Checkers Or Chess? - Plaintiffs In Arbitration Fail To Set Aside DOCA Extinguishing Their Claim

In the recent case of Sino Group International Limited v Toddler Kindy Gymbaroo Pty Ltd,¹ the Federal Court dismissed an application under sections 445D and/or 445G of the Corporations Act² for orders to terminate a deed of company arrangement (DOCA) executed in respect of Toddler Kindy Gymbaroo Pty Ltd (Company).

The Company had been involved in a long running arbitration with Sino Group International Limited and Beijing Yingquidi Education and Technology Ltd (together, the Sino Creditors) which was still ongoing when the Company was placed into administration.

The Sino Creditors submitted a proof of debt for their claim for costs and damages in the arbitration but were only admitted for $1 in respect of their claim for damages of $5m.  The Sino Creditors voted against the DOCA but lost, and subsequently applied to set aside the DOCA on a number of grounds including that it was unfairly prejudicial to and discriminatory against the Sino Creditors. 

Background

The Company carried on a business that provided neuro-developmental and sensorimotor movement programs for children aged up to five.  The Company either franchised or licenced the use of those programs and the associated brands in Australia and abroad.

As part of these activities, the Company had entered into a master licencing agreement with the Sino Creditors for the use of the Company’s programs and brands in China.  A dispute arose between the Company and the Sino Creditors, and the Sino Creditors commenced arbitration proceedings against the Company in 2018 alleging that the Company had unlawfully sought to terminate the licencing agreement and was taking steps to directly operate in China.

By November 2021, the Sino Creditors had obtained a partial final award holding that the Company’s attempt to terminate the licencing agreement was unlawful and not effective as well as orders for costs in the arbitration proceedings, and had filed a further amended statement of claim setting out the Sino Creditors’ claim for loss and damage of around $5m.

The following steps then took place:

• on 17 November 2021, Mr Peter Sasse, one of the directors and shareholders of the Company, sent an email on behalf of his father Mr Harry Sasse calling in a loan made by Mr Harry Sasse to the Company for approximately $690,000;
• on 17 November 2021, the directors of the Company, being Mr Peter Sasse and his siblings Dr Janet Williams and Mr Bill Sasse, resolved that the Company was unable to repay this loan and was therefore insolvent or likely to be insolvent; and
• the Company was placed into administration on 22 November 2021.

The Administration and the DOCA proposal

The Sino Creditors submitted a proof of debt in the administration claiming legal costs in the arbitration (both fixed and unfixed) of $960,000 and loss and damage of $5m in relation to the Company’s breaches of the licencing agreement.

However, the administrators only admitted the loss and damage claim for $1 on the basis that there was inadequate information to assess the value of the claim.  The administrators also admitted some of the Sino Creditors’ claims for costs in whole and others in part, but then applied a set-off for the Company’s claim that the Sino Creditors had not paid licencing fees under the licencing agreement, resulting in a final admitted claim value of $161,000.

Separately, Dr Williams, one of the directors of the Company and a member of the Sasse family which owned and controlled the Company, put forward a DOCA proposal which:

• noted that the Sasse family members including Dr Williams were owed a total of approximately $1.9m; and
• proposed that there be a deed fund of $600,000 to pay creditor claims (comprised of the Company’s cash plus contributions from Dr Williams), and that the Sasse family members would be excluded from the DOCA and the deed fund.

The administrators issued their report to creditors on 18 March 2022.  The report recommended the DOCA proposal on the basis that it would result in the creditors receiving 100c/$ for their claims, as opposed to a winding up scenario where the excluded creditors’ claims would be included and where creditors would then receive a dividend of between 33c and 42c.  These calculations were based on the Sino Creditors’ claims being admitted for $161,000.

The second meeting of creditors was held on 25 March 2022.  There were 14 general unsecured creditors in attendance by special proxy who were owed around $50,000 in total, the 4 members of the Sasse family who were also in attendance by special proxy were admitted for $1.9m, and the Sino Creditors who were admitted for $161,000. 

The Sino Creditors voted against the DOCA but all 18 special proxies were in favour of the DOCA.  The resolution to enter into the DOCA was carried, and the Company executed the DOCA on 28 March 2022.

The Sino Creditors commenced proceedings on 29 March 2022 seeking orders to terminate the DOCA.

The Application

The Sino Creditors argued that the DOCA should be terminated pursuant to s75-41 of the Insolvency Practice Rules (Corporations) 2016 (Cth) (IPR) or ss455D or 455G of the Corporations Act 2001 (Cth) (Act) on the grounds that:

• materially misleading information was provided to creditors – s445D(1)(a) of the Act;
• there were material omissions from the reports to creditors – s445D(1)(c) of the Act;
• the DOCA is oppressive or unfairly prejudicial to or unfairly discriminatory against the Sino Creditors – s445D(1)(f)(i) of the Act;
• the DOCA is contrary to commercial morality and the public interest – s445D(1)(g) of the Act; and
• the DOCA should otherwise be set aside under the Court’s discretion in s75-41 of the IPR.

The Decision

Justice Anderson noted that the essence of the Sino Creditors’ complaint was that there needed to be an assessment of whether the administrators had adequately performed their statutory duty to investigate the Company’s financial circumstances, in particular the claim by the Sino Creditors, and whether the administrators had had a sufficient basis to recommend the DOCA.

As to the question of whether the administrators had adequately performed their duty to investigate the financial circumstances of the Company, Anderson J was satisfied that the administrators had done so on the basis of the administrators’ evidence (which Anderson J accepted) that:

• the information provided by the Sino Creditors in support of the claim for loss and damage lacked particularity and did not provide any causal basis between the breaches of the licencing agreement established in the arbitration and the alleged loss and damage; and
• specifically, the proof put the claim as “approximately $5,000,000”, the amended statement of claim in the arbitration did not provide particulars of the loss and damage claim, and the particulars provided by the Sino Creditors to the administrators were general, were not supported by financial information, could not be substantiated or linked to the breaches of the licencing agreement (particularly as to asserted trading losses) and were not the subject of any objective independent evidence such as a forensic accounting or expert report.

In the circumstances, the Court was satisfied that the administrators were justified in only admitting the loss and damage claim of the Sino Creditors for $1 as the administrators did not have sufficient probative information to be able to make a just assessment of the damages claim and the quantum of the claim rose no higher than ‘mere assertion’.

This finding then formed the basis for the Court rejecting the specific grounds raised by the Sino Creditors as:

• there was no materially misleading information or material omission in the report to creditors as there had not been a “substantial understatement” of the Sino Creditors’ claims;
• the DOCA was not oppressive or unfairly prejudicial to or unfairly discriminatory against the Sino Creditors as it treated the Sino Creditors the same as the other participating creditors in respect of their properly admitted claims;
• the DOCA was not contrary to commercial morality and the public interest; and
• there was no basis for the Court to exercise its discretion under s75-41 of the IPR.

The application was therefore dismissed.

Lavan comment

While this case illustrates the pragmatic approach that the Courts will take in assessing conduct in an external administration, it is also an important reminder to creditors that they need to be keenly aware of the role and function of external administrators as well as the steps that they will need to take to protect and assert their rights in an external administration.

For example, it is arguable that if the Sino Creditors had collated and submitted detailed and appropriate evidence to support their claims for loss and damage, the outcome of this case could have been very different.

If you have any questions regarding making or assessing a complex unliquidated claim in an external administration, the experienced Lavan team is ready to help.