Purpose vs effect: Federal Court terminates DOCA

A recent judgment of Justice Derrington in R.W. Pascoe Pty Ltd v Crimson Fresh Produce Pty Ltd (subject to deed of company arrangement) [2023] FCA 705 highlights the supervisory role to be played by the courts to ensure that a deed of company arrangement (DOCA) is for a proper purpose.

In this case, the court ordered that the DOCA be terminated on the grounds that it was for an improper purpose and not consistent with the objectives of Part 5.3A of the Corporations Act 2001 (Cth) (Corporations Act). The court held that there was no real benefit to creditors and that the effect of the DOCA was to avoid investigation into the affairs of the company.

Background

Crimson Fresh Produce Pty Ltd (Crimson Fresh) operated a produce growing and export business in and around Mildura, Victoria.

Mr Padia, the sole director/secretary, appointed voluntary administrators to Crimson Fresh on 4 November 2022. At the time of the appointment Crimson Fresh had already stopped trading and had limited assets, including no real property. Any assets owned by the company, such as farming machinery and similar items, were subject to third party security interests. There was no indication that the company would recommence trading.

Voluntary administrators' report

In the voluntary administrators' report dated 2 December 2022 the administrators conveyed a bleak outlook, stating that:

• Crimson Fresh appeared to have been insolvent from at least 30 June 2020 (nearly two and a half years prior to their appointment);
• the company had ceased to trade prior to being put into administration;
• there was an excess of liabilities over assets to the value of approximately $5.8 million;
• any return to unsecured creditors was unlikely; and
• there was no proposed DOCA.

The report also stated that the financial position of the company was, in part, due to poor management and that there had been continued trading losses dating back to July 2018. The administrators identified several potential claims including preferential payments, unreasonable director transactions and insolvent trading claims against Mr Padia for approximately $1.8 million. The administrators indicated to creditors that in the best-case scenario the potential return would be 53.63 cents in the dollar (however, this was later identified by Derrington J as an arithmetical error, with the actual best-case scenario for unsecured creditors being 100 cents in the dollar).

Proposed DOCA

In the days prior to the second meeting of creditors Mr Padia notified the administrators that he intended to propose a DOCA. As a result, the meeting was adjourned to allow creditors to consider the proposal. Mr Padia proposed to contribute $200,000 to constitute the deed fund, which was referred to as the "director's contribution" in the proposal. However, it was identified that this contribution was being obtained from the company's assets (an uncultivated crop) rather than Mr Padia's assets. A very real question existed as to whether the company would recover the $200,000 from the crops, and therefore in essence the DOCA was contingent on a farming event. The overall effect of the DOCA was that the return to creditors would be minimal and estimated to be around 2.35 cents in the dollar.

In light of the proposed DOCA the administrators produced a supplementary report to include their recommendations, in which they significantly revised the company's potential recoveries from nearly $2.5 million to $650,000, with the best-case scenario on winding up being 23.72 cents in the dollar. The administrators did not provide a detailed explanation for this revision, however Derrington J suggested that it recognised the potential difficulties of recovering from Mr Padia. The administrators recommended that, based on its financial position, the better option was to place the company into liquidation.

Second creditors' meeting

Mr Padia's DOCA was proposed at the second creditors' meeting and received six votes in favour (debts totalling approximately $290,000) and five votes against (debts totalling approximately $690,000). Regardless, the DOCA was entered into on 3 March 2023, requiring the director's contribution to be paid to the administrators by 30 June 2023. The creditors' reasons for voting in favour of the DOCA despite the limited return is unclear, however Derrington J suggested that it may have been due to their unwillingness to fund any litigation.

The decision

The plaintiff, R.W. Pascoe Pty Ltd (a creditor who had voted against the DOCA) applied to the court for termination of the DOCA under s445D of the Corporations Act, specifically in circumstances where giving effect to the DOCA would be unfairly prejudicial to, or unfairly discriminate against, one or more creditors or be contrary to the interests of the creditors as a whole.

The purpose of entering into a DOCA is to ensure that the company remains as a going concern, providing creditors with a higher return than if the company were placed into liquidation. Importantly, it is the effect of the DOCA ─ not the purpose ─ which is determinative. In this case, Crimson Fresh had ceased trading prior to the administrators' appointment and the DOCA did not in any way contemplate the company's continuation as a trading entity. Derrington J also noted that entering into the DOCA would allow Crimson Fresh to avoid the usual tasks and obligations of a liquidator, such as investigations into the company's management and affairs to determine any potential claims.

"There is no element of the DOCA that seeks to rehabilitate Crimson Fresh as a trading entity. On the contrary it is not trading at all and does not carry on any business. This is significant."

Considering the likely return to creditors would be approximately 2.35 cents in the dollar, Derrington J determined that the DOCA was being entered into for an improper purpose and as such, the court's power to terminate was enlivened under s445.

The plaintiff also sought relief under s447 of the Corporations Act, which provides that the court has general powers to make orders in relation to the operation of Part 5.3A of the Corporations Act in respect of a particular company. Derrington J found that the power of the court to make an order under s447 was enlivened as the effect of the DOCA was not to achieve a more favourable outcome for creditors compared to if the company was to be wound up.

"There seems to be sufficient grounds to conclude that giving effect to the DOCA will involve an injustice to the plaintiff; being, the injustice of a proper investigation of the transactions identified by the Administrators being avoided."

Key takeaways

The decision in this case highlights the importance of ensuring the effect of a DOCA is consistent with the objectives of Part 5.3A of the Corporations Act ─ that is, achieving a more favourable result for creditors than would otherwise be achieved if the company were placed in liquidation.

Whilst entering a DOCA provides a debtor company and its creditors with a large degree of flexibility, it is important to remember that the court has broad supervisory powers to intervene if it is being entered into for an improper purpose.

Authors: Jonathon Turner, Partner and Sophie Timms, Lawyer.

For more information on the voluntary administration process, please contact our experienced insolvency & restructuring team.

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