A recent Australian Federal Court judgment1 arising out of the Lehman collapse has established that a Deed of Company Arrangement (DOCA) cannot bind a company’s creditors insofar as the DOCA purports to release third parties from liability. The decision is likely to be followed in New Zealand given the level of similarity between the DOCA regimes in New Zealand and Australia.
In our view, the Lehman decision is clearly correct but it sits uncomfortably alongside the Opes Prime2 decision, in which the Federal Court recently permitted the release of third party liability within the context of a scheme of arrangement and reconstruction (scheme).
With the DOCA door having closed on third parties, it is probably only a matter of time before an attempt is made to obtain a release of liability through a scheme instead.
This Brief Counsel considers whether Part 14 of the Companies Act 1993 (Compromises with Creditors) is likely to be interpreted as granting the requisite power to creditors to release third parties from liability.
The Opes Prime decision
We discussed the Opes Prime decision in a recent Brief Counsel. The Court’s reasoning was that:
Part 5.1 of Corporations Act 2001 (Cth) (CA01) which deals with schemes is sufficiently flexible and wide in its scope to be capable of incorporating the release of third parties’ liabilities to a company’s creditors.
The release of the relevant third party financiers was appropriate because there was an “adequate nexus between the release… on the one hand and the relationship between the creditor and the company, as creditor and debtor, on the other hand”.
The claims against the financiers were pursuant to an indemnity granted in respect of the company and therefore, the creditors' rights of action against the company and the third parties often completely overlapped.
Without the release of the financiers, there could have been no compromise or arrangement with the creditors.
The third party financiers were contributing $226 million cash to the scheme, which was a significant proportion of the funds made available to the creditors.
In the circumstances, the financiers were an integral part of the scheme and the financiers were part of a proper settlement rather than merely obtaining a release of liability.
The Lehman DOCA
The DOCA sought to:
impose a moratorium to prevent any creditors from taking action not only against Lehman Brothers Australia Ltd but also against any other members of the Lehman Group and/or their insurers
give the DOCA administrators sole and absolute discretion over the prosecution of any insurance claims, and
release all companies in the Lehman Group from any liability to the creditors of Lehman Brothers Australia Limited upon payment to those creditors of all amounts due under the DOCA.
The DOCA was executed in accordance with the statutory requirements relating to process and voting criteria but the Court found that these third party indemnities went beyond the limits of Part 5.3A of the CA01. The Court declared the entire DOCA to be void because the impugned provisions could not be severed from the remainder of the deed.
The Lehman decision
In Lehman, the Court undertook an in-depth analysis of the wording of Part 5.3A of the CA01 and concluded that:
The operation of Part 5.1 (which deals with schemes) and Part 5.3A of the CA01 are separate and distinct, with different purposes such that an interpretation of one regime is not necessarily relevant to an interpretation of the other (and therefore, the Lehman Court was not bound by the Opes Prime decision).
The purpose of the voluntary administration regime is (as in New Zealand) to enable a struggling company to have the best chance of continuing to operate, or, where that is not possible, to offer a better return to creditors than in an immediate liquidation. The Court thought: “These purposes are not reflective of the Parliament expressing an intention that… the majority of creditors are entitled to deprive some of their numbers of other rights to recover claims or debts they may have, not against the company, but against third parties”.
Whereas with schemes, the Court is required by the Australian legislation to undertake a significant supervisory role, a DOCA provides an insolvent company with far more autonomy of process, and therefore the regime relating to DOCAs can be interpreted as providing a company with less latitude as to the terms of the compromise.
The detailed provisions of Part 5.3A “do not contain either express words or unmistaken clarity of language to lead to such a draconian inference with the proprietary rights of creditors against third parties or other creditors of a company in administration”. “Considerable weight” was placed on the absence of such wording as a matter of statutory interpretation. The language in Part 5.3A refers throughout to a company’s arrangements with its creditors, not to any third parties who might also be affected.
The question of whether a wider application for Part 5.3A was appropriate was one for the legislature rather than the Court.
The Court in Lehman contemplated that DOCA creditors could agree individually to a wider arrangement with respect to third parties, but could not become bound simply as a result of a decision made by the majority creditors. This must be correct, though it is difficult to see how it would work in practice.
The Lehman entities are entitled to apply for leave to appeal to the High Court of Australia. If Australian commentary is to be believed, such an application is to be expected and leave will likely be granted in light of the contrasting results.
How will all of this be interpreted in New Zealand?
As we have reported in a recent Brief Counsel, several of New Zealand’s DOCAs have purported to release directors and guarantors from their liability to company creditors.
We do not think this practice is permitted by New Zealand’s voluntary administration regime. In order for a minority of creditors to be bound by a majority vote, that majority must be granted a power to do so. The DOCA regime in New Zealand contains no express wording to support the view that a majority of creditors are entitled to bind the minority to a release of third party liability. Furthermore, Section 239ACW expressly provides that the release of a company’s indebtedness under a DOCA does not affect the liability of a guarantor or indemnifier.
Assuming the Lehman decision is not overturned, we consider that it puts this point beyond question. It will be interesting to see whether there are any further attempts in New Zealand to bind creditors in respect of third party actions, especially given the danger that the whole DOCA may be declared void.
New Zealand’s equivalent scheme provisions are found in Part 14 of the Companies Act 1993. Part 14 essentially requires a “proponent” (being the board, a receiver, a liquidator, or with leave, a creditor or shareholder) to compile a list of the company’s creditors, and deliver to the Registrar with the form of proposed compromise, notice of an intention to hold a meeting of creditors for the purpose of voting on a resolution putting that compromise into effect.
Whether New Zealand’s courts would be prepared to allow an exclusion of liability to form part of a compromise with creditors under Part 14 of the Companies Act 1993 will ultimately turn on whether Part 14 is interpreted as impliedly conferring a power on majority creditors to bind the minority in the absence of creditor’s individual agreement to a release of liability.
As with Australia’s corresponding regime, Part 14 contains no express wording whereby majority creditors are granted a power to bind the minority. Furthermore, there are a couple of important distinctions between the New Zealand and Australian regimes:
The Australian regime requires that in order for a scheme to be binding on creditors; (1) the creditors must have passed an extraordinary resolution at a creditors’ meeting and (2) the scheme must be approved by an order of the Court. New Zealand’s regime requires creditor approval in the same way but does not require Court sanction. The ability of the Court to refuse to make an order in respect of a Part 5.1 scheme was a persuasive factor in the Australian decisions.
Australian schemes do not presuppose that the company with whom creditors enter into a compromise is insolvent. In contrast, the New Zealand regime requires the proposer to have “reason to believe that a company is or will be unable to pay its debts”. In Lehman, the Court noted that, in contrast to the scheme regime, the Australian DOCA regime applies only to insolvent companies. The Court seemed to consider the insolvency element as a reason telling against the appropriateness of the DOCA regime in situations where a wider restructuring and settlement proposal was being proposed.
As with the DOCA regime, we do not consider that Part 14 contains adequate wording for the courts to be able to imply a power on majority creditors to bind the minority in respect of third party liability. In light of the Lehman decision, it may be that Part 14 is used as an alternative avenue to achieve such a result but it is by no means certain that a New Zealand court will follow Opes Prime.