Australia: Does a deed of company arrangement (DOCA) extinguish claims by creditors for latent defects?

Last Updated: 30 March 2016
Article by Heather Collins

In brief - Building companies should consider a risk assessment of past projects

While an effectuated DOCA extinguishes all claims that existed at the time when a company was placed into administration, the law is not yet settled on whether this is also the case for latent defects claims which were not known at the time. To mitigate risk, building companies considering a DOCA should review all past projects.

DOCAs extinguish all known claims when company is placed into administration

In the building industry, it is common for defects to remain unknown for an extended period of time. During the intervening period the building company may have appointed an administrator, proceeded to a DOCA and effectuated the DOCA. One of the outcomes of an effectuated DOCA is that all claims that existed at the time when the company was placed into administration are extinguished. The question is whether a claim relating to a latent defect, which was not known to exist at the time that the company was placed into administration, is also extinguished by the operation of the DOCA.

Section 553(1) of the Corporations Act includes future and contingent claims, among others

Section 444D(1) of the Corporations Act 2001 (Cth) provides:

A deed of company arrangement binds all creditors of the company, so far as concerns claims arising on or before the day specified in the deed under paragraph 444A(4)(i).

Under section 444A(4)(i), a DOCA must indicate what date on or before which claims must have arisen. Usually this date will be the date of appointment of the administrator. The courts have held that the use of the term "creditors" in Pt 5.3A is similar to its use in those parts of the Act that relate to winding up. (See Brash Holdings Ltd v Katile Pty Ltd [1996] 1 VR 24 at [34]) Therefore, the term "creditors" in section 444D(1) should be construed in accordance with section 553 of the Act.

Section 553(1) provides:

Subject to this Division and Division 8, in every winding up, all debts payable, by and all claims against, the company (present, future, certain or contingent, ascertained or sounding only in damages), being debts or claims the circumstances giving rise to which occurred before the relevant date, are admissible to proof against the company.

Therefore, it is clear that a DOCA will not only bind creditors with a debt that was due and payable at the time that the company was placed in administration, but also persons with a claim which is "future, certain or contingent, ascertained or sounding only in damages".

Defining whether a claim is contingent or prospective

It is then necessary to consider whether a latent defect claim falls within the definition of a contingent or prospective claim so as to be extinguished by the operation of the DOCA.

In Edwards & Ors v Attorney-General & Anor [2004] NSWCA 272 at [59] to [60] the NSW Court of Appeal considered the difference between actual and/or contingent claim and a "mere expectancy". According to the Court:

...A contingent creditor is a person to whom a corporation owes an existing obligation out of which a liability on its part to pay a sum of money will arise in a future event, whether that event be one which must happen or only an event which may happen...
.......a prospective creditor being one who is owed a sum of money not immediately payable but which will certainly become due in the future either on some date which has already been determined or on some date to be determinable by reference to future events...

However, the Full Federal Court in Lam Soon Australia Pty Ltd v Molit (No. 55) Pty Ltd [1996] 70 FCR 34 [at 43-44] noted, by way of obiter, that a right to sue for damages for a future breach of covenant is not a contingent claim until the breach occurs. Prior to the breach occurring, the Court considered any entitlement to be a mere expectancy which could not be classified as an admissible claim.

In Lam Soon, the right of the creditor was that of a landlord's claim for future rent.

Professor Donovan in Company Receivers & Administrators (Lawbook Co, Sydney, 2001) at [17.2810]) asserts that warranty holders should not be considered contingent creditors because a DOCA "is not intended to wipe the company's slate clean for all time and to deal with speculative claims. It is not intended to exorcise all the company's ghosts".

In Community Development Pty Ltd v Engwirda Construction Company [1969] HCA 47, the High Court considered whether a building company was a contingent creditor of a developer. The parties had entered into a contract for the construction of a block of home units. A dispute arose as to whether the building company had discharged its contractual obligations so as to become entitled to a final certificate. Under the contract, the building company had no moneys owing to it unless and until it could discharge those contractual obligations. The High Court held that the developer was:

....at all material times, under a contractual obligation to pay to the respondent the amount, if any, which might be found by an arbitrator to be due to it under the building contract. Whether or not that obligation would ultimately result in a debt becoming payable by the appellant to the respondent was dependent on a contingency, namely the making of an award.... ((1969) 120 CLR 455 at 461-462)

Therefore, the High Court concluded that the building company was indeed a contingent creditor of the developer.

Latent defect claims are usually brought under statute, in contract or in tort

Most latent defect claims are brought:

  • under statute, for example the Home Building Act 1989 (NSW) or other relevant state based legislation which implies warranties into relevant contracts
  • in contract (generally for breach of contractual warranties), or
  • in tort for breach of a relevant duty of care, generally to undertake the work in a proper and workmanlike manner or the like

In re Motor Group Australia Pty Ltd [2005] FCA 985, the Court considered whether a group of persons who purchased a new motor vehicle from the company and had a motor vehicle warranty but had not made a warranty claim were contingent or prospective creditors caught by the DOCA. Hely J regarded such persons as being contingent or prospective creditors as at the date of the voluntary administration because warranties had been issued prior to the company being placed in administration, notwithstanding that the liability on the warranty was dependent on the occurrence of later events.

In BE Australia WD Pty Ltd (subject to a deed of company arrangement) v Sutton [2011] NSWCA 414, the NSW Court of Appeal considered whether an undetermined court application constituted a "claim". The facts in that matter were that Ms Sutton had performed work as a consultant for BE Australia but had no direct contractual relationship with BE Australia. Her services were provided through labour hire companies. Prior to BE Australia being placed into administration, Ms Sutton's services were terminated without prior notice or payment in lieu of notice. Ms Sutton filed a claim with the Industrial Relations Commission alleging that the "arrangements" with BE Australia had been unfair and should be varied to provide that her services could not be terminated without reasonable notice. Shortly before the proceedings before the IRC were heard, BE Australia was placed into administration.

NSW Court of Appeal at odds with Full Federal Court over contingency claims

Campbell J of the NSW Court of Appeal analysed the differing views of the Full Federal Court in Lam Soon and the judgment of Hely J in Re Motor Group and said as follows:

In my view it follows inexorably from the remarks of Kitto J in Engwirda Constructions, treated as still relevant to section 553 by the majority in Sons of Gwalia, that the warranty creditors in Re Motor Group would be contingent creditors of the company. There might be big problems in valuing their claims: unless there was a sound statistical basis for estimating the probability that a particular car would turn out to have a defect within the warranty period, and a sound statistical basis for quantifying the likely cost of remedying a defect, the claims might need to be valued at zero or merely a nominal amount. But that does not deny that, as a matter of analysis, they are contingent creditors. The position of the warranty creditors in Re Motor Group is distinguishable from that of Ms Sutton, who at the start of the administration had no legal rights against the company at all.
The Full Federal Court in Lam Soon at 44 made the obiter remark that a right to sue for damages for a particular future breach of covenant to keep leased premises in repair was not even a contingent claim. To that extent, Lam Soon is, in my respectful opinion, contrary to the decisions in Engwirda and Sons of Gwalia that I am obliged to follow. There may be excellent reasons for concluding that the right to sue for damages for a particular future breach of a covenant to keep leased premises in repair could not be valued at anything other than zero or a nominal amount, but it still gives rise to a contingent claim. (At [200] to [201])

It is apparent from Campbell J's analysis that this area of law is not entirely settled and that the view of the NSW Court of Appeal is at odds with that of the Full Federal Court. Accordingly, for a building company considering a DOCA there is a risk that claims that are not yet manifest but which may arise in the future against them (such as latent building defects), may not be extinguished by the DOCA.

However, the NSW Supreme Court is bound to follow the decision in BE Australia, which is consistent with the High Court's approach in Engwirda Constructions and the general "basal fact" test which is often applied to determine whether a claim has arisen, e.g. Larkenden Pty Ltd v Lloyd Energy Systems Pty Ltd [2011] NSWSC 1567 at [57]. The High Court decision will also bind the courts of the other states and territories.

Likely that future latent defect claims bound by DOCA if building owner holds right pursuant to statutory or contractual warranty

Further, at a practical level, the differing approaches of the NSW Supreme Court and the Federal Court may not be relevant to the majority of latent defect claims. That is because most claims are brought on alternate bases (breach of contractual or statutory warranty and alternatively in tort for breach of a duty of care). In the case of a claim alleging a construction defect, the "breach" (of statutory or contractual warranty) which was considered relevant by the Federal Court, occurs at the time of construction.

Accordingly, in most instances the latent defect claim will have been elevated from a mere expectancy to a contingency prior to the administration commencing (providing the claim is based on a breach of warranty). That may not be the case in tort. Whilst the relevant breach has occurred, no cause of action (that is, legal entitlement) accrues until the damage becomes manifest which will potentially be after the administration commences. To that extent, claims in tort may suffer a similar fate to Ms Sutton.

Whilst not without some doubt, the most likely outcome, in either the Supreme Court of any state or the Federal Court, would be a finding that, because the building owner held the right pursuant to the statutory or contractual warranty at the time of appointment, then future claims in respect of latent defects are bound by the DOCA.

Review past projects to assess risk of latent defect claims

Given that the law is not settled in this area and it is not possible to be absolutely certain that a latent defect claim will be extinguished by an effectuated DOCA, it is recommended that any building company considering a DOCA should conduct an assessment of the risk associated with any claim against it for defective work by reviewing each project undertaken in the previous fifteen years and considering whether latent defect claims may still be available, pursuant to statutory or contractual warranties or in tort.

Heather Collins
Restructuring and insolvency
Colin Biggers & Paisley

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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