Divisive DOCA set aside

In Pilot Advisory Pty Ltd1, Pilot- the major creditor of Cloud 92 - successfully applied to the Federal Court to set aside a DOCA relying on the Court’s power to act in “the interests of the creditors as a whole, and in the public interest.”  


Pilot assisted Cloud 9 with due diligence ahead of the sale of its business assets.  After Cloud 9’s failure to pay Pilot’s invoice, Pilot was successful in proceedings for payment of the outstanding invoice.  On 16 May 2018 Pilot issued a statutory demand for the amount of its judgment debt. 

Some 2 weeks later, Cloud 9 was placed into voluntary administration by its sole director.  By then, Cloud 9 had not traded for 3 ½ years however, it remained in existence primarily to distribute the asset sale proceeds to its creditors and shareholders. Relevantly, the sale proceeds significantly exceeded the value of Pilot’s claimed invoices and were distributed over about 2 years.

Importantly, after entering into administration:

  • Pilot’s admitted debt accounted for some 82.7% of the total value of debts admitted for voting purposes;
  • the administrators’ reports to creditors identified a number of questionable transactions as potential breaches of directors’ duties, noting the likely cost of further investigation and the role of a liquidator in doing so. The transactions were not obviously supported on any of the company’s books and records. For example:
    • a $3.6M payment was made to an offshore company – purportedly representing commission on the sale of Cloud 9’s business, at a rate of 29% of the sale price – without any supporting documents. The directors and other officers and advisors of Cloud 9 gave evidence about the existence of an agreement to support the commission paid, but on further questioning, agreed that the ‘side deal’ would have breached the business sale agreement and therefore did not proceed. The evidence revealed was that there was no obvious justification for the $3.6M payment. Moreover, questions were raised about whether Cloud 9 was related to the offshore company, a question which had not been resolved at the time of the second meeting;
    • various payments were made to a related entity purportedly for superannuation and payroll commitments, and purportedly made to offset intercompany loans. But no documents indicated the existence of a loan and the related entity was delisted by a common director;
    • additionally, $2.4M was paid out in dividends to shareholders and a further amount was paid as a ‘catch-up’ dividend;
  • a DOCA was proposed at the (adjourned) second creditors’ meeting and was passed as a result of the exercise of the chairperson’s casting vote.  Pilot was the only creditor to vote against the DOCA resolution. Cloud 9 was immediately returned to the control of its directors. The directors were also responsible for making payments under the DOCA to constitute the DOCA fund.

Pilot's position

Pilot’s application to set aside the DOCA was predominantly advanced on the grounds of public interest (s 455D(1)(g) of the Corporations Act3) claiming that it was in the public interest to investigate “misconduct in the affairs of the company.”4  Pilot also contended that the DOCA was unfairly prejudicial (s 455D(1)(f) of the Act).  

In relation to the public interest argument, Pilot claimed that it was in the public interest to investigate misconduct in the affairs of the company5 and that the former and current directors of Cloud 9 should be orally examined about certain transactions.  Pilot claimed that the DOCA:

  • had the effect of allowing the directors to escape examination about certain transactions; and
  • the effect of the DOCA allowed the directors to use and control Cloud 9 and to reclaim any debt due by the Cloud 9 to the directors after termination of the DOCA.

Pilot had previously offered some $60,000 to fund the public examinations of the directors which would not be treated as a cost of the liquidation but rather, added to the debt it would prove for in the liquidation. 

The administrators’ position and Cloud 9’s position

Both the administrators and Cloud 9 opposed the orders sought by Pilot.  

The administrators claimed that the chairperson’s reasons for voting in favour of the DOCA were (among other things):

  • the return to creditors under the DOCA was greater than liquidation;
  • the return under the DOCA was certain whereas under liquidation, significant legal action was required and there was no certainty as to any recoveries;
  • protracted litigation in the liquidation would deplete the director’s resources and leave less potential available funds to creditors by way of a recovery; and
  • the chairperson had considered the benefits to all creditors and their preference – expressed by the resolution at the meeting, at least in number of voices - for Cloud 9 to execute the DOCA.

Cloud 9 relied on (amongst other things) the following contentions:

  • the structure and object of Part 5.3A of the Act and the free commercial choice it conferred on the creditors of an insolvent company;
  • the importance of the administrators’ views, pointing out that they were “experienced, independent, arms’ length officer[s] of the Court and ... registered liquidator[s];” and
  • the scope and detail of the administrators’ investigations, as evidenced by their reports, leading to the vote of creditors to adopt the DOCA.

The Court's approach

Before exercising its discretion as to whether the DOCA should be terminated, the Court was required to form a view about whether Pilot had made out one of the grounds set out in s455D(1) of the Act.  

The Court ultimately determined, after assessing the provisions of the DOCA against the background facts and circumstances, that notwithstanding the objects of Part 5.3A of the Act, the DOCA was unfairly prejudicial and contrary to public policy on the basis that it required Pilot to “forego approximately $880,000 of its judgment debt and preclude it from procuring any scrutiny of the prima facie breaches of the directors’ duties.”6  Relevantly, the creditors whom voted in favour of the DOCA were the directors and shareholders of Cloud 9 as well as its former financial and legal advisors.

In reaching is decision, His Honour set out at [105]:

…most importantly of all, the DOCA, which was the ultimate result of the directors’ course of conduct as outlined above, contains the following provisions. First, clauses which act to shield the directors from the scrutiny that would otherwise occur in a liquidation in respect of their prima facie breaches of duty[…] Secondly, and to compound the above, a clause which conditionally discharges the directors from liability for those breaches of duty[…] And finally, a provision which returns the company to the control of the directors and anticipates it will continue in existence[…]

Following making out of the ground(s) for termination of the DOCA, His Honour exercised his discretion to terminate the DOCA in accordance with s 445D(1) of the Act.

Lavan comment

The provisions of that Part 5.3A of the Act were not intended to be used as a device to protect directors from their misconduct in the affairs of a company7.  Insolvency practitioners should keep this matter in mind when exercising their judgment for recommending a proposal and also exercising casting votes in favour of DOCAs.  Careful consideration should be given to the ultimate effect of a DOCA, particularly where investigations reveal prima facie suspicious transactions which are unsupported by records. The creditor composition voting for/ against the DOCA should also be borne in mind when considering the use of a casting vote.

Disclaimer – the information contained in this publication does not constitute legal advice and should not be relied upon as such. You should seek legal advice in relation to any particular matter you may have before relying or acting on this information. The Lavan team are here to assist.
Joseph Abberton
Dean Hely
Managing Partner
Lawrence Lee
Restructuring & Insolvency


[1] Pilot Advisory Pty Ltd, in the matter of ACN 137 806 574 Pty Ltd (Administrators Appointed) formerly Cloud 9 Software Pty Ltd v ACN 137 806 574 Pty Ltd (Administrators Appointed) formerly Cloud 9 Software Pty Ltd [2019] FCA 2171.

[2] ACN 137 806 574 Pty Ltd (Administrators Appointed) formerly Cloud 9 Software Pty Ltd

[3] 2001 (Cth)

[4] Pilot Advisory Pty Ltd, [55].

[5] Pilot Advisory Pty Ltd, [55].