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Brief Counsel

Guarantor directors cannot hide beneath DOCAs

07 July 2010

A recent District Court decision has confirmed that deeds of company arrangement (DOCAs) cannot be used to release directors from personal liability unless the creditors expressly relinquish the guarantees and vote in favour of the DOCA.  It follows that a dissenting creditor can bring proceedings against a guarantor director without having to apply for leave from the High Court to set the DOCA aside. The New Zealand case is the first to consider the issue and reflects the High Court of Australia’s judgment in Lehman Brothers.

The background

Atlas Resources Ltd v Aull and Timbers1 considered whether a DOCA purporting to release the personal guarantors of a company’s debts could bind the minority creditor owed the guarantee without that creditor’s consent.  Ms Aull and Mr Timbers, as the sole company directors and shareholders of A&M Construction (Auckland) Limited (A&M), had entered into a credit agreement with Atlas Concrete Ltd (Atlas) for the purchase of concrete. A&M, which built houses under franchise to Platinum Homes, struck financial difficulty and was placed into voluntary administration.  Under the proposed DOCA, the directors agreed to sell their house, repay their mortgage and distribute the proceeds to A&M’s creditors.  In exchange, creditors would not bring proceedings against A&M or its directors except with the leave of the High Court.  The proposed DOCA was approved at A&M’s watershed meeting.  However, Atlas did not vote in favour of the DOCA and the Administrators did not call for a vote against the DOCA.  Atlas went to Court to enforce the guarantee against the directors, notwithstanding the DOCA.

The arguments

The directors accepted that they had given personal guarantees to Atlas and also accepted A&M’s indebtedness to Atlas.  However, they argued that Atlas was precluded from pursuing them personally because of the terms of the DOCA. Atlas argued that a DOCA can only bind a dissenting minority creditor to the extent provided for by the Companies Act 1993.  The Act does not provide for release from third party obligations without the individual creditor’s approval.  The purported releases were, therefore, not binding on Atlas.  Further, as Atlas was not challenging the validity of the DOCA, just its effect, there was no need for Atlas to apply to the High Court for the DOCA to be set aside before proceedings could be brought against the guarantor directors.

The decision

His Honour, Judge Hinton, reinforced that a DOCA is only binding and effective to the extent provided for by statute and any additional level of agreement from individual creditors.  The Court noted that the voluntary administration regime is directed at rehabilitating companies, or providing a better return to creditors than in a liquidation.  These aims are concerned with claims against the company, not claims against third parties.  There is no statutory authority allowing a DOCA to bind a dissenting creditor in relation to that creditor’s other remedies.  In this finding, the District Court closely followed the High Court of Australia decision in Lehman Brothers2 on almost identical statutory wording. It is permissible for the terms of a DOCA to deal with the liability of third parties to DOCA creditors.  However, the DOCA creditors must agree individually to that wider arrangement and cannot be bound by the majority of DOCA creditors in the same way as in relation to a debt owed by the company.

Involvement of the High Court not necessary

Judge Hinton also found that, while the High Court has exclusive jurisdiction to rule on the validity of DOCAs, it was not necessary in these circumstances to obtain such a ruling.  Atlas was not seeking to invalidate the DOCA because the claim it sought to bring against the guarantor directors fell outside the scope of the DOCA.

Implications

We are aware of a total of 18 DOCAs agreed to in New Zealand.  Of those, six have expressly purported to prevent DOCA creditors from pursuing directors or shareholders of the company. 

Creditors who opposed those DOCAs may now enforce the personal guarantees they had previously thought lost.

The Atlas decision reduces the incentive for directors to contribute their own personal assets to repaying the company’s creditors.  It is not possible for directors and others to trade contributions to the company’s funds for release from personal liability, except with the consent of the creditors to whom they owe that personal liability. Guarantors in some company collapses may be more likely to favour a scheme or creditor compromise over a DOCA.  In Australia, the Full Federal Court in Opes Prime permitted the release of third party liability within the context of a scheme.  Whether New Zealand will follow this approach is still up for debate (for further detail, see our previous Brief Counsel).

Administrators should not include a blanket third party release clause and assume it to be water-tight.  We believe that such a clause should not be included at all, and certainly not without a statement advising creditors that it will not bind them if they vote against the DOCA.

If obtaining releases from guarantees is, in a commercial sense, an important part of agreeing the terms of a DOCA, then that release should be negotiated in conjunction with reaching individual agreement from each relevant creditor.  It may be better to record the agreement in a separate document.  

In preparing rescue plans and DOCAs, Administrators may need to consider other sources of funds beyond payments from directors in exchange for release of guarantees.

Atlas confirms that creditors holding third party guarantees should not vote in favour of a DOCA containing a third party release unless they agree to abandon claims pursuant to the relevant guarantee.

Our thanks to Daniel Street for writing this Brief Counsel. 

For further information, please contact the lawyers featured.

Footnotes

  1. Atlas Resources Ltd v Aull and Timbers DC North Shore CIV-2009-044-2051, 21 June 2010.
  2. Lehman Brothers Holdings Inc v City of Swan [2010] HCA 11.

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