August 2009

Insolvency practitioners: dodgy proofs of debt and paltry dividends

Grocon Constructors Pty Limited v Kimberley Securities Limited [2009] NSWSC 541

In this case, Grocon obtained orders setting aside a resolution of creditors to approve a Deed of Company Arrangement (DOCA) pursuant to section 600A of the Corporations Act 2001 and terminating the DOCA.  In doing so Justice Barrett in the Supreme Court of New South Wales has raised two important considerations for insolvency practitioners:

  • When should an insolvency practitioner look behind a proof of debt, particularly as to the identity of a creditor lodging a proof of debt?
  • At what point does a dividend return to creditors become so small that it should be disregarded

Background

At a decision meeting of creditors of Kimberley Securities Pty Limited (Kimberley), held on 30 March 2009, a resolution was passed that the company execute a DOCA.  Of the 22 creditors who voted, 17 creditors (with a total value of $13,585,530.11) voted in favour of the resolution, whilst five creditors (with a total value of $5,557,864.89) voted against the resolution.  Of the creditors who voted in favour, 11 were agreed to be \"related creditors\" for the purposes of section 600A(3) of the Act.

The DOCA provided for a deed fund to be contributed by the secured (and related) creditor, Lohemi Pty Limited (Lohemi).  Related party creditors would not participate in the deed fund, which was estimated to deliver a dividend to participating creditors of between 1.18 and 3.96 cents in the dollar. 

Purchase of debts by related creditors

The five apparently external creditors who voted in favour of the DOCA were found to in fact be assignees of debts paid out by a related entity of Kimberley (Selwan).

Justice Barrett found that:

\"The true position was that Selwan, a vehicle controlled by Kimberley's directors, purchased the debts of the five external creditors with money of its own but in the names of what were really five nominees; and that it did so to ensure that voting power was ostensibly in the hands of the five nominees but in the knowledge that the nominees, with nothing financially at stake and no reason to take any independent interest, would ? or, at least, would be likely to ? co-operate with the directors of Kimberley when it came to the matter of voting at any meeting of creditors\" (at [56]).

His Honour then went on to find that although the five assignees were not within the section 9 definition of related entity, \"they were in substance related entities\" (at [57]).

By engineering the vote in this way, the DOCA resolution was passed without going to the Administrator's casting vote.

Paltry dividend

Barrett J indicated that there was no need in the present case for a \"separate and objective inquiry\" into whether the external creditors were prejudiced. The five prejudiced creditors had clearly indicated (by voting against the DOCA) that they preferred a winding up (at [80]).

In case some objective inquiry was needed, however, his Honour noted that:

\"Under the proposed deed, the \"optimistic\" outcome was 3.96 cents in the dollar and the \"pessimistic\" 1.18 cents in the dollar ? in other words, only very marginally better than zero in each case\" (emphasis added): at [82].

In a colourful turn of phrase, his Honour expressed the opinion that:

\"No one with an eye to their own financial interests would regard such a return as worth pursuing with any greater vigour than one might expend in picking up a coin found lying on the pavement\" (at [84]).

On this basis the Court was satisfied there was \"very little difference between winding up and the deed proposal from the point of view of the creditors whose debts were to be subjected to the deed\" (at [82]).

Orders made

His Honour was satisfied that the DOCA resolution should be set aside pursuant to section 600A(2).  Further, in exercise of the broad power given to the Court by section 600A(2)(d), his Honour made an order terminating the DOCA.

Implications

When should an insolvency practitioner look behind a proof of debt that may have been assigned?

So what should the administrator do when confronted with a situation such as occurred in Grocon?  Would the administrator be justified in refusing to allow the assigned debts to vote, because there appeared to be a potential abuse of Part 5.3A?

The short answer is that it is not an abuse of Part 5.3A, of itself, to take account of debts which have been assigned.  Subject to being satisfied that the assignment is valid, the administrator would not be entitled to reject the debt for voting purposes. 

One matter for consideration is disclosure to creditors.  It is suggested that it would be appropriate that (if identified) an assignment such as occurred in Grocon should be noted in the administrator's report and in the minutes of meeting. 

Similarly, where the \"alignment\" with the directors is only identified at the meeting, it would be appropriate for administrators to consider an adjournment so that creditors can be advised. 

When does a dividend return become too small to warrant consideration?

Experienced insolvency practitioners will have seen proposed DOCAs in which the anticipated return was similar to or even less than that which was anticipated in Grocon.

It can be seen from decisions such as Grocon that in some circumstances the Courts will adopt a 'realistic' approach to the value of a paltry dividend to creditors, particularly where external creditors are against the DOCA resolution.

The question is whether administrators, in deciding what recommendation they will make, should adopt a mathematical, \"anything is better than nothing\" approach.  It is suggested that the mere fact that a dividend under a DOCA is greater than zero does not of itself require administrators to recommend in favour of the DOCA.  Administrators should use their commercial and professional experience and judgment in all the circumstances of the case in order to form a view on whether a DOCA proposal for a few coins on the pavement is, really, in the interests of creditors as a whole.

This publication is intended as a source of information only. No reader should act on any matter without first obtaining professional advice.

Ben Mackay