When one creditor is more equal than the other: winding up applications and related party creditors

In the recent decision In the matter of Cresco Opus Fund No 4 Pty Limited (Administrator Appointed) [2019] NSWSC 941 the Supreme Court of New South Wales considered competing positions of ordinary creditors and related party creditors when deciding the future of a company in external administration.

Key points

• An administrator seeking an adjournment of a winding up application must demonstrate that it is in the interest of the company’s creditors for the administration to continue (the test enshrined in section 440A(2) of the Corporations Act 2001(Cth) (Act)).
• In considering an application pursuant to section 440A(2) of the Act the Court will have regard to the substance of the claims of the various creditors who are in favour of the adjournment (and any proposed deed of company arrangement), in particular if those creditors are related to the company.
• The Court will consider whether those creditors are to receive any benefit under the proposed deed of company arrangement (or merely avoid a liquidator conducting further investigations into those transactions) to determine whether those interests should be considered or discounted in their entirety.

Background

Cresco Opus Fund No 4 Pty Limited (Cresco) was a special purpose vehicle which undertook a property development in Turramurra, NSW for the construction of 13 townhouses. Cresco was the trustee of the Wonga Wonga Property Trust. To complete the project Cresco entered into construction contract with Mono Constructions Pty Limited (Mono) and obtained finance from a three investors (Investors) in the sum of approximately $3.7 million. The relevant loan agreement outlined the funds were advanced for the purpose of purchasing and developing the land, with the Investors being issued with preference shares in the Trust.

Cresco subsequently completed the project and sold the townhouses for approximately $28 million, following which it loaned three related entities a total sum of $2.4 million and entered into loan agreements with the Investors (referred to under those agreements as “Financiers”). The Company paid to the Investors the sum of approximately $1.4 million in respect to interest (as part of a larger payment of $2.1 million in respect to mezzanine interest). A further sum of approximately $500,000 was paid to the Investors a month later.

Mono ultimately commenced winding up proceedings and the Investors registered a security interest on the Personal Property Securities Register. Cresco’s sole director (who had been appointed shortly beforehand) resolved to appoint a voluntary administrator. Relevantly, the voluntary administrator considered the redemption of preference shares, the loans to the related companies, the payment of interest and further payment to the Investors, and the registering of security all to be matters that further investigation (in particular as to whether they were voidable transactions).

Following the administrator’s appointment, a related party of Cresco proposed a deed of company arrangement (DOCA) which provided that all related parties would not prove in the DOCA and the Investors would defer any claim against Cresco and not prove in the DOCA. The administrator estimated a return to creditors of 30 cents in the dollar. The administrator estimated a return of 8.49 cents in the dollar in a liquidation scenario (taking into account the costs of conducting examinations, obtaining legal advice, and the risk of defendants being unable to satisfy judgement).

The Administrator sought an adjournment of the winding up application pursuant to section 440A(2) of the Act to allow creditors to vote on the DOCA, the evidence being that the majority in number and value supported the DOCA. Mono opposed the adjournment.

Statutory framework

Section 440A(2) of the Act provides:

The Court is to adjourn the hearing of an application for an order to wind up a company if the company is under administration and the Court is satisfied that it is in the interests of the company’s creditors for the company to continue under administration rather than be wound up.

Relevant principles

The reference to “interest of creditors” in section 440A(2) of the Act is a reference to creditors’ interest as creditors and what they may recover from the company, not interests “arising from family relationships, friendships or emotional attachment” (see Deputy Commissioner of Taxation v Alternative Business Solutions (Aust) Pty Limited (administrators appointed) [2006] FCA 400). Where there is no financial / commercial interest in foregoing a debt, the Court will then look to the interest of the remaining creditors (as was the case in Alternative Business Solutions).

In refusing the administrator’s application for an adjournment the Court reiterated that the provisions of Part 5.3A of the Act were not designed to enable directors to avoid having their conduct investigated by using the voting power of a majority of creditors whom were either related or party to the very transactions that would be the subject of investigations. Although the interest of related creditors is not to be disregarded, the Court will have regard to the interest of creditors opposing a DOCA supported by related creditors who derive no benefit from that composition of debt (see In the matter of Sales Express Pty Ltd (Administrators Appointed) [2014] NSWSC 460).

Whilst there may be nothing untoward about a related entity foregoing participation in a DOCA, the reasons for that non-participation must be assessed. This is particularly so in circumstances where those related parties are controlled by the same person (as was the case in Sales Express).

Enquiries

If you have any questions about this article, please get in touch online (below).