likely that its business will continue, then unless there are real public interest concerns, termination of a DOCA and causing a company to be wound up are inappropriate outcomes. The interests of creditors should be the primary consideration, but they may be outweighed if the DOCA has a fraudulent or wrongful purpose."

Exercise of Discretion

The Court's approach when considering an application to terminate a deed of company arrangement (DoCA) under s 445D(1) of the Corporations Act 2001 (Cth) (CA) has been summarised as follows:

"… [T]here is a two-step approach to the application of s 445D(1). First, the Court must be satisfied of at least one of the statutory criteria prescribed in s 445D(1). Secondly, on being so satisfied, the Court must determine, in the exercise of its discretion, whether it is in the interests of creditors as a whole to set aside the DOCA, or whether allowing it to continue is contrary to the public interest. It is at this point that the Court may have regard to factors not expressed in the legislation, but which are, nonetheless, relevant to the exercise of the discretion."; McCabe at [46]

In Dalma it was further observed that (at [70]):

"...the Court has a discretion whether to terminate a deed of company arrangement even if it is satisfied that a ground under section 445D(1) of the Corporations Act is established. That discretion is to be exercised having regard to all of the relevant circumstances viewed as a whole including the interest of creditors as a whole and the public interest." (citations omitted)

As was also noted in McCabe:

"It appears to have become orthodox for an application under s 447A to be coupled with an application under s445D" (at [3]).

Section 447A provides:

(1) The Court may make such order as it thinks appropriate about how this Part is to operate in relation to a particular company.

(2) For example, if the Court is satisfied that the administration of a company should end:

(a) because the company is solvent; or

(b) because provisions of this Part are being abused; or

(c) for some other reason;

the Court may order under subsection (1) that the administration is to end.

Accordingly, the exercise of the discretion to terminate a DoCA, in the typical case, will also be informed by those matters to which the court will have regard when exercising its power under s 447A, CA. See also Dalma at [197].

Whilst the exercise of the discretion to terminate a DoCA is contingent upon the establishment of at least one of the grounds for which s 445D(1), CA provides, the establishment of one or more of those grounds, of itself, will be a significant factor influencing the court's exercise of that discretion. In that regard, the court in Canstruct held (at [249]):

"In this case, each of the conclusions that section 445D(1)(b), (c), (e) and (f) are satisfied are weighty considerations in favour of terminating the DOCA. Indeed, each or any combination of them support the exercise of the discretion to terminate."

Beyond a consideration as to whether any of the grounds in s 445D(1), CA supports the exercise of the court's discretion to terminate a DoCA, the court in Dalma said (at [72]):

"The following non-exhaustive list of factors, drawn from the authorities, are relevant to the exercise of the Court's discretion:

• (1) whether the creditors voted to enter into a DOCA, noting that creditors are generally taken to be in a better position to judge what is in their best interests than the Court;

• (2) whether the vote is carried by the votes of related creditors whose interests are not aligned with the unrelated creditors
  ...
• (5) whether creditors would be better off under a DOCA or in a liquidation;
• (6) whether the dividend under a DOCA is likely to be insignificant;
• (7) whether the continuation of the DOCA would have the effect of eroding commercial morality or public confidence in financial systems; and
• (8) whether the effect of the DOCA, once implemented, would be to permit an insolvent company to continue to trade, contrary to the public interest."

In McCabe the following further factors were identified (at [156]):

• (a) Whether the DoCA allows a director to avoid public examination and the possibility of claw back litigation.

Issues relevant to this factor include whether, if liquidators are appointed to the company, they will have sufficient funds to pursue possible claims and whether the prospective defendants to such proceedings will be able to satisfy any judgment; Academy Construction at [88].

• (b) Whether, having regard to the size of the dividend, and/or the prospects of preference or uncommercial transaction or insolvent trading recoveries, an investigation is called for.

• (c) Whether the application is brought by a creditor whose debt is disputed.

• (d) Whether there has been a delay in bringing the application;

In Won Capital there was a delay in bringing the application which the court considered to be explicable and, moreover, both the purpose of the DoCA in that case - which was, in essence, in the nature of a holding DoCA - had been achieved and the termination of the DoCA would not have adverse consequences. In the circumstances, the delay in pursuing the application to terminate the DoCA was not an impediment to the exercise of that power.

• (e) Whether the DoCA is to effect a purpose which cannot be effected under the law such as altering the priority of the Commissioner of Taxation without his consent.

• (f) Whether there has been some unconscionable conduct such as making side deals with certain creditors.

The consideration of these various factors is undertaken in the context of a "balancing act" which involves weighing the interests of the creditors of the company on the one hand, and the interests of the public, on the other; Toddler Kindy at [74].

The undertaking of that "balancing act" was considered in Academy Construction when deciding whether the DoCA should be terminated "for some other reason"; s 445D(1)(g), CA. That provision should not be exercised, at most, rarely; McCabe at [86]. However, it would be justifiable in circumstances where the public interest outweighs the interest of creditors. In that regard the court in Academy Construction adopted (at [81]) the following passage from the judgment in Habrok (Dalgaranga) Pty Ltd v Gascoyne Resources Ltd [2020] FCA 1395 at [410].

"…generally speaking, one should not terminate a DOCA and order a company to be wound up if the DOCA will restore the company to financial health and the DOCA does not have the purpose or effect of unjustifiably quarantining third parties from investigations. If the company is trading and it is likely that its business will continue, then unless there are real public interest concerns, termination of a DOCA and causing a company to be wound up are inappropriate outcomes. The interests of creditors should be the primary consideration, but they may be outweighed if the DOCA has a fraudulent or wrongful purpose."

In McCabe, further consideration weighed against the exercise of the discretion; namely, that the companies in the group to which voluntary administrators had been appointed and which had continued to trade consistently with the arrangements made under the DoCAs were solvent and had been trading solvently for approximately one and a quarter years since the DoCA was voted upon with the result that the court concluded (at [157]) that:

"To the extent that one can discern the meaning of 'public interest' from the statute, it is clearly not in the public interest to wind up solvent companies and make in excess of 80 employees redundant. To the contrary that would be anathema to Pt 5.3A."

In each of Canstruct and Academy Construction, the DoCA under consideration provided for the discriminatory treatment of an individual creditor. In both cases it was held that the DoCA involved an abuse of Part 5.3A as the proposed discrimination did not involve a legitimate commercial consideration related to the continued operation of the company's business. In those cases that consideration supported the exercise of the discretion to terminate the DoCA.

Authors: Emanuel Poulos, Partner and Richard Fisher, Consultant