Australia: Speculation about insolvent trading not enough to terminate a Deed of Company Arrangement (DOCA)

In brief - NSW Court of Appeal refuses to terminate Deed of Company Arrangement

The NSW Court of Appeal has recently determined the standard required to overturn the decision of the majority of creditors to enter into a Deed of Company Arrangement (DOCA). In Vero Insurance Ltd v Kassem, the Court held that mere speculation as to possible insolvent transactions is not enough to terminate a DOCA and appoint a liquidator.

Vero Insurance seeks to set aside DOCA

Vero Insurance Limited brought proceedings in the Supreme Court to try to set aside a Deed of Company Arrangement (DOCA) entered into by the administrators and creditors of Ungul Properties Pty Limited.

Barrett J found against Vero. That decision was appealed.

Dispute over liability for construction defects in block of units

In June 1999, Ungul entered into a contract with Lusted Pty Limited (a building company) to construct a block of units in Blue Bay NSW. Under the Home Building Act 1989 they were required to obtain insurance for those units, which they did from Vero.

After construction was completed and five of the seven units had been sold, a number of substantial defects were revealed. A subsequent dispute arose as to who was liable.

Ultimately, Vero paid the owners corporation $808,621.70 in settlement of the claim in June 2007. Vero then proceeded to bring an action against Ungul in the name of the owners corporation to recover that amount.

Before those proceedings could be heard, voluntary administrators were appointed to Ungul. Vero lodged a proof of debt with the administrators for $794,012.80, being the amount paid to the owners corporation less $100,113.80 received from Lusted Pty Limited (which had now entered liquidation), plus $85,504.90 in legal costs.

DOCA proposed at meeting of creditors

At the meeting of creditors on 11 June 2009 a DOCA was proposed. Vero, through their representative Ms Vivienne Montgomery, opposed the DOCA on the basis that they wished investigations to be conducted into transactions prior to the administration.

Mr Barnden, one of the administrators who was also chairman of the meeting, found however that Ms Montgomery's proxy to vote on behalf of Vero was invalid. He also said that the majority of the creditors were in favour of the DOCA, and that even if the proxy was valid, he would make his casting vote in favour of the DOCA.

Insurer launches legal proceedings to set aside DOCA

Vero brought proceedings in the Supreme Court, arguing that their claim should have been admitted and that the DOCA should be terminated.

Barrett J found that Vero's claim should have been admitted, but only for a nominal amount. His Honour decided that the proxy was invalid and that Mr Barnden thus acted appropriately.

Finally, his Honour said that no sufficient reason had been shown to justify an order terminating the DOCA.

Vero appealed this decision on two grounds:

  • that Barrett J was wrong in finding that Vero was a creditor for a nominal sum only and that the proof should have been admitted for more than that
  • that the DOCA should have been terminated

Vero submitted that its claim against Ungul was and is a significant one. Ungul provided three arguments against this on the basis of circuity, limitation and mitigation of damages.

Circuity: can an insurer sue a co-insured for the other co-insured's claim?

The circuity argument is based on the principle that if an insurer has indemnified an insured, A, the insurer has no right of subrogation entitling it to bring an action against B in the name of A, if A and B are co-insureds under the same insurance policy: Petrofina (UK) Ltd v Magnaload Ltd [1984] QB 127; Placer v Dyno [1999] NSWSC 1292.

The Court of Appeal decided here that an exclusion clause in the insurance policy applied, so that Ungul was not covered by it and thus was not a co-insured. This finding invalidated the circuity argument.

Limitation: when does the limitation period run from?

Section 18E of the Home Building Act 1989 sets out that proceedings for a breach of a statutory warranty must be commenced within seven years after 'the completion of the work to which it relates'.

Ungul argued that since the defects were almost all a consequence of poor waterproofing and drainage, the claim began when that part of the work was done, not when practical completion of the entire project was certified. This would have the effect that Vero's proceedings were out of time.

However, the Court of Appeal did not see the need to rule definitively on this point in light of the other issues in this case.

Mitigation of damages: was Vero's delay unreasonable?

Ungul submitted that the action of Vero in not settling the claim for almost four years was an unreasonable failure to mitigate its damage. Campbell JA said that this was also a 'live topic' that would require investigation.

He also said that the Court would require further information to make a decision properly about the validity of these arguments, but proceeded on the assumption that Vero was a creditor for a substantial amount.

Insurer seeks appointment of liquidator to investigate insolvent trading

Under section 445D(1) of the Corporations Act, the Court can terminate a DOCA if it is satisfied that the DOCA, or some part of it, was oppressive or unfairly prejudicial to, or unfairly discriminatory against, a creditor or creditors, or for any other reason it sees fit.

Vero suggested that the DOCA should be terminated and Ungul should be wound up so that a liquidator could be appointed to investigate insolvent trading. According to Vero, this could very well eventually result in a better return to creditors.

Vero argued that Ungul may have engaged in insolvent trading in paying out a dividend to its shareholders in February 2007 and also in transferring two units at a potential undervalue. Vero indicated that it would be prepared to fund these investigations.

Insurer alleges that transferred units were undervalued

Two of the seven units were transferred on 15 November 2006 by Ungul to one of Ungul's directors and to a company controlled by that director and his wife, for $1,050,000 and $500,000 respectively. A handwritten entry in the general ledger of Ungul's company records next to an entry relating to the sale of the $500,000 unit states 'no GST because valuation @ 30.6.00 was > $500k'.

On the basis of this entry and of the fact the proceeds were deposited into a bank account of a related entity and used to offset costs incurred in relation to the development by that related entity, as well as to pay a dividend to Ungul's shareholders, income tax liability and another debt, Vero argued that there was a significant enough argument that the properties were sold at an undervalue to warrant a liquidator's investigation.

Court of Appeal unanimously preserves the DOCA

Campbell JA held that on the basis of the evidence before the Court, it was not in a better position than the administrators had been at the time of the meeting of the creditors. His Honour found that 'it was no more than speculation' that Ungul was insolvent at the time of the dividend payment.

In regard to the unit transfers, he stated that the valuation as at 30 June 2000 could not be relied on to suggest that the particular unit in issue was sold at an undervalue, since the unit had substantial defects and there was a significant risk that any purchaser might bear the costs of reparation themselves - both factors which would have reduced the property's value.

Another judge, Young JA, thought that the transactions had 'some indicia that they are worthy of investigation', but was doubtful that any such investigation would produce a better result for creditors than under the DOCA.

All three judges of the Court of Appeal believed that a good reason is required to override the choice of a majority of creditors to enter a DOCA. Campbell JA found that 'a speculative prospect of there being asset recoveries by a liquidator' was not a sufficiently good reason for termination.

Declaration of interest: CBP Lawyers acted for Ungul Properties Pty Limited in both the Supreme Court and the Court of Appeal proceedings.

For more information about insolvency and reconstruction, please see the website of CBP Lawyers or contact Peter Harkin at pjh@cbp.com.au or Damian Barlow at dpb@cbp.com.au

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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