Court agrees with administrators decision to reduce a $5 million proof of debt to one dollar - Insolvency/Bankruptcy

In a recent decision of the Federal Court of Australia (Sino Group International Limited v Toddler Kindy Gymbaroo Pty Ltd [2022] FCA 630), administrators were held to have validly admitted a $5 million claim for a nominal value of one dollar.

The case is a timely reminder of the importance of appropriately evidencing debts, particularly for the purposes of creditors meetings to determine next steps.

Key takeaways

Undetermined claims for damages against a company do not translate to a liquidated debt without evidence and should be particularised clearly for the purposes of submitting a proof of debt.
For the purposes of creditors' meetings during external administration, administrators are empowered to admit debts and reduce them to a nominal value where insufficient information is provided. This can have significant impacts for creditors when decisions are ultimately made about how to distribute funds and determine next steps.
When deciding whether an administrator has failed to adequately investigate a matter for the purposes of a report to creditors, the Court will account for the time-constraints on the administration process.

Background

Sino Group International Limited and another company (together, the Sino Creditors) had been involved in an arbitration with Toddler Kindy Gymbaroo Pty Ltd (TKG). In 2020, the Arbitrator determined TKG was liable for the Sino Creditors' costs after various applications to terminate the proceedings were dismissed. In 2021, the Arbitrator issued a partial final award in favour of the Sino Creditors, for which they could recover costs.

External administrators (the Administrators) were subsequently appointed for TKG. At that time, the remaining claims in the arbitration proceeding had not been heard or determined, nor had evidence or submissions in respect of damages payable for the alleged breaches been filed.

On 30 November 2021, the Sino Creditors lodged a proof of debt for $5,964,197.15. Of this debt, $5 million was a claim for unspecified damages arising out of the breach of contract subject of the arbitration. The remaining amount was the combined costs ordered by the Arbitrator. For the purposes of voting at the meetings of TKG's creditors, the Administrators:

allowed the debt for the costs ordered in the arbitration (with a significant reduction); and
allowed the claim for damages but reduced it to a nominal amount of one dollar.

A resolution was subsequently passed at the second meeting of TKG's creditors to execute a Deed of Company Arrangement (DOCA), despite the Sino Creditors unanimously voting against it.

The application

The Sino Creditors brought an application to have the DOCA terminated or set aside under section 455D of the Corporations Act 2001 (Cth) (the Act). Under section 455D of the Act, a court may terminate a DOCA in a range of circumstances. Relevantly here, this includes situations where the disputed deed is the result of false or misleading information being included in the Report to Creditors, or there has been an omission of material information from the Report to Creditors. A court may also terminate a DOCA where it is oppressive, or unfairly prejudicial or discriminatory against a group of creditors.

Among other things, the Sino Creditors alleged that the external Administrators failed to adequately investigate the company and its affairs. This error was said to have resulted in the Administrators assessing the claim for damages as the nominal amount of one dollar. The Sino Creditors alleged that this error infected the Reports to Creditors that led to the DOCA, which was alleged to be unfairly prejudicial or discriminatory, or oppressive.

Applicable law

Anderson J recognised that whether an administrator has produced a report infected by errors is partially determined by reference to whether they have complied with their statutory obligations under section 438A of the Act to adequately investigate a company's affairs.

His Honour considered that the standards applicable to an administrator's investigation are necessarily influenced by the time-constraints of the external administration process. This meant the Sino Creditors' application needed to be viewed in the context of the information available at the time at which the DOCA was entered.

Additionally, Anderson J considered that the Insolvency Practice Rules (Corporations) 2016 (Cth) were relevant insofar as they identify the entitlement of creditors to vote at meetings of creditors. His Honour pointed in particular to the distinction between ruling on entitlement to vote at meetings (as was the case here) and ruling on proofs of debt for dividend purposes.

What did the Court decide?

The Court dismissed the application.

Anderson J noted that the information available to the Administrators regarding the quantum of damages lacked sufficient particularity. In light of the evidence, it could only be characterised as a 'mere assertion'.

Anderson J referred to the Administrators' evidence that:

the Sino Creditors had described the debt as 'approximately $5,000,000';
the spreadsheets purporting to set out the breakdown of this figure could not be reconciled with a total of $5 million; and
there was no objective evidence by way of a forensic accounting expert or other expert report.

The debt was therefore an unliquidated contingent debt.

The Administrators were held to have acted in line with authority by admitting the debt for a nominal amount of one dollar for the purposes of admitting the Sino Creditors to vote at the creditors meeting. Anderson J concluded the report to the creditors was therefore not misleading or suffering from material omissions. This finding filtered into his Honour's reasons for dismissing the other grounds, which relied in part on the allegation that the Sino Creditors had been denied a 'very substantial damages claim against [TGK]'.

Comment

This case is a useful reminder that proof of debts need to be appropriately evidenced. A finding in a court or arbitration that a party is liable for breach will not automatically translate to a liquidated claim for damages sufficiently detailed enough to give rise to a proof of debt. When contemplating a proof of debt in situations like this, creditors should consider briefing forensic experts and should word their documentation carefully.

In fact, parties should be aware of the significant influence of creditors meetings. Although the debt in this case was admitted for the purposes of creditors meetings, it ultimately influenced the decision to execute a DOCA. It is therefore critical to remember (and consider) the downstream effects that an insufficiently particularised proof of debt can have on a creditor's interests.

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.