Yesterday the Federal Court handed down its decision on an application by administrators of related parent and subsidiary companies for directions under s 447D of the Corporations Act 2001 (Cth) in Strawbridge, in the matter of Retail Adventures Pty Ltd (Administrators Appointed) [2013] FCA 891. **See the end of this post for further developments.

The parent company Retail Adventures Holdings Pty Ltd (RAHPL) had given a guarantee under certain leases of the subsidiary (RAPL) which did not allow it to “prove in competition with” the landlord in the administration of the subsidiary company. The parent company had, however, and prior to the appointment of its Administrators, submitted two informal proofs of debt for the purposes of voting at the creditors meeting of the subsidiary. The parent company’s Administrators now sought directions as to whether they were justified in withdrawing those proofs of debt – one for nearly $80.5m in respect of loans said to be secured by a charge, and the other for $68m in respect of debts arising from subordinated notes.

Relevant Legal Principles

Section 447D(1) of the Act relevantly provides –

“The administrator of a company under administration, or of a deed of company arrangement, may apply to the Court for directions about a matter arising in connection with the performance or exercise of any of the administrator’s functions and powers.”

Although he did not enumerate them as I now will, his Honour Jacobson J distilled the following principles from the key authorities on such an application (see [36]-[41] and the authorities there cited) –

1. It is well established that the principles and authorities relevant to the rights of liquidators to seek directions from the Court are applicable to the rights of administrators to seek directions.

2. The purpose of s 447D is to provide a procedure for administrators to obtain the benefit of the Court’s guidance on matters of principle and law. Directions given under the section provide protection to the administrator against incurring personal liability in relation to the action the subject of the application.

3. There must be something more than the making of a business or commercial decision before a court will give directions in relation to, or approving of, the decision. It may be a legal issue of substance or procedure, it may be an issue of power, propriety or reasonableness, but some issue of this nature is required to be raised.

4. The Court will not make orders as to the rights of third parties in an application under s 447D.

5. Accordingly, directions under s 447D do not constitute any binding or authoritative determination of substantive rights, but function to protect the administrator’s rights in the event of an allegation of breach of duty in respect of the conduct of the administration.

6. The Court has the power to grant leave to, inter alia, a creditor of the company to be heard on the question in order to assist the court, without being made a party or for any directions to take any binding effect over the creditor.

Application

Clause 23.8 of the guarantee the parent company RAHPL had given to guarantee the performance of its subsidiary RAPL’s obligations to its landlords under the leases was entitled “Suspension of Guarantor’s rights” and provided relevantly as folllows –

“The Guarantor [RAHPL] may not:

(a)…(b)…

(c) make a claim or enforce a right against the Tenant or its property; or

(d) prove in competition with the Landlord if a liquidator, provisional liquidator, receiver, administrator or trustee in bankruptcy is appointed in respect of the Tenant or the Tenant is otherwise unable to pay its debts when they fall due,

until all money payable to the Landlord in connection with this Lease or the Tenant’s occupation of the Premises is paid.”

The companies in question were part of a larger group. RAPL conducted a business involving a number of discount variety store businesses around Australia under various trading names. RAHPL had never traded. It was the immediate holding company of RAPL and its sole role was as a vehicle for the movement of funds between another company in the group and RAPL.

Following their appointment, the Administrators had granted one of the related companies (DSG) a licence to operate the business of RAPL whilst the Administrators conducted a sale process. Subsequently, the Administrators sold the business of RAPL to DSG for $58.9m.

There had been a DOCA proposed in respect of both RAPL and RAHPL, involving the creation of a single DOCA fund against which the creditors of both companies would claim, comprising cash held by the Administrators at the time of execution of the DOCA and a $5.5m contribution from two related companies (DSG and Bicheno) and the current and former directors. The Administrators estimated that under the DOCA, unsecured creditors of RAPL would receive about 6.46 cents in the dollar. By contrast, if RAPL were wound up, they were likely to receive between 20.71 cents and 45.12 cents in the dollar. Based on this, as well as some additional inherent risks and issues associated with the DOCA, the Administrators recommended that creditors not accept the DOCA proposed by the related entities.

A key issue was whether the relevant restrictions in the lease guarantees prevented RAHPL from lodging proofs in the administration of RAPL, giving them a significant proportion of the voting rights at the second creditors meeting.

Jacobson J observed that this was an issue of construction which affected the reasonableness of the proposal of the Administrators to withdraw the informal proofs of debt. It was quintessentially one which fell within the power of the Court to give directions to an administrator to guide him or her on matters of law or principle so as to protect him or her against accusations of acting unreasonably. His Honour proceeded to evaluate the arguments and do so.

The Administrators submitted that the proofs of debt lodged by RAHPL would constitute “proving in competition” with the landlord for the purposes of clause 23.8(d), and that in lodging an informal proof or voting at the second meeting of creditors of RAPL, RAHPL would also be making a claim or enforcing a right against RAPL or its property within the meaning of cl 23.9(c).

Counsel for DSG, a related company, submitted that ordinarily the phrase “prove in competition” would connote the lodgement of a proof of debt for the purpose of obtaining a distribution or dividend in the winding up of a company. However his Honour took the view that the terms of the clause do not merely preclude RAHPL from proving in competition with the landlord if a liquidator is appointed. RAHPL was also so precluded in a wider range of insolvency events, including the appointment of an administrator.

As his Honour observed (at [57]), distributions to creditors are not payable out of an administration. They are payable to creditors in a winding up, or under a DOCA if one is adopted. But it follows from this that proofs of debt are not lodged in an administration for the purposes of payment. They are so lodged for the purposes of voting. And since RAHPL contractually bound itself not to “prove in competition with the Landlord if a[n]…administrator…is appointed in respect of the Tenant…“, it in effect agreed not to lodge a proof for the purpose of voting in an administration. Whilst his Honour observed that there was some force in the DSG’s submission that proving for the purposes of voting is not proving in competition with the Landlord, in the end his Honour concluded otherwise, observing that to read the clause as DSG urged would give no effect to the extension of the prohibition beyond the event of liquidation to other insolvency events including administration. And, his Honour opined, the clause made some sense read that way. The competition with the Landlord arose from the assertion of an entitlement to attend and vote.

His Honour acknowledged that the construction he preferred would have the serious consequence of preventing RAHPL from voting on the question of whether RAPL should enter into the DOCA or be placed into liquidation. The outcome of the meeting would be left to the votes of a minority of creditors. However that was the effect of cl 23.8(c) and (d), and its proper construction as supported by its language, the objective purpose of the clause, and also by regulation 5.6.23 of the Corporations Regulations 2001 (Cth). (See paras [47]-[68].)

In terms of the outcome of the meeting, it is to be noted that a decision to wind up RAPL would mean a liquidator could potentially act on the Administrators’ report to ASIC that in their view there was compelling evidence of insolvent trading (link to reference). A liquidator could also explore the possible claw back of any voidable transactions. In this regard it has been reported that the Administrators had informed creditors in April that whilst investigations were not yet finalised, their investigations to date indicated that some 90% of a $98million debt incurred by RAPL had been formed within 5 months of the Administrators being appointed.

The Court made orders that the Administrators of RAHPL were justified in withdrawing and conversely, as Administrators of RAPL they were justified in rejecting, the proofs of debt lodged by RAHPL in the amounts of $69m and $80.5m respectively. An order was made that notice be provided to the creditors of RAPL by email or, where none was known, in writing to their last known address.

Postcript 

This application by the Administrators was filed on 27 August 2013, heard on 27, 28 and 30 August 2013, and judgment was handed down yesterday, 2 September 2013. This was also the scheduled date for the second creditors meeting.

It has been reported that at the meeting yesterday, interestingly, creditors of RAPL voted in favour of the DOCA. This is despite the fact that unsecured creditors would receive between 5 and 6 cents in the dollar, much less than was projected under a liquidation.