MV’s top 5 insolvency cases for July 2015

We are into the second half of the year.

This month’s top five thought-provoking cases deal with issues including whether a liquidator must comply with a ‘section 264’ notice issued by the Commissioner of Taxation, whether a proof of debt claiming entitlements under an employment contract designed to avoid paying income tax should be admitted in a winding up, the tests to be satisfied when asserting an equitable lien over real property, what constitutes a material omission from a section 439A report and whether a secured creditor stays secured under a DOCA.

Case No. 1: Commissioner of Taxation v Warner [2015] FCA 659 – 1 July 2015

Together with Mr Kugel, Mr Warner was the joint liquidator of a number of companies that comprised a consolidated group for tax purposes. The Commissioner of Taxation was a creditor of those companies.

The Commissioner issued a notice to the liquidators under section 353-10 of Schedule I to the Taxation Administration Act 1953 (Cth) and section 264 of the Income Tax Assessment Act 1936 (Cth) for the production of documents relating to a number of the companies in liquidation. The liquidators refused to produce the documents called for under the section 264 notice on the basis the Commissioner was a creditor who had not obtained leave of the court under section 486 of the Corporations Act 2001 (Cth) to inspect the documents.

The issue before the Court was whether section 264 of the ITAA 1936 trumped section 486 of the Corporations Act. In finding for the Commissioner, Justice Perry of the Federal Court canvassed the following:

  1. The powers in section 264 of the ITAA 1936 and section 353-10 of the TAA are exercisable against a liquidator regardless of how the liquidator is appointed (ie voluntarily or involuntarily).
  2. There is nothing in the text of either section to indicate a liquidator is exempt from compliance with the sections.
  3. Section 264 is intended to give the Commissioner wide-ranging powers in the discharge of his obligations to administer the tax laws, including the ability to “fish” for information, and that power should not be read down.
  4. The fact a taxpayer is in liquidation may give rise to a circumstance where it is imperative that the Commissioner can compel the production of documents in order to protect the revenue (for example, and in this case, where there is suspected illegal phoenix activity).
  5. Section 486 of the Corporations Act deals with a debtor and creditor relationship and does not capture, nor is intended to capture, the additional relationship between the Company and the Commissioner in the administration of the tax laws.
  6. The fact the Commissioner is on par with other unsecured creditors in the winding up in terms of distribution of assets does not of itself mean the Commissioner is, or should be, on par with other unsecured creditors insofar as access to the company’s books and records is concerned.
  7. The Commissioner’s interest in the company’s books and records is broader than that of an ordinary creditor.

This decision confirms that in some aspects of a liquidation, the Commissioner does outrank the rights of other creditors and liquidators ignore requests for information from the Commissioner at their peril.

Case No. 2: Perthmetro Pty Limited, in the matter of Perthmetro Pty Limited (In Liquidation) [2015] FCA 671 – 3 July 2015

Perthmetro carried on business as a commercial builder. The applicant in this proceeding was the liquidator of Perthmetro, who was appointed voluntarily by the members of that company under section 491 of the Corporations Act.

During the course of the liquidation, four employees indicated they would lodge a proof of debt claiming leave and other entitlements as employees. The four employees were two couples – each husband worked full-time for Perthmetro, while one wife worked part-time for the company and the other wife did not. Perthmetro had agreed with the two husbands that they may direct part of their salary to their respective wife. It was clear that the purpose of the arrangement was to split income and evade the payment of income tax.

The liquidator applied to the Court for a determination about whether one or more of the four employees at issue should be rejected from proving in the liquidation for their entitlements when their employment contracts were tainted by illegality or were offensive to public policy.

Justice Gilmour of the Federal Court said that on their face, the schemes in the employment contracts at issue were offensive to the system to collect income tax in Australia. His Honour held the contracts were not enforceable and that to regard the agreements as unenforceable was not disproportionate to the seriousness of the unlawful conduct. Accordingly, his Honour held that none of the employees should be permitted to lodge a proof of debt claiming entitlements in respect of the income-splitting employment contracts. Only the part-time employee wife was permitted to lodge a proof of debt for entitlements relating to her part-time work.

This case demonstrates the power liquidators have in relation to admitting or rejecting proofs of debt, and that claims concerning employment entitlements are not free from scrutiny.

Case No. 3: Kerr (Trustee), in the matter of Cross (Bankrupt) v Bechara (No 3) [2015] FCA 708 – 8 July 2015

In April 2013 Gabriel Cross and Rosabelle Cross entered into a contract for the sale of their property at Lane Cove for $1.8M. The contract was to have settled by the end of May 2013, but that did not occur and the contract was still incomplete by the time the Crosses both entered into bankruptcy in October 2013.

Maria Bechara and Feridun Ackan (the respondents) were creditors in both bankrupt estates. From shortly after the Crosses became bankrupt, the respondents commenced proceedings to stop the sale of the Lane Cove property. During the course of the proceedings, two valuations of the property were obtained: first one by the respondents and the other by the Crosses’ previous trustee, Mr Reidy. Both valuations disclosed the Lane Cove property was actually worth around $3M and had been significantly undervalued in the original sale contract.

Mr Reidy, in his capacity as trustee of the bankrupt estates, sought a resolution of the sale contract and attempted to renegotiate terms with the purchaser. However, he did not succeed and St George Bank (as mortgagee) ultimately took control of the property and sold it for $3M. In this proceeding, the respondents sought a declaration that their interests in relation to the sale proceeds of the Lane Cove property were to be ranked above those of any other unsecured creditor by virtue of an alleged equitable lien by the respondents over the property.

The issue before the Court was whether the respondents’ actions in attaining a valuation that increased the value of the property, and consequently the bankrupt estates, was a benefit they conferred on the trustee and should be rewarded for.

In finding against the respondents, Justice Jagot of the Federal Court cited the decision in Cadorange Pty Ltd (in liq) v Tanga Holdings Pty Ltd (1990) 20 NSWLR 26, in which the three elements of an equitable lien were held to be:

  1. the defendant accepted a benefit;
  2. the benefit was incontrovertible and no reasonable person could say that the defendant was not enriched; and
  3. on an objective valuation of the benefit conferred by the plaintiff, it is conscionable that the defendant should have to pay for it.

Her Honour held that the respondents’ actions in obtaining the first valuation and providing it to Mr Reidy had not conferred any benefit that would not have been already conferred by Mr Reidy, and so the respondents should not be rewarded. Specifically, Justice Jagot declined to recognise that the actions of the respondents bolstered any extra benefit in realising the value of the Lane Cove property, and that the realisation of the value of the property would have been found regardless.

The Court ordered the new trustee, Mr Kerr, to apply the sale proceeds first to the secured creditors’ debts and expenses, and then to the unsecured creditors generally with no priority interest to the respondents.

Time and again we hear creditors claiming an equitable lien over property, or some other equitable right, in an effort to get hold of funds ahead of other creditors. This case is a reminder that an equitable right is not readily recognised and something out of the ordinary must be done in respect of the property to obtain a right in it.

Case No. 4: In the matter of Recycling Holdings Pty Limited [2015] NSWSC 1016 – 27 July 2015

Recycling Holdings was ordered into liquidation in June 2014. In September 2014 the liquidator appointed administrators to the company to, among other things, assist the director of Recycling Holdings propose a deed of company arrangement (DOCA) to creditors.

At the time the liquidator was appointed, Recycling Holdings was engaged in litigation with three specific unsecured creditors (the plaintiffs). The plaintiffs had cross-claimed against Recycling Holdings and its director personally.

In their report to creditors under section 439A of the Corporations Act, the administrators set out the terms of the director’s proposed DOCA, broadly that:

  • control of Recycling Holdings would be returned to the director;
  • a deed fund of not less than $131,000 would be established for creditors and guaranteed by the director;
  • the current litigation against the plaintiffs would be funded by a related entity;
  • the proceeds from the litigation would be used to pay creditors; and
  • if the litigation was successful for Recycling Holdings, creditors would receive 100 cents in the dollar.

In their section 439A report recommending the proposed DOCA, the administrators did not advise there was any cross-claim in the litigation against the director personally. Nor did the administrators provide detailed advice about the state of the litigation and the evidence for and against each party.

The DOCA proposal was discussed and approved (by creditors excluding the plaintiffs) at the second meeting of creditors. Among other things, the administrators said that if the litigation was unsuccessful such that creditors would not receive 100 cents in the dollar, creditors would be entitled to vote to terminate the DOCA. However, the final DOCA executed did not contain that term.

The plaintiffs applied to have the DOCA terminated under section 445D of the Corporations Act, or declared void under section 445G, on the basis it contained material omissions and misstatements, including in relation to the cross-claim against the director and the conflict that claim gave rise to in his proposing the DOCA.

In finding against the plaintiffs, Justice Brereton of the Supreme Court of New South Wales found that:

  • As to the failure to disclose the cross-claim against the director personally – this was a material omission by the administrators from their section 493A report, but the resolution approving the DOCA would have carried nevertheless because most of the votes in favour were related to the director.
  • As to the failure to give detailed information about the status of the litigation – this was not a material omission by the administrators because they had informed creditors generally as to the nature of the cause of action, the estimated quantum of the claim, the arrangements for funding the litigation, the director’s belief he had good prospects of success and the estimated timeframe for the hearing. The administrators were only required to report on the information available to them, and without disclosing legally privileged material.
  • As to the failure to execute a DOCA on the terms approved by creditors – the DOCA had not been entered into in accordance with Part 5.3A of the Corporations Act, however leave was given for the DOCA to be varied.

While his Honour refused to terminate the DOCA or remove the administrators, this case is a reminder that a section 439A report containing a DOCA proposal should have all information relevant to creditors as is known by the administrators. It is also a reminder that administrators should ensure the terms of the DOCA executed properly reflect the terms approved by creditors.

Case No. 5: In the matter of Bluenergy Group Limited (subject to a Deed of Company Arrangement) (administrator appointed) [2015] NSWSC 977 – 21 July 2015

Keybridge Capital Limited was one of a number of secured creditors of Bluenergy when Bluenergy entered into voluntary administration. In August 2014 a DOCA was executed for Bluenergy which, among other things:

  • gave secured creditors three fully paid ordinary shares for each dollar of debt (clause 6.4); and
  • otherwise ‘fully and irrevocably’ released and discharged Bluenergy from all creditor claims (clause 3.2).

Keybridge abstained from voting for the DOCA. Then, in March 2015, Keybridge appointed its own administrator to Bluenergy (the second administration) purportedly under the terms of the security interest Keybridge still held in Bluenergy.

The issues before the Court were whether Keybridge was:

  1. a creditor of Bluenergy at the time it appointed its own administrator; and
  2. entitled to appoint its administrator.

Justice Black of the Supreme Court of New South Wales summarised the issues as not being about ‘whether the DOCA bound Keybridge but whether, on its proper construction, it extinguished Keybridge’s debt’ and the effect of section 444D of the Corporations Act ‘in preserving Keybridge’s debt or its security interest or both’.

On the first question, his Honour found that clause 3.2 of the DOCA ‘extinguished Keybridge’s debt, subject to the preservation of its ability to realise or deal with its security, in respect of its proprietary interest in the secured property and to the extent that its debt was provable and secured assets were availability at the date that its debt would otherwise be released under the DOCA’. According, Justice Black found that Keybridge was not a creditor of Bluenergy’s at the time it appointed its administrator and it was not a creditor in the second administration.

On the second question, his Honour found that while Keybridge had not been a creditor of Bluenergy’s at the time Keybridge appointed its administrator, Keybridge’s ‘right to realise or otherwise deal with its security in respect of the debt that had existed prior to the release under the DOCA was preserved by section 444D(2) of the Corporations Act and it was entitled to appoint an administrator notwithstanding the execution of the DOCA, just as it would have been entitled to appoint a receiver over the assets then subject to its security, notwithstanding the execution of the DOCA’.

This case comes hot on the heels of Australian Gypsum Industries Pty Limited v Dalesun Holdings Pty Limited [2015] WASCA 95 – which we have previously discussed, and is another reminder that secured creditors should take positive action to enforce their security interest or get involved in the DOCA process to preserve their position.

As an aside, given there have been two cases from superior courts in quick succession about the potential loss of rights for a secured creditor under a DOCA, it would be prudent for administrators to consider adding a comment to that effect in their section 439A report recommending any DOCA lest that administrator be accused of making a material omission as discussed in Case No. 4 above.

For more information contact:

Bernice Ellis — Senior Associate — Dispute Resolution Team
(02) 6279 4385
bernice.ellis@mvlawyers.com.au

Greg Brackenreg — Partner — Dispute Resolution Team
(02) 6279 4409
greg.brackenreg@mvlawyers.com.au