Australia: Does a DOCA release a company from a debt arising under a guarantee?

Key Points:

A DOCA can extinguish claims under a guarantee, even where those claims arise following the DOCA's termination.

If the underlying debt has already been extinguished by a DOCA, can a secured creditor still enforce the charge? A recent case explored the role of section 444D(2) of the Corporations Act in this situation, with implications for parties seeking to rely on guarantees from companies that have been through a DOCA (Australian Gypsum Industries Pty Ltd v Dalesun Holdings Pty Ltd [2015] WASCA 95).

Dalesun becomes a guarantor ‒ and AGI a secured creditor

AGI entered into an agreement with Newglen Nominees Pty Ltd, under which AGI agreed to supply building products and services to Newglen on a 30-day credit account. Newglen's obligations were guaranteed by Dalesun, and that guaranteed obligation was secured by a floating charge over Dalesun's assets in favour of AGI.

Dalesun went into administration and later executed a DOCA which compromised its creditors' claims (AGI did not, apparently, know about the creditors' meeting and so did not vote on the DOCA). At the time of the appointment of administrators, Dalesun had no existing liability to AGI under the guarantee. The DOCA was successful resulting in Dalesun carrying on its business after the DOCA terminated.

Following termination of the DOCA, AGI continued to supply products to Newglen on credit. Newglen ultimately found itself in financial difficulty and AGI received only part payment of debts owed by Newglen.

To recover the shortfall, AGI proceeded to demand payment from Dalesun pursuant to the guarantee.

The legal question: what effect did the DOCA have on guarantees?

This case raised two significant questions:

  • Did the extinguishment of Dalesun's debts through the DOCA also extinguish the guarantee? As AGI had not voted for the DOCA, did this mean that it retained its rights under the guarantee (as a secured creditor within the meaning of section 444D(2))?
  • Do sections 444H and 444J of the Act (which say that a release of a company's debts under a DOCA "does not affect a creditor's rights under a guarantee or indemnity") apply only to guarantees given by a third party in respect of the company's debts? Or do they also apply to guarantees that the company itself has given?

Western Australian Court of Appeal: DOCAs' purpose is to allow "a fresh start for the future"

As AGI had not voted for the DOCA, it argued that the charge securing the guarantee extended to all current and future liabilities incurred by Newglen. Therefore, section 444D(2) of the Act preserved AGI's right to enforce the charge against Dalesun.

The Western Australian Supreme Court held that this was an incorrect interpretation of section 444D: the security which AGI could enforce under section 444D was only in respect of liabilities that already existed at the time of the DOCA. At the date of the DOCA there was no enforceable security for future debts. Thus, the DOCA had extinguished all of AGI's existing and future claims under the guarantee provided by Dalesun.

Finally, section 444J of the Act only applied to third party guarantees and not to guarantees given by a company that executed the DOCA.

On appeal, AGI changed tack; it argued that section 444D does not prevent a secured creditor who did not vote in favour of a DOCA from realising or otherwise dealing with its security in respect of contingent or future claims which were extinguished after the date specified in the DOCA. This meant that, by reason of section 444D(2), the charges were still valid and enforceable and secured the obligations in question.

The Western Australian Court of Appeal disagreed and dismissed the appeal. It held that the fundamental objective of a DOCA was to allow "a fresh start for the future" by discharging a debtor from any future liability for its existing debts.

Further, before a secured creditor can enforce its security under section 444D(2), the company must have an existing obligation to pay the secured creditor. That is, a charge can only be enforced to satisfy the company's obligation to pay the secured creditor.

Implications for parties seeking reliance on guarantees

The dismissal of the appeal confirms that a party may not be able to rely upon a guarantee that has not crystallised at the time a guarantor company executes a DOCA. In this respect, a DOCA has the effect of extinguishing a claim under the guarantee, even if the money claimed pursuant to the guarantee arises after termination of the DOCA.

If a third party guarantee from a company that has gone through a DOCA is still required in respect of an ongoing trading relationship, the party that seeks the benefit of the guarantee should ensure that the third party provides a fresh guarantee and fresh security once the DOCA has been fully effectuated.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.

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