A recent Queensland Court of Appeal judgment has highlighted the vulnerability of deeds of company arrangement approved by related-party creditors in certain circumstances.
In Promoseven Pty Ltd v Prime Project Development (Cairns) Pty Ltd (Subject to a Deed of Company Arrangement) & Ors  QCA 405, the Court of Appeal held that a deed of company arrangement should be terminated because it precluded an investigation into the questionable affairs and related-party transactions of a company under administration.
The interests of related-party creditors and the recommendation of the administrators were outweighed by "commercial morality", which dictated that a deed of company arrangement could not remain in place when it has been forced upon minority creditors by other creditors related to the subject company with the consequence of avoiding scrutiny of its directors and officers.
This marks a landmark shift away from previous rulings, which have prioritised the entitlements to creditors over public interest considerations.
Partner Liam Prescott and solicitor Joel Borgeaud explore the decision in more detail below.
How the decision affects creditors and company directors
The Court of Appeal's decision draws a stark comparison with the decision of the Court below (attached). Priority was given by the Court of Appeal to the public interest and the interests of unrelated creditors to ensure that advantage could not be taken of the statutory external administration process offered by deeds of company arrangement which, if allowed to stand, would have prevented a public review of the affairs of the company and the conduct of its directors. The likely dividend to unrelated creditors was seen to be of secondary importance.
The Promoseven decision also comes as a timely reminder to company directors about the risks associated with entering and performing related-party transactions. Whilst it is not uncommon for related-parties to deal with one another, directors must ensure that such transactions are both commercially justifiable and transparent.
The decision provides guidance as to the Court's reluctance to allow a deed of company arrangement to remain in place where:
- the majority of creditors adopting the deed are related to the subject company;
- the assets of the subject company involve dealings with related-parties;
- there is an apparent lack of commerciality and transparency which is not explained by directors or officers of the subject company;
- the conduct of the subject company's directors and officers may otherwise be the subject of external scrutiny in the absence of the deed; and
- it appears that the deed is being used to preclude an investigation into the affairs of the subject company.
Promoseven Pty Ltd (Promoseven) was a creditor of Prime Project Development (Cairns) Pty Ltd (Prime) which was placed into administration in May of 2013. As a result of a series of complicated and questionable related-party transactions, the only substantial asset held by Prime at the time it went into administration was a debt owed to it by a related-party.
Nine of Prime's eleven creditors were related-parties (by directorships and shareholdings) and they voted to adopt a deed of company arrangement which would see unrelated creditors receive a return of between 4.3 to 7.4 cents in the dollar, but would also extinguish any possibility of an investigation into the affairs of Prime, including the public examination of its directors.
The issue before the Court was whether the deed of company arrangement should be terminated pursuant to section 445D of the Corporations Act 2001 (Cth) on the basis that it produced an injustice, namely, precluding an investigation into the related-party dealings of Prime.
The Court below primarily had regard to the objects of Part 5.3A of the Corporations Act 2001 (Cth) (found in section 435A) which provides that an insolvent company should be administered in a way which results in a better return for creditors than the result of an immediate winding up. The Court was satisfied that an investigation into the affairs of Prime would, even if successful, result in a lower or no return for all of Prime's eleven creditors (evidence which the Court said was unchallenged).
The Court refused to terminate the deed of company arrangement because the public interest consideration did not outweigh the rights of unrelated creditors to receive a return in satisfaction of their respective claims. In arriving at that conclusion, the Court also appeared to take into account the fact that Promoseven had not committed to funding the liquidation should the deed be terminated, but that it was only willing to consider such an option.
On appeal, the Court of Appeal concluded that the original decision failed to engage in a proper consideration of the authorities relating to the public interest and, in particular, the termination of deeds of company arrangement which offend commercial morality by precluding public investigation into improper corporate dealings.1 Had proper consideration been given, the related-party dealings of Prime would have been looked at with greater scrutiny.
The Court of Appeal examined Prime's related-party transactions and concluded that they were on uncommercial terms which lacked transparency and warranted investigation. Particular emphasis was placed on the fact that no director or officer of Prime had provided any evidence as to the commercial justification of the related-party transactions.
As to section 435A and the objects of Part 5.3A of the Corporations Act 2001 (Cth), the Court of Appeal identified those creditors related to Prime and excluded their interests from consideration when determining whether public interest factors outweighed the harm that might be caused to creditors if the deed was to be terminated. The Court of Appeal adopted this approach by reference to section 600A of the Corporations Act 2001 (Cth).
In its concluding remarks, the Court of Appeal was critical of the deed of company arrangement being forced upon the minority creditors by those creditors related to Prime, saying:
Finally, in allowing the appeal and proposing that orders be made terminating the deed of company arrangement, the Court of Appeal dismissed any concern about Promoseven's lack of commitment to fund the liquidation, saying that it is not uncommon for creditors first to demand an investigation before committing funds to litigation.
1The authorities referred to are: Deputy Commissioner of Taxation v TMPL Pty Ltd (2011) 289 ALR 69, Emanuele v Australian Securities Commission (1995) 63 FCR 54 and Bidald Consulting Pty Ltd v Miles Special Builders Pty Ltd  NSWSC 1235.
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