So Much For A Fresh Start - DOCA Terminated For Improper Purpose And Effect

In the recent case of R.W. Pascoe Pty Ltd v Crimson Fresh Produce Pty Ltd (subject to deed of company arrangement) [2023] FCA 705, the Federal Court of Australia considered an application by a creditor of Crimson Fresh Produce Pty Ltd (Crimson Fresh) to terminate the deed of company arrangement (DOCA) entered into by Crimson Fresh and to place Crimson Fresh into liquidation.

The DOCA in question had been proposed by Crimson Fresh’s sole director, did not provide for the rehabilitation of or the return to trading by Crimson Fresh, and appeared to provide for a lower and less certain dividend to creditors.

In considering the application under sections 445D and 447A of the Corporations Act 2001 (Cth) (Act), Justice Derrington considered the case law regarding when a Court can terminate a DOCA if it is for the purpose, or has the effect, of avoiding a proper investigation of a company’s affairs or transactions, before ordering that the DOCA be terminated.

Background

Crimson Fresh operated a produce growing and export business in and around Mildura in Victoria.  However, Crimson Fresh held minimal assets, did not own any real property and conducted its business on leased land, and to the extent that it owned equipment this equipment was subject to securities in favour of other entities.

At some time in 2022 Crimson Fresh ceased to trade, and then on 4 November 2022, Crimson Fresh’s sole director, Mr Padia, placed the company into voluntary administration.

The administrators issued their report to creditors on 4 December 2022 which noted the following bleak matters:

• the company had been trading at a loss since 1 July 2018, and had been insolvent from at least 30 June 2020;
• there was an excess of liabilities over assets of $5.8m;
• a key factor in the failure of the company had been poor management;
• there were 21 creditors that had received potential unfair preference payments of around $530,000, there were potential unreasonable director related transactions totalling around $140,000, and there was a potential claim against Mr Padia for insolvent trading worth approximately $1.8m;
• these claims meant that in a hypothetical best case scenario there could be a return to unsecured creditors of 53.63c/$ (although the Court noted that in fact, this report contained an arithmetical error and based on the claim values in the report, the hypothetical best case return was actually 100c/$); and
• however, in a practical sense, any return to unsecured creditors was unlikely.

As at the time of the report, no DOCA proposal had been received and the administrators recommended that Crimson Fresh be wound up.

The second meeting of creditors was scheduled to take place on 9 December 2022, but shortly before the meeting Mr Padia submitted a DOCA proposal to the administrators.  The meeting was then adjourned to 10 February 2023 to allow the creditors time to consider the proposal.

The administrators issued a supplementary report to creditors analysing the DOCA proposal and providing an update of the administrators’ findings.  The supplementary report noted the following:

• the DOCA proposal provided for Mr Padia to contribute $200,000 to constitute a deed fund.  However, the $200,000 was in fact to come from any net proceeds received from the sale of current crops being grown by the company and Mr Padia was not actually contributing any funds from his own pocket.  Further, the crops were growing on land owned by other companies controlled by Mr Padia and there was a real question as to whether the company would in fact realise any net proceeds from the sale of these crops;
• the DOCA did not contemplate Crimson Fresh returning to trading;
• even if the $200,000 was received, once the administrators’ costs and fees were paid, the amount left over would only allow for a return to creditors of around 2.35c/$;
• the administrators had significantly downgraded their estimate of potential recoveries from voidable transaction claims from over $2m as set out in their original report down to only $650,000 (there was no explanation as to why this estimate had been downgraded), but this still provided for a potential dividend of 23c/$ to unsecured creditors; and
• the administrators still recommended that Crimson Fresh be wound up.

The creditors meeting was then reconvened on 10 February 2023.  Although it is not clear from the judgment, it appears that the following matters took place at the meeting:

• voting was carried out at the meeting ‘on the voices’;
• a resolution to wind up the company was put to the creditors, however only two creditors (including the plaintiff) with debts of $434,000 voted in favour of this resolution.  Seven creditors with debts of $416,000 voted against a winding up.  This resolution was taken as having failed on the voices;
• a resolution to accept Mr Padia’s DOCA was then put to the creditors.  Six creditors with debts of $290,000 voted in favour of the DOCA.  Five creditors with debts of $690,000 voted against the DOCA.  This resolution was taken as having been carried on the voices; and
• no poll was called for by any party as to the outcome of the votes on these resolutions.

The DOCA was entered into on 3 March 2023. 

The plaintiff, who was one of the creditors who had voted in favour of a winding up and against the DOCA, then applied to the Court for orders under sections 445D(1)(e), 445D(1)(f) and/or 447A to terminate the DOCA.  The deed administrators neither opposed or supported the application.  All known creditors were given notice of the application and none opposed the application, and one gave written notice that it supported the application.

The decision

In terms of the provisions relied on by the plaintiff, the Court noted that:

• section 445D(1)(e) gives the Court the power to terminate a DOCA where effect cannot be given to the deed without injustice or undue delay.  The authorities have confirmed that the element of injustice may be established if the effect of the deed would be to avoid a proper investigation of relevant transactions;
• section 445D(1)(f) gives the Court the power to terminate a DOCA where the deed is oppressive or prejudicial or discriminatory in relation to one or more of the company’s creditors, or where the deed is otherwise contrary to the interests of creditors as a whole.  The authorities have confirmed that a deed will be oppressive or unfairly prejudicial if it interferes with a creditor’s general right to be paid or to have the company wound up or to have the company administered in a way which keeps the company’s business going and will see the creditor paid something out of the property of the company; and
• section 447A(2)(b) provides for specific power for the Court to terminate an administration if the provisions of the Act are being abused.  The authorities have confirmed that this includes situations where administration processes are being employed for ulterior and improper purposes not envisaged by the legislation.

The Court then went on to find that:

• for the purposes of section 445D(1)(e), giving effect to the DOCA in this case would cause the injustice of a proper investigation of the transactions identified by the administrators being avoided.  As a result, the power to terminate under section 445D(1)(e) was enlivened;
• for the purposes of section 445D(1)(f), the DOCA was both unfairly prejudicial to the plaintiff and was contrary to the interests of the creditors as a whole, because the plaintiff and the creditors were being denied the opportunity to pursue the processes that would be available in a liquidation.  As a result, the power to terminate under section 445D(1)(f) was enlivened;
• for the purposes of section 47A(2)(b), no part of the DOCA was directed towards the continuation of the company, the company had ceased trading and there was no suggestion that it would ever trade again.  Part 5.3A of the Act is not intended to assist companies in this position, and the process of administration and the execution of a DOCA should not be used as a de facto winding up for the purpose of avoiding the consequences of a properly conducted liquidation.  As a result, the power to terminate under section 447A(2)(b) was enlivened.

The Court therefore ordered that the DOCA be terminated and that Crimson Fresh be wound up in insolvency.

Lavan comments

This case serves as a useful reminder that while DOCAs are flexible instruments and may have an independent commercial objective, the purpose and effect of a DOCA must not be contrary to the objectives of Part 5.3A.

In this case, the DOCA in question was clearly designed to avoid a formal winding up and the investigations and potential recovery actions that would arise.  It is worth noting that the DOCA therefore fell foul of each of sections 445D(1)(e), 445D(1)(f) and 447A(2)(b) and could have been (and was) terminated under any of these sections.

If you have any questions regarding this decision, or in relation to the process of administration or deed administration in general, the experienced Lavan team is here to assist.