The Full Court of the Federal Court of Australia (Full Court) recently delivered judgment in the matter of Sino Group International Limited1, which provides a timely reminder of the relevant principles of which administrators ought to be cognisant when they are preparing statutory reports to creditors.
Toddler Kindy Gymbaroo Pty Ltd (Gymbaroo) provides neuro-developmental and sensorimotor movement programs for children from birth to five years old. Gymbaroo either franchises or licences the use of the programs and the brands in Australia and overseas. Sino Group International Limited (Sino) was the master licensee for Gymabroo in Greater China pursuant to a master licence agreement dated 13 September 2013 (MLA). In 2018, Sino, Beijing Yingqidi Education and Technology Corporation Ltd (together, the Sino Creditors) commenced arbitration proceedings against Gymbaroo in respect of a claim arising from the MLA.
Prior to the determination of the arbitration proceedings, on 22 November 2021, the directors resolved to appoint administrators of Gymbaroo pursuant to section 436A of the Corporations Act 2001 (Cth) (Act), (Administrators). Subsequently, the Sino Creditors lodged a proof of debt in the administration of Gymbaroo, which totalled a sum of nearly $6 million.
The Administrators provided a revised assessment of the competing creditor claims in their Administrators' Report to creditors dated 18 March 2022 (Report to Creditors). This had the effect of reducing the Sino Creditors' claims for voting purposes to the sum of $161,647.
On 18 March 2022, the Administrators convened a second creditors' meeting (Second Creditors' Meeting). During this meeting, the Administrators recommended that creditors resolved that Gymbaroo enter a deed of company arrangement (DOCA). This was on the basis that it provided an estimated dividend to participating creditors of 100 cents in the dollar, primarily due to some related-party creditors being prepared not to participate in a dividend. In the alternative, the Administrators concluded that, in a winding up scenario, it was likely that creditors would receive a dividend in the range of 33 to 42 cents in the dollar.
The related-party creditors voted in favour of the resolution for the Company to enter a DOCA, whilst the Sino Creditors voted against it.
On 28 March 2022, the Company entered into a DOCA. Dr Janet Williams was the DOCA proponent, and is a director, shareholder and creditor of Gymbaroo.
The Sino Creditors subsequently made an application to the Federal Court of Australia to:
- terminate the DOCA pursuant to section 445D of the Act; and
- set aside the resolutions passed at the Second Creditors' Meeting in relation to the execution of the DOCA pursuant to section 75-41 of the Insolvency Practice Schedule (Corporations), being Schedule 2 of the Act (IPS).
Amongst other things, the Sino Creditors claimed in their application that:
- Gymbaroo would remain insolvent even after completion of the DOCA due to the debts owed to related party creditors and for that reason the Sino Creditors contended that the DOCA should be terminated and Gymbaroo be wound up; and
- the Report to Creditors was misleading and failed to consider the true value of the Sino Creditors' claims.
The Sino Creditors' application was dismissed by the Court. The Sino Creditors then appealed to the Full Court on the grounds including that:
- the Court incorrectly concluded that information about Gymbaroo's business, property, affairs or financial circumstances was misleading and could have been material to its creditors in deciding whether to vote in favour of the resolution to execute the DOCA; and
- the Court should have found that false or misleading information was given to creditors, or there was an omission from the Report to Creditors in respect of the estimated return to participating creditors.
Principles considered by the Full Court
The Full Court considered the "materiality test" set out in section 445D(1)(a)(ii) of the Act, which is incorporated by reference to section 445D(1)(c), noting that the Court may terminate a DOCA if it is satisfied that information about the Company's business, property, affairs or financial circumstances can reasonably be expected to have been material to creditors in deciding whether to vote in favour of the resolution for the Company to execute the DOCA.
The Full Court identified a list of useful considerations for insolvency practitioners in relation to the "materiality test" in relation to sections 445D(1)(a) and (c), being2:
- The test for whether information is false or misleading or contains a material omission is determined objectively;
- The inquiry is directed to the adequacy of the information presented to creditors to enable their decision making, not to the intention or conduct of any person who provides the information;
- It is the objective quality of the information that is assessed, not whether anyone in fact is misled;
- The inquiry is directed to the information available at the date of the hearing and is not limited to the information available at the time the information was produced;
- Estimates as to recoverability may be misleading in circumstances where there is no qualifying information or if doubt is expressed as to the recoverability of the certain amounts, notwithstanding that a creditor may appreciate that the information is merely an estimate or prediction;
- Estimates of liability that are not close to the actual liability later revealed may be false or misleading for the purposes of section 445D(1)(a) of the Act; and
- Where an estimate of a liability is represented to be "likely to arise in the future" and that figure ultimately proves to be far too low, the estimate may be false or misleading where based on an incorrect and material particular or by reason of an omission of a material particular.
Application of section 445D(1)(a) and (c)
The Full Court highlighted that any omission that can reasonably be expected to have been material to creditors in deciding to vote in favour of the execution of a DOCA may justify its termination under s 445D(1)(c) of the Act3. Section 445D(1)(c) of the Act must also be understood in the context of an administrator's statutory and other duties to undertake investigations and inquiries into the external administration4. The Full Court examined the word "material" in the context of section 445D(1)(a) of the Act which means something which was relevant and did affect, or might have affected, the outcome being the decision to execute the DOCA5.
Circumstances where a DOCA will be set aside
The Full Court observed that section 445D(1)(f)(i) of the Act will be satisfied if the DOCA (or one of its provisions) is oppressive or unfairly prejudicial to, or unfairly discriminatory against, one or more creditors6. The Full Court highlighted that the test pursuant to section 445D(1)(f)(i) is not merely prejudice or discrimination but unfair prejudice or unfair discrimination7. Relevantly, whether the creditors bound by the DOCA will be "better off" in a winding up scenario is a significant consideration to the question of whether the DOCA involves the relevant unfairness8.
The Full Court also observed that section 445D(1)(f)(ii) of the Act will be satisfied if the DOCA, or a provision of it, is contrary to the interests of the creditors of the company as a whole having regard to the following relevant considerations9:
- The objectives of Part 5.3A of the Act;
- The interests of other creditors, the Company and the public;
- The comparable position of the creditors on a winding up scenario compared with their position under the DOCA; and
- Other relevant factors such as the relative position of creditors under the DOCA (i.e. whether they will be better off), the existence of a collateral benefit to the shareholders and the whole of the effect of the DOCA.
Full Court's decision
The Full Court concluded that the Report to Creditors was misleading because:
- It stated that there would be an estimated return of 100 cents in the dollar to creditors in the DOCA scenario based on certain assumptions (including that the Sino Creditors did not dispute the assessment of their claims and there is no continuing or other litigation) and there was no statement of the relative probability of the best-case scenario eventuating or the risk that it may not eventuate, which was in stark contrast to the liquidation scenario that provided a qualified statement that "it is likely that."10;
- There was no comparison in in it as to the best- and worst-case scenarios for a DOCA and the Full Court observed that the absence of a comparison created the impression to creditors that the worst-case scenario was not likely 11;
- The only return estimated in respect of the DOCA was 100 cents in the dollar; however, if the worst-case scenario had been included in the Report to Creditors, the range of outcomes for the DOCA, based on the Administrators' assumptions as revealed by the Report to Creditors and the Administrators' Remuneration Approval Report would have been in the range of between 38 cents and 100 cents in the dollar12; and
- It failed to disclose continuing litigation between Gymbaroo and the Sino Creditors and those costs had been incurred in those proceedings13.
The Full Court determined that the primary judge erred in concluding that the conditions necessary to enliven the Court's discretion to make an order terminating the DOCA were not satisfied. Ultimately, the Full Court considered that claim afresh and held that the appropriate course was to terminate the DOCA under section 445D(1) of the Act as it was likely that unrelated creditors' interests as a whole would be better served by the winding up of the Company, taking the range of estimates between the DOCA scenario and winding up scenario into consideration14.
Insolvency practitioners often work under intense time and commercial pressures to analyse and review competing DOCA proposals and write their statutory report to creditors providing their recommendations. The viability of any DOCA proposal should always include the necessary analysis prescribed by the Act also having regard to the broader duties and obligations of administrators to ensure that any statutory report is not (unintentionally) misleading to creditors. Any failure to do so may have the unfortunate effect of unwinding the potential benefits of a DOCA to creditors if it is later set aside by application to the Court pursuant to section 445D of the Act.
Insolvency practitioners should reflect on the principles summarised above from the Sino Case in the context of preparing their statutory reports and ensure that they consider the:
- the materiality test in the context of their statutory and other duties to conduct investigations and inquiries into the external administration;
- carefully consider the range of estimated returns in a DOCA scenario as compared to a winding up scenario and provide any qualifications as to the likelihood of the returns for each scenario;
- ensure that a best and worst case scenario is imbedded into the comparative analysis in the statutory report;
- expose any assumptions which would inform, the low and high end of any range of returns on a DOCA analysis;
- ensure that the report and recommendations reflects the objectives of Part 5.3A of the Act; and
- consider other relevant factors such as the relative position of creditors under the DOCA (i.e. whether they will be better off), the existence of a collateral benefit to the shareholders and the whole of the effect of the DOCA.
1 Sino Group International Limited v
Toddler Kindy Gymbaroo Pty Ltd  FCAFC 110
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7 At ; Decon Australia Pty Ltd v TFM Epping Land Pty Ltd (No 2)  FCA 32 At 
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9 At ; TiVo, Inc v Vivo International Corporation Pty Ltd (Subject to deed of company arrangement)  FCA 789 At 
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