When will a DOCA be terminated on the grounds of commercial morality?

Posted on February 3, 2014 by carrieromesievers

Happy New Year, and welcome to my first post for 2014. At the end of last year, the Queensland Court of Appeal handed down judgement in a notable case, in favour of termination of a deed of company arrangement on public interest grounds. The DOCA had been approved by related party creditors, but their Honours took the view that it was detrimental to commercial morality by precluding public investigation into questionable related-party dealings of a company in administration – in Promoseven Pty Ltd v Prime Project Development (Cairns) Pty Ltd (Subject to a Deed of Company Arrangement) [2013] QCA 405.

Background

In 2005 Prime Project Development (Cairns) Pty Ltd (Prime) and Promoseven Pty Ltd (Promoseven) entered into a joint venture agreement to carry out a property development in Cairns. The joint venture vehicle was a company named Bluechip Development Corporation (Cairns) Pty Ltd (Bluechip). HSBC provided $21 million to fund the development, secured by a first registered mortgage. Both Prime and Promoseven advanced millions of dollars in funds to Bluechip to progress the development, some of which was secured by a second registered mortgage given by Bluechip over the development.

The development was completed in 2009, and was then progressively being sold down by Bluechip. HCBC’s indebtedness was discharged, save for the claim of one subcontractor. However by 2010 Prime and Promoseven were in dispute. Promoseven succcessfully applied to have Bluechip wound up in insolvency, and Prime was ordered to pay Promoseven’s costs (relevantly, making Promoseven a creditor of Prime).

At the heart of the case, was this: In August 2011, Prime transferred all of its interest in the Bluechip mortgage – alleged to have been valued at some $9 million – to a related company Refund. This dealing is discussed in more detail below.

Prime went into administration in May 2013. It had eleven creditors on administration. One was Promoseven. Of the other ten creditors, nine were related parties. The related parties voted to adopt a DOCA which would give the unrelated creditors a return of 4.3 to 7.4 cents on the dollar. Without a liquidation, there would be no investigation into the affairs of Prime and no public examination of its directors.

Promoseven applied inter alia under s 445D of the Corporations Act 2001 (Cth) for an order terminating the DOCA on the basis that it produced an injustice, by precluding an investigation into Prime’s pre-administration related-party dealings.

Promoseven also relied upon s 600A of the Act, which deals with the powers of the court where the outcome of voting at a creditors’ meeting has been determined by related entities. Broadly, it empowers the Court to make certain orders, including an order setting aside the resolution, if it is satisfied inter alia that the resolution would not have passed without the related party votes, and that the voting outcome was contrary to the interests of creditors or a class of creditors as a whole, or is unreasonably prejudicial to the interests of the non-related creditors.

(It should be noted that under reg 5.3A.07(1)(a) of the Corporations Regulations (2001) (Cth), a company that has executed a DOCA that is later terminated under s 445D by the court, “is taken to have passed a special resolution under s 491 that the company be wound up voluntarily“.)

First Instance

As the Court of Appeal noted at [42], under s 445D there are effectively four grounds upon which a DOCA can be terminated. These are –

(a) if effect cannot be given to the deed without injustice or undue delay – s445D(1)(e);

(b) if the deed, or something done under it, would be oppressive, unfairly prejudicial to, or unfairly discriminatory against, one or more of the creditors – s 445D(1)(f)(i);

(c if the deed, or something done under it, is contrary to the interests of the creditors of the company as a whole – s 445(1)(f)(ii); and

(d) if the deed should be terminated for some other reason – s 445D(1)(g).

At first instance, Martin J of the Queensland Supreme Court noted that under sub-section 445D(1)(e) it is the “effect” of the deed rather than its purpose which is to be considered. The question, his Honour said, is whether the effect of the deed is unfair or inequitable in the impact it has upon one or more of the creditors bound by it (at [15]).

In considering s 445D(1)(f), his Honour said a court does not proceed “upon mere possibility or speculation, it makes a determination on the characteristics of the deed as they are seen to be at the date of the hearing“. One looks, his Honour said, to the effect of the deed as a whole and assesses its unfairness, if any, to the applicant being in mind the scheme of Pt 5.3A and the interests of other creditors, the company, and the public generally (at [16]).

The applicant Promoseven made two allegations –

(1) That the vast majority of creditors were related entities of Prime. The inference ought be drawn that the creditors who voted for the DOCA were either controlled by or friendly to Prime. This does not of itself require that anything be done, but it detracts from the arguments for the DOCA that a majority of creditors has made a commercial decision as to what is in the interest of creditors as creditors (at [23]);

(2) The DOCA would have the effect of precluding investigation into the transfer by Mr Knell of a chose in action (a second registered mortgage) valued at $9 million to a related company called Refund (at [24]).

In relation to this last point, his Honour remarked pointedly that Promoseven did not allege that it was inevitable that this transaction would be unwound; rather it argued that the transaction “might be voidable” and “there is a prospect” that proper enquiries into Prime’s affairs would result in a greater return to creditors than that offered under the DOCA (at [25]).

He noted that even if the transfer were set aside, Promoseven had failed to demonstrate the unfairness or prejudice required to engage the various sections on which it relied – (at [31]). Martin J also observed that the administrators had recommended the DOCA, and there was unchallenged expert evidence that whilst the DOCA would result in a small dividend to creditors, under a winding up the likely return to creditors would be nil (at [27]).

Martin J cited the object of Pt 5.3A of the Act, set out in s 435A which provides –

“The object of this Part is to provide for the business, property and affairs of an insolvent company to be administered in a way that:

(a) maximises the chances of the company, or as much as possible of its business, continuing in existence; or

(b) if it is not possible for the company or its business to continue in existence – results in a better return for the company’s creditors and members than would result from an immediate winding up of the company.”

His Honour took the view that the orders sought by the applicant Promoseven would be inconsistent with the object of Pt 5.3A (at [31]), and that Promoseven could not demonstrate the effect necessary to engage s 445D or the prejudice which s 600A requires to be shown (at [32]). (There was also an issue as to whether the liquidators would be funded properly if the DOCA was set aside and the company was wound up – see [33]).

His Honour was in little doubt of the correct course to take on this application. He held that “the overwhelming weight in the balance of this application” was that even if the company was liquidated and the transfer was unwound, the creditors would suffer. In dismissing the application, he observed:

“While the public interest is an element to be considered, the applicant’s case did not rise high enough to demonstrate that it was sufficient to overcome the other factors to which I have referred.”

The Appeal Decision

The Court of Appeal disagreed, and took an entirely different approach.

The Court examined the dealings between the related companies Prime and Refund in greater detail, and had distinct reservations about the commerciality of the arrangement, in particular –

on the face of the Agreement there was no attempt to quantify the value of Prime’s half interest in the second mortgage, making it difficult to conclude that it was sold for value, particularly between related entities (at [53]);

the purchase price was difficult to identify. It was defined to mean “$3,710,701.23 plus any lawful adjustments to the loan account as at the date of completion or revision thereafter made hereunder“. The sum stated was acknowledged in Recital B to be simply the state of the loan account between the companies as at a certain date (at [54]);

the purchase price was then met not in the form of money, but by the issuing of redeemable preference shares by Refund. The Agreement said nothing about payment being made that way. There was no evidence as to how that came to pass. However 3,710,702 shares were issued to Prime which, on the face of it, suggested that each preference share was worth one dollar. But there was no evidence that this was so (at [55]);

the Administrators’ Report was the only source of evidence about the adjustments to the purchase price. It noted that a final accounting was completed on 21 March 2013, resulting in Refund being required to and issuing a further 4,668,658 preference shares to Prime. However there was no evidence to show that this equated to an advance of $4,668,658. And there was nothing to show why Refund was “required” to issue further preference shares (at [56]);

the question of the value of the redeemable preference shares in Refund was unanswered. The Administrators’ Report was the only source of information on this, but it was not sworn and the basis for some of the information it set out was not apparent. What information there was, cast doubt on the true worth of the preference shares (at [57]);

The effect of the agreement was that Prime sold its interest in the mortgage – its only substantive asset – to Refund for a consideration, the value of which would be determined by Refund, and dependent on how Refund chose to structure its business affairs (impacting whether any dividends would become payable to redeemable preference shareholders, like Prime). Related though they were, Prime could not control how Refund went about its affairs. Their Honours concluded that the result was that the consideration was uncertain, if not illusory (at [58]).

What made it worse – particularly notable where transparency was a problem – was Recital G, which provided that the purchase price would be left outstanding, by way of loan or similar transaction, so that “the start up business activities of [Refund] may be funded“. Nowhere was it explained why it would be in Prime’s interest to defer receipt of the purchase price to this end. Prime was divesrting its only substantive asset. It was not at all clear why it had any legitimate interest in being Refund’s benefactor, the Court noted (at [59]).

The Court of Appeal remarked twice on the fact that even though the transaction was between companies controlled by “the one set of directors” (a husband and wife Mr and Mrs Knell), no director went on oath to depose as to the rationale of the agreement. It required explanation, and they did not explain it. The Court said it made it very difficult to reach a conclusion that there was commercial justification to the Agreement (at [50]-[51] and [60]).

There were also a series of related transactions, which raised concerns. In summary –

Prime subsequently contracted with a company called Bypass to purchase $4.2 million worth of shares in Bypass, in part-payment of which it transferred to Bypass the 3,710,702 preference shares it held in Refund. (These were the shares Refund had issued to Prime, in part satisfaction of the price Refund had to pay to purchase Prime’s interest in the second mortgage over Bluechip.)
Then in June 2012, Bypass transferred those 3,710,702 preferential shares in Refund to another related company called Radanco (owned and operated by Mr Knell’s nephew), purportedly for $10 million. The ASIC document detailing that transaction was signed by Mrs Knell.
Less than 2 months later, those same shares were purportedly transferred by Radanco to MDA, another company controlled by Mr and Mrs Knell, for only $15,000. Mrs Knell signed the ASIC document for that transaction also. (It was this company – MDA – which had proposed the DOCA in question, proposing to contribute $80,000, most of which was to pay administration costs.)

There was no material put before the Court explaining how it could be commercially justifiable that the same shares which are transferred for $10 million in June 2012 could then be transferred for $15,000 two months later. Nor, in the face of allegations by the Knell family that Prime did not in fact contract to purchase Bypass shares and that there had been a fraud, did they explain why two Knell family companies would then seek to take transfers of shares which had been obtained from Prime in circumstances of fraud. The Court remarked that those unexplained transactions did little to dispel the sense that Prime had been involved in transactions without an apparent commercially justifiable basis.

The Court of Appeal concluded that the circumstances surrounding Prime’s transfer of its interest in the mortgage to Refund was such that an investigation by a liquidator should not be prevented by the related parties forcing a DOCA on the other creditors. A public examiation of the affairs was warranted, and the institution of claw back litigation may prove to be warranted. It would, in the sense of the terms used by the Full Federal Court in Emanuele v ASC (1995) 63 FCR 54 at 69-70, “be deterimental to commercial morality to dispense with the opportunity which the winding up law provides for the investigation of the affairs of Prime” (at [84]).

The Court of Appeal did not consider that the absence, at that point in time, of a final commitment to fund a liquidator in full to completion of the liquidation weighed against the conclusion.

Comment

This case illustrates how fine a line it can sometimes be between success and failure, on applications to terminate deeds of company arrangement. The Court at first instance took one approach and reached a firm conclusion that the DOCA should stand; the Court of Appeal took an entirely different approach, with a different emphasis and analysis, and unanimously reached the opposite conclusion.

Cases such as these tend to turn on their own facts in the same way that, for example, shareholders oppression actions do. In each case it will be a matter of evaluating and adding together the various aspects and circumstances of the pre-administration dealings in question to test whether, considered together, the balance is tipped in favour of scrutiny of what took place, over letting a decision of creditors to endorse a DOCA stand. If, as was the case here, there is a lack of transparancy or certainty about key aspects of an arrangement where a significant asset is being transferred away from the company, and questions are raised which are not answered or explained by those who could do so, it becomes more likely that a Court may conclude that the interests of the public require investigation into what took place. In Promoseven, the Court was so concerned that it gave precedence to the public interest in commercial morality, without requiring that it be satisfied as to the utility of the investigations and the likelihood of a satisfactory recovery and better return for creditors.

One example of a case where the balance tipped the other way, was the NSW Court of Appeal’s decision in Vero Insurance Ltd v Kassem [2011] NSWCA 381; (2011) 86 ACSR 607. There, although Young JA noted that the transactions had ‘some indicia that they are worthy of investigation‘, all three judges of the Court of Appeal declined to terminate the DOCA, considering that good reason is required to override the choice of a majority of creditors to enter a DOCA. An example of another case where, like in Promoseven, the balance tipped in favour of terminating the DOCA which was described by the Court as “a device by which Mr Triguboff and his associated companies are avoiding scrutiny of a number of highly questionable transactions the net effect of which is to allow TMPL to walk away from a tax debt of $19,551,033.77…” is Deputy Commissioner of Taxation v TMPL Pty Ltd (subject to a Deed of Company Arrangement)(No 3) [2011] FCA 1403.

Newsflash: High Court today dismissed Willmott Forests appeal

Posted on December 4, 2013 by carrieromesievers

In a 4:1 judgment the High Court today held that liquidators of landlord companies – not only liquidators of tenant companies – can disclaim leases under s 568(1) of the Corporations Act 2001 (Cth), and that the disclaimer terminates the tenants’ rights arising under the leases. The judgment in Willmott Growers Group Inc v Willmott Forests Limited (Receivers and Managers Appointed)(In Liquidation) [2013] HCA 51 is now on Austlii and can be read in full here.

The majority was French CJ, Hayne, Kiefel and Gageler JJ, with his Honour Gageler J delivering his own judgment. The dissenting judgment was that of Keane J.

Their Honours French CJ, Hayne and Kiefel JJ identified the central question of construction of s 568(1) as being whether a lease granted by a landlord company to a tenant is “a contract” within the meaning of s 568(1)(f). It is, according to their Honours, by virtue of s 568(1A) of the Act which provides that “[a] liquidator cannot disclaim a contract (other than an unprofitable contract or a lease of land) except with the leave of the Court” (see [4]). The question then became whether the reference to “a lease of land” in s 568(1A) should be read as referring to any lease to which the company is a party, or only to leases of which the company is the tenant? Their Honours concluded the former was correct.

Broadly, the power of disclaimer of liquidators under s 568(1) is expressed as a one to “disclaim property of the company”. What such “property” includes is then set out in sub-paragraphs, (f) of which is “a contract”.

The appellant advanced two principal arguments. The first was that the only relevant property of the landlord company capable of being disclaimed was its unsaleable reversionary interest in the land the subject of the leases; the second, that the tenants’ leasehold estates would survive disclaimer of the lease contracts (see [27]). Their Honours French CJ, Hayne and Kieffel JJ considered and rejected the first of these arguments at [28]-[50] and the second at [51]-[55].

In relation to the second, their Honours held that it follows from the operation of s 568D(1) that, from the effective date of the disclaimer, the company’s liability to provide the tenant with quiet enjoyment of the lease property and the tenant’s rights to quiet enjoyment of the property are terminated. If the tenant suffers loss thereby, the tenant may prove for that loss in the winding up (see [8]). At [57], to make the point clear, their Honours expressly held that from the day on which the disclaimer takes effect, each tenant’s estate or interest in the land would be terminated.

Strikingly, though, their Honours added their own observation, under the sub-heading of “Questions not considered”, demonstrating a consciousness of at least some of the ramifications of their judgment, a matter to which I will later return:

“Obviously, a tenant whose lease has been disclaimed by the liquidator of a landlord may consider that being left to proof as an unsecured creditor in the winding up gives little effective compensation for what has been taken away. Whether that is so in this case was not examined in argument and is not considered. Nor has there been any occasion to consider in this case whether the liquidators require the leave of the “Court” before disclaiming the investors’ leases or, if they do require leave, what considerations would inform the decision to grant or refuse leave. It may be noted that the Act does provide expressly, in s 568B(3) that the “Court”, on application, may set aside a disclaimer “only if satisfied that the disclaimer would cause, to persons who have, or claim to have, interests in the property, prejudice that is grossly out of proportion to the prejudice that setting aside the disclaimer would cause to the company’s creditors” (emphasis added). Again, however, whather or how that provision would apply in this case was not explored in argument.”

Heads Up – Willmott Forests High Court Appeal – Judgment imminent

Posted on December 1, 2013 by carrieromesievers

The High Court of Australia is to hand down judgment in the Willmott Forests High Court appeal this Wednesday 4 December. I will be interstate for a mediation, but will provide an update as soon as I am able.

To refresh your memories as to developments to this point –

February 2012 – The first instance decision of Davies J of the Victorian Supreme Court as to whether the disclaimer of a lease by the liquidator of the landlord’s company extinguishes the tenant’s proprietary interest in the land is handed down. Her Honour held that it did not – see my post here;
September 2012 – The Victorian Court of Appeal overturns the judgment of Davies J and holds that a leasehold interest in land is extinguished by the disclaimer of the lease agreement by the liquidator of the lessor, pursuant to s 568(1) of the Corporations Act 2001 (Cth) – see my post here;
May 2013 – The High Court grants special leave to appeal that decision – see my post here;
August 2013 – The High Court hears the appeal – see my post here.

No doubt many of us are awaiting the High Court’s decision with interest.

National Bankruptcy Congress – Sydney – 9 December 2013

Posted on November 19, 2013 by carrieromesievers

Many of you will already be familiar with the annual outstanding Practical Insolvency Conferences held by Traill & Associates in Sydney each year in March/April, chaired by Richard Fisher AM. This year Rosie’s firm is also holding a National Practical Bankruptcy Congress on Monday 9 December 2013 in Sydney. I do not yet know if my practice will permit me time to duck up to Sydney myself, but I have reviewed the program and it looks excellent. Topics to be covered include –

Sections 104 and 178 challenges to Trustees’ decisions – a review of recent cases and various practical recommendations;
Dealing with conflicts of interest – ss 156A and 179 – Applications to remove Trustees – a review of recent cases including Barlaw Pty Ltd v Crouch [2012] FCA 961;
Trustees’ remuneration issues;
Regulator issues – AFSA’s practitioner inspection program and other issues, presented by Mark Findlay, Director of Regulation and Enforcement, Central Region, AFSA;
Part XI – Insolvent estates – a presentation by my highly esteemed Melbourne colleague barrister Peter Agardy, outlining the implications of Re Macryannis; McDonald v Young [2012] FCAFC 137 and other recent cases;
Dealing with claimed trusts;
Voidable transactions – ss 120, 121 and 122 – a review of recent cases by the reknowned Sally Nash of Sally Nash & Co Lawyers, Sydney;
Recent cases on costs and sales of property – coverage of recent cases including Sopikiotis, in the matter of Sopikiotis (Bankrupt) v Vince (Trustee) [2013] FCAFC 24; Tadrosse v Barnden [2013] FCCA 207; Barnden v Tadrosse (No 2) [2013] FCCA 744;
Personal insolvency agreements;
Dealing with vexatious and/or litigious bankrupts and unreasonable creditors – presented by Scott Pascoe, partner, PPB Advisory;
And my personal favourite – s 139ZQ notices – are they a waste of time, or a useful tool when used correctly – to be discussed by a panel of speakers.

For those interested to attend, the full program and invitation to attend may be found here.

Timbercorp appeal fails, as the Great Southern trial draws to a close

Posted on October 18, 2013 by carrieromesievers

As the marathon Great Southern trial finally draws to a close in the Victorian Supreme Court – just before the first anniversary of its commencement (link) – there has been a significant, relevant judgment delivered. Last week the Victorian Court of Appeal handed down its decision in another class action case involving failed agribusiness managed investment schemes with questions raised about their product disclosure statements – Woodcroft-Brown v Timbercorp Securities Ltd & Ors [2013] VSCA 284.

In dismissing the investors’ appeal, the Court of Appeal held that the trial judge Judd J had not erred in any of his challenged findings. One of those was that the Timbercorp directors did not have actual knowledge of a significant risk to viability until bank support wavered. This was well after publication of the last PDS, and after the collapse of Lehman Brothers in late 2008, which was swiftly followed by the sudden termination of negotiations Timbercorp had been engaged in for the sale and leaseback of certain of its properties and forestry assets. Even then the directors were able to manage those set-backs and address them opening new negotiations with other parties, keeping the banks onside, until their support was withdrawn shortly before Timbercorp’s collapse in mid-April 2009 .

Background

Beginning in 1992, the Timbercorp Group operated a number of horticultural and forestry managed investment schemes (MISs), including almonds, olive oil, grapes and eucalypt plantation projects, with Timbercorp Securities PL as the Responsible Entity. Timbercorp Finance PL’s role was to lend money to investors so that they could invest in the MISs. The defendants to the litigation were those two companies plus three persons who were directors of both companies and of the holding company Timbercorp Ltd.

The Timbercorp Group invested in excess of $2 billion on behalf of about 18,500 investors. Using a combination of debt and equity, the Group would acquire and develop land into plantations and orchards to generate a long term revenue stream from management fees and licence fees and would sell interests in the project to investors. The land and its developments would then be sold either into a property trust where the Group would retain some of the equity in the asset, or it would be sold to a third party buyer, usually on a sale and leaseback basis.

The Group also generated profit by Timbercorp Finance lending to investors, usually up to 90 per cent of their investment. In addition the Group raised funds by securitising its loan book and using the loans as security for finance bonds and bank facilities. To fund the infrstructure and working capital of the projects, the Group would sell assets, raise equity, securitise loans, and arrange debt facilities with the Commonwealth Bank, ANZ, HBOS and Westpac.

After the Group began to experience trouble, Timbercorp kept its bankers informed of developments and the Group’s financiers entered into or renegotiated facilities, extended repayment dates, increased facility amounts and, when necessary, modified covenants to avoid a breach.

The Group’s profitability began to be affected by an adverse tax announcement by the ATO impacting upon the Group in 2007/08. Three days before Lehman Brothers collapsed the Group was managing that issue and its impact, and had already commenced negotiations with various third parties for the sale and leaseaback of a number of its properties and forestry assets.

When Lehman Brothers collapsed in the US on 15 September 2008, this lead to the effective closure of global markets. The next day, one of the purchasers terminated negotiations and the others soon followed. In November further steps were taken to seek to sell assets, and the Group’s auditors expressed concerns about the business as a going concern, noting its working capital deficiency of $82.8 million

In December 2008 Timbercorp Ltd presented an “apparently healthy position” in its Annual Report, including a directors’ declaration of solvency, though the opinion in the audit report included was guarded.

The Group managed to maintain bank support until April 2009, when it collapsed and went into voluntary administration; liquidation followed in June 2009. At the time the company was wound up, Timbercorp Finance had outstanding loans to more than 14,500 investors totalling $477.8 million.

First Instance Judgment

In striking contrast with Great Southern, the Timbercorp trial ran over (only) 24 sitting days. It dealt with common questions and only looked at individual loss, reliance and causation in relation to the appellant Mr Woodcroft-Brown, and a Mr Van Hoff.

Mr Woodcroft-Brown had commenced proceedings on his own behalf and on behalf of persons who, at any time during the period 6 February 2007 and 23 April 2009 acquired or held an interest in a MIS of which Timbercorp Securities was the Responsible Entity. Earlier investors were represented by Mr Van Hoff, who had invested in MISs before and after 6 February 2007 and financed the majority with money borrowed from Timbercorp Finance, and evidence was led from him as to breach, causation and reliance.

Mr Woodcroft-Brown argued that had certain matters been disclosed, he would neither have invested in the MISs nor borrowed money from Timbercorp Finance. Mr Van Hoff made a similar argument on behalf of early investors. In particular, they argued that Timbercorp Securities failed to disclose in its Product Disclosure Statement (PDS) information about significant risks, or risks that might have had a material influence on the decision to invest, in breach of disclosure obligations under the Corporations Act 2001 (Cth). They also argued that the Directors’ declarations made in two scheme financial reports were false or misleading and in breach of the Corporations Act, the ASIC Act 2001 (Cth) and the Fair Trading Act 1999 (Vic). The relief sought included declaratory relief, damages and/or compensatory orders, including an order that investors were not liable for repayment of the loans from Timbercorp Finance.

The directors denied the allegations against them, claiming to have taken reasonable steps to ensure that the PDSs would not be defective, a defence under s 1022B(7) of the Corporations Act.

His Honour Justice Judd at first instance found comprehensively in favour of the defendants. His Honour found that they were not required to diclose the risk identified by the plaintiffs, that there had been no misleading or deceptive conduct and, in any case, that there had been no relevant reliance by Mr Woodcroft-Brown or Mr Van Hoff on the alleged non-disclosures or representations. His Honour also made several adverse findings about the way the plaintiffs conducted their case. The first instance judgment may be read here.

The Non-Disclosure of Risk Case – see [29]-[57]

It was necessary for the plaintiffs to establish that there was an obligation to disclose certain matters under either s 1013D or s 1013E of the Corporations Act. Broadly, those provisions relevantly require PDSs to include information which a person would reasonably require for the purpose of making a decision as a retail client whether to acquire the financial product, including information about any significant risks associated with holding the product, and information which might reasonably be expected to have a material influence on their decision.

Section 1013C(2) of the Corporations Act qualifies that, by not requiring disclosure to the extent the information concerned is not known to the disclosing party, here Timbercorp Securiites or any director of it. Section 1013F(1) contains a further qualification, providing that information is not required to be included in a PDS if it would not be reasonable for a prospective (my word) retail client considering the product to expect to find the information there.

The plaintiffs had argued that there should have been discosure of the ‘structural risk’ in each PDS issued after April 2000, and of information about ‘adverse matters’ (matters which put the Group at a heightened risk of failure) as and when they occurred.

His Honour held that because of financial information about the Group available on its website, Annual Reports, ASX announcements and the material prpared by analysts, the information the plaintiffs argued ought to have been provided to potential and existing investors was not required because of the operation of s 1013F.

His Honour found ultimately that the appellant failed to satisfy or displace the operative effect of s 1013C(2) given the absence on the evidence of actual knowledge by the corporation or its directors of the risks as alleged, due to the way in which the appellant pleaded its case. For instance the Directors did not have actual knowledge that the adverse matters (such as the tax issue and the GFC) posed a risk that Timbercorp Securities would be unable to fulfil its contractual obligations, until the Directors realised bank support became equivocal. That was the point at which the ‘adverse matters’ stopped being the types of events that management deals with day to day and address, and turned into a crystallised risk to viability (see [38] and [40]-[53]).

In order to succeed on appeal, the appellant needed to demonstrate that the findings of fact of his Honour on these issues, were not open.

The Misrepresentation Case – [58]-[71]

Section 1022A of the Corporations Act defines a disclosure document or statement (including a PDS) as ‘defective’ if, inter alia, it contains a misleading or deceptive statement. Section 1022B(7) provides a defence of having taken reasonable steps to ensure it would not be defective. Section 12DA of the ASIC Act, prohibiting misleading or deceptive conduct in certain documents, and s 9 of the Fair Trading Act, prohibiting misleading or deceptive conduct in trade or commerce, were also relied upon by the plaintiffs.

They alleged the Timbercorp Group had made two types of false or misleading representations. The first was that the Group was financially sufficiently strong that investors would reasonably expect the MISs to be managed for the foreseeable future and that the principal risks associated with the relevant MISs were fully disclosed. His Honour found that the representations as to the Group’s strength were too vague and uncertain to be actionable, and that there were reasonable grounds for that confidence in any case.

The second was that scheme contributions equalled or exceeded the cost of establishing and maintaining a scheme, in that investors’ payments would be ‘quarantined’ and applied only to their relevant MIS, and MIS contributions would be sufficient to fund the relevant MIS. His Honour held that those representations alleged were not in fact made, and were indeed inconsistent with the PDSs and other generally available information.

The appellant also argued that Timbercorp Securities and the Directors made statements in March and September 2008 that were misleading or deceptive, to the effect that there had been no circumstances that had or may have significantly affected the operations of the relevant MISs. Judd J found that their case here failed on both causation and reliance. It was necessary for the appellant to establish that there was reliance placed upon the non-disclosures and the misleading conduct so as to cause entry into the investment product and, therefore, subsequently to cause loss. His Honour did not believe the evidence advanced by the appellant, or by Mr Van Hoff, on these issues (see [68]).

The Court of Appeal added the observation that the provisions relied on in relation to misleading conduct did not operate in relation to the disclsoure obligations in the PDSs per ss 1041H(3) and 1041K(2) of the Corporations Act, and s 12DA(1A)(c) of the ASIC Act (see [67]).

Shift in the appellant’s case – see [71]-[86]

There was a dispute both at trial and on appeal as to whether the appellant’s case had shifted during the course of the trial such that the appellant pursued a case that went beyond his pleading. The shift concerned the identification of the risks the appellant alleged should have been disclosed. The trial judge found that during the course of the trial, the appellant had materially shifted his conception of the relevant risk and in doing so departed from his pleaded case. One of the changes the trial judge found was the change in the way the appellant relied on the ‘adverse matters’ (such as the tax issue, and the GFC) in that, rather than focusing on their importance as stand alone risks, they achieved their materiality from the risk to the Group’s financing facilities increasing the risk of failure.

His Honour took the view that the reformulation of the appellant’s case was an attempt to ‘sidestep’ the opinions in the joint experts’ report, that as long as the Group’s bankers continued to support the Group’s operations, there was no significant risk that the Group would not have the financial capacity to manage any of the schemes through to their contemplated completion.

His Honour held that the appellant should be confined to his case as pleaded, both because the expert reports and the joint expert report were directed to the case as pleaded, and because of the way in which the respondents had fashioned and presented their evidence in response to that case. The Court of Appeal found no error in his Honour’s approach. Their Honours noted that on appeal, the appellant purported to urge the very case that was not pleaded at trial and which the trial judge rejected. Moreover, so the Court of Appeal observed, even if the appellant was permitted to advance the unpleaded case it was not supported by the evidence at trial.

On Appeal

The appeal was heard by their Honours Warren CJ, Buchanan JA and Macaulay AJA, who delivered a joint judgment.

After a discussion of the decision below, they reviewed the detailed evidence led by the Directors about the Group’s business model and the effect of the events of 2008.

The Group’s business model was to create capital intensive assets with a long term income stream and then to sell those assets within the period of three to five years. For each horticultural scheme, after five years the consequences of failing were intended to reduce to virtually nothing. For each forestry scheme, from about five years, the consequences of failure were intended to reduce gradually until harvest. The appellant submitted that the proper test would be that a risk of total loss of the investment must be disclosed unless the chance of the risk materialising was negligible.

In 2007 moving into 2008, the financial position of the operation was seen to be strong and profitable. The Court noted that importantly, as at 30 September 2008, there was no indication of any risk by reason of financial circumstances to the Group’s capacity to discharge its obligations in relation to the management of the projects. It was not until the last quarter of the 2008 calendar year, following the collapse of Lehman Brothers and after the proposed sale of forestry assets to Harvard Management Company failed to proceed, that banker support wavered. Even then, banker support continued into the new year, with the banks providing Timbercorp with an opportunity to dispose of assets.

At the end of 2008, the bankers for the Group were prepared to increase support. As late as November 2008, the CBA agred to vary loan covenants and extend expiry dates into 2009. Judd J had found there was no sign of the Group having difficulty in securing from capital markets the requisite funding for its activities.

Indeed Judd J had noted that the experts’ report provided a complete answer because, whilst the bank support evaporated eventually after the Lehman collapse, before that time, there was no reason to conclude that it would not be continued on an indefinite basis. In light of that, the experts’ opinion was that there was no significant risk that the Group would not have had the financial capacity to manage any of the schemes through to their contemplated completion, for their full term.

Grounds of appeal

Some of the specific grounds of appeal raised were as follows –

Ground 1 – [125]-[132] – The complaint was essentially that his Honour had erred in construing the expression “significant risk” in s 1013D(1)(c) of the Corporations Act. The Court of Appeal held that the trial judge was correct when he said the definition was intended to be a flexible requirement tailored to the type of product involved and its particular circumstances. Amongst the constellation of issues in weighting ‘significant risk’, there is the probability of the occurence, the degree of impact upon investors, the nature of the particular product, and the profile of the investors, together with other matters. This group of issues is not closed and will vary depending upon the circumstances. (See [125]-[132])

Ground 2 – [133]-[141] – Again as to the construction of s 1013D(1)(c), the appellant argued his Honour erred in his assessment of when a risk is “significant”. This ground invoked matters associated with management of risk. In essence, the appellant submitted that the trial judge erred in holding that a risk is not significant if it is capable of successful management and is being managed. However the Court of Appeal disagreed that his Honour considered management of risk for the purposes of construction of the section. Rather, his Honour considered it as a matter of evidence and something that may intercept the potential emergence of a risk of significance.

Ground 4 – [144]-[157] – The appellant argued his Honour erred in his construction of s 1013F, which provides for what information need not be included in a PDS.

Ground 13 – [212]-[225] -The appellants alleged that in his analysis of whether “the financial representations” and “project contributions representations” were misleading or deceptive, his Honour erred by failing to consider the effect of each PDS on an ordinary and reasonable reader. The criticism made was the focus of the analysis should be the effect of the representations upon the persons to whom the representations were addressed, not upon the mental state of the person making the representations.

The Court of Appeal expressed the view that whether the representations were misleading and deceptive did depend at least in part upon the mental state of the maker of the representations, because they would ordinarily be understood as statements of opinion. They were not apt to mislead if the opinion was genuinely and reasonably held by the maker of the statements. Their Honours also noted that the obligation to disclose risks to the schemes depended upon the actual knowledge of the risks. The respondents met the allegations with detailed evidence of their management of the business risks including the taxation announcement and the credit crisis, and the state of mind of the Directors as to the Group’s financial health and future prospects. It was entirely appropriate, so their Honours averred, for the trial judge to have regard to this evidence in determining whehter the alleged representations were misleading or deceptive. In any event, so the Court found, the trial judge did not simply analyse the representations from the standpoint of the respondents, but examined their likely effect upon the class of investors to whom the PDSs were addressed.

Counsel for the appellant submitted that the trial judge erred in that he failed to consider the impression which the PDSs would have had upon a relatively unsophisticated investor. However the Court disagreed that his Honour’s reasons disclosed that he unduly elevated the understanding and experience of the investors. Their Honours noted that the only two investors to give evidence were both knowledgeable and sophisticated. One was a qualified engineer and successful business engaging in property development through several companies. He was familiar with the share market and was computer literate. He understood balance sheets and P&L statements. The other, Mr Van Hoff, was the sole shareholder and director of a company that conducted a transport business. He had been in business for some 22 years, had a portfolio of shares and a self-managed superannuation fund. In any event, the plurality observed that the appellant’s claim failed for reasons which did not turn upon the perceptiveness, sophistication or knowledge of the investors.

Ground 14 – reliance – [226]-[239] – The appellant challenged the trial judge’s finding that there was no relevant reliance by the two plaintiffs on the alleged non-disclosures, by concluding that the sole driver for their decision to invest was the tax-effective nature of the projects and that they were indifferent to the content of the documents, and that there was a necessary inconsistency between reliance on the strength of the group, and the assumption that projects were quarantined one from another.

To succeed, the appellant had to establish that the alleged representaions constitued a decisive consideration in the decision to invest in the Timbercorp scheme. The witness statements of Mr Woodcroft-Brown and Mr Van Hoff recorded that they read the PDSs and stated their reliance on the representations in temrs which were virtually identical and which echoed hte allegations made in the statemnt of claim. The Court of Appeal described it as unsurprising that the trial judge stated he placed little reliance on this formulaic evidence.

In light of evidence given on cross-examination, the trial judge was not persuaded that the appellant Mr Woodcroft-Brown had read the PDSs in any detail. There had been a meeting with a financial adviser where he was presented with a number of PDSs for a three different investments schemes for him to consider, with a view to reducing his tax liability on a profit earnt, and did not have time to do much more than skim through them. The trial judge concluded that the appellant acted on the recommendation of the financial advisor, motivated by his “anxious desire” to obtain a tax deduction. The trial judge found that the actual content of the PDS or the absence of information, was not what induced the appellant to invest in the project. It was a matter of selecting a project to provide him with the required tax-relief. His Honour said he had no doubt that the financing option – 12 months interest free = was an inducement.

The trial judge found similarly with respect to Mr Van Hoff. He was not satisfied that Mr Van Hoff read any of the PDS in any detail. He may have glanced at parts, but was willing to invest without careful consideration of the documents. That was treated as undermining his evidence insofar as he relied on the contents of the documents, or the absence of information contained in them. His Honour found that Mr Van Hoff did not look to the PDSs as a source of information to assist him in his decision to invest in Timbercorp schemes. He chose the schemes on the basis of advice from his accountant and others, in search of tax relief.

Counsel for the appellant submitted that there was no inconsistency between investing with a view to obtaining a tax-deduction, and investing to obtaining income. However the Court of Appeal observed that while it may be acepted that the appellant and Mr Van Hoff were not indifferent to whether their investments would be profitable, it does not follow that their hope of profit was derived from any representations made by the respondents.

Their Honours upheld the trial judges’ conclusions here also.

Overall, the Court of Appeal held that the appellant had failed to demonstrate that the factual conclusions the trial judge made upon the application of correct legal test were not open to his Honour to find. They held that none of the grounds succeeded, and dismissed the appeal.

Conclusion

Not a good result for the investors in the Timbercorp management investment schemes, although the Timbercorp liquidators should be commended for their announcement following the judgment that they would offer some borrowers a chance to settle their loans and receive a 15% or 10% discount on their debt, although even this may do little to assuage the ongoing financial pain of the borrowers.

It could be a long while yet before his Honour Justice Croft hands down his judgment in Great Southern. After the 24 sitting days of the Timbercorp trial from late May to early July 2011, Judd J handed down his judgment an admirable 2 months later. After the almost full calendar year of the Great Southern class action trial, albeit with breaks punctuating that timeframe, Croft J will have a sizeable job ahead, and it is hard to see how his Honour’s judgment could be likely to be delivered much before mid-2014, and possibly later.

Thus it could be a while yet before we learn what evidentiary problems the Great Southern investors might have had and whether they went to issues that were sticking points in Timbercorp, such as reliance or causation. Nor will we know for a while in detail what the evidence disclosed about the knowledge of the representors in the Great Southern PDSs as to the risks of the investments at the relevant times.

We also do not yet know whether there was a smoking gun in the new evidence found on several company servers and computers that were discovered late in the trial. It has been reported that this development lead to the reconvening of the trial after evidence had been thought to have been closed, and the recalling of several witnesses. It was reported that counsel for the Great Southern investors submitted that the new evidence showed Great Southern used cash top-up payments to mask the fact that log yields from plantations were below forecast. It was not until the 11th month since the trial opened that evidence was reportedly heard from the former head of forestry at Great Southern, that the company was aware at a material time that plantations were not meeting forecast yields. It was also submitted by counsel for the investors that to sate investor demand, the firm bought plots not suitable for yielding plantations as forecast in the PDS (link).

In any event what we can probably be confident of, is that much will now be made in final oral submissions of the Court of Appeal’s judgment in Timbercorp by the Great Southern defendants.

Newsflash: The Bell Group litigation has settled

Posted on September 18, 2013 by carrieromesievers

Late yesterday and today, an announcement by liquidator Tony Woodings that the Bell Group litigation has finally settled, is being reported in the press. The case is said to be Australia’s longest and most expensive legal action, and has taken nearly two decades to resolve.

Mr Woodings’ statement noted that: “The sum for which the case has been settled has not been disclosed. It is subject to various approvals being obtained which are necessary for the settlement to be given effect.”

The High Court appeal had been due to be heard this month. Last week it came out that the case had been adjourned for six months and withdrawn from the High Court list pending the outcome of settlement negotiations. You can read my post discussing that and other details of the case here.

The reports have appeared inter alia in the Australian (here and here) and ABC News (here and here).

Newsflash: Bell Group litigation adjourned amidst settlement negotations

Posted on September 12, 2013 by carrieromesievers

For those of you who have not yet heard, it is being reported today that the Bell Group litigation has been adjourned for six months and withdrawn from the High Court list pending the outcome of settlement negotiations. The High Court appeal had been due to be heard this month.

There is far more to this very complex and multi-faceted case, but broadly, in 1990 the Banks had agreed to extend the Group’s loans in order to allow it to restructure and remain afloat, in exchange for a range of securities. Perhaps the Banks were in too deep – some of the banks had already committed staggering percentages of their own capital base to the one client (see [1839]-[1848] of the appeal judgment). However at the time, Bell Group was on the brink of insolvency, and it was alleged that the Banks knew enough regarding Bell Group’s financial position and other relevant circumstances. When Bell collapsed in 1991, the Banks seized assets worth $280 million.

At first instance in 2008, the consortium of 20 banks including Westpac, the CBA, the NAB, HSBC Australia and a range of overseas banks including Lloyd’s TSB Bank had been found liable by his Honour Justice Owen – at the conclusion of his 2,600 page judgment – in all the circumtances, to pay approximately $1.58 billion to the liquidators of Bell Group (link).

The Banks’ appeal of that decision to the West Australian Court of Appeal substantially failed in August last year (link), and in broad terms, the Banks had been ordered to pay to the liquidators more than $2 billion.

Now, Australia’s reportedly most expensive and longest-running court case could finally, potentially, be drawing to an end. If the settlement negotiations prove to be successful, the liquidators of the Bell Group might finally be placed in a position to commence the process of making distributions to creditors, who have been waiting an exceedingly long time.

Administrators’ applications for directions s 447D – Strawbridge, re Retail Adventures

Posted on September 3, 2013 by carrieromesievers

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.

Insolvent trading, public examinations and privilege – Le Roi Homestyle Cookies v Gemmell

Posted on August 30, 2013 by carrieromesievers

Yesterday her Honour Ferguson J handed down an interesting decision, which serves as a useful reminder about public examinations of directors for potential insolvent trading claims – including de facto and shadow directors – and the consequences of those individuals failing properly to maintain their privilege against self-incrimination for criminal or penalty proceedings. The case was that of Le Roi Homestyle Cookies Pty Ltd (in liquidation) v Gemmell [2013] VSC 452.

Before issuing any insolvent trading proceedings against two individuals alleged to have been both de facto and shadow directors, the liquidators had conducted public examinations of each of them. In large part, the insolvent trading claims against the defendants were based on information elicited in the course of the public examinations.

Public examinations are seen as something of a Star Chamber procedure, although there are obvious public policy reasons for permitting this. Whilst directors are inevitably reluctant to answer questions under public examination and potentially furnish the liquidators with evidence to use against them in future litigation, under s 597 of the Corporations Act 2001 (Cth) examinees are compelled to attend (s 597(6)) and to answer the liquidators’ questions (s 597(7)).

Whilst examinees must answer even if the answers might expose them to a penalty or criminal prosecution, they are afforded some protection. If they expressly claim the privilege, their answers may not be used against them in criminal or penalty proceedings. Sub-sections 597(12) and (12A) provide –

“(12) A person is not excused from answering a question put to the person at an examination on the ground that the answer might tend to incriminate the person or make the person liable to a penalty.

(12A) Where:

(a) before answering a question put to a person (other than a body corporate) at an examination, the person claims that the answer might tend to incriminate the person or make the person liable to a penalty; and

(b) the answer might in fact tend to incriminate the person or make the person so liable;

the answer is not admissible in evidence against the person in:

(c) a criminal proceeding; or

(d) a proceeding for the imposition of a penalty;

other than a proceeding under this section, or any other proceeding in respect of the falsity of the answer.”

Generally, where advised to do so by their legal practitioner and/or given the usual warning in this regard by the Associate Judge, director examinees will claim the privilege and thereafter simply say the word “privilege” as a preface to every answer they give.

Here, whilst they received the warning, neither defendant claimed either penalty privilege or privilege against self-incrimination. Despite this, in the insolvent trading proceedings subsequently brought they sought orders dispensing with and relieving them from complying with the pleading and discovery requirements of the rules to the extent that compliance may have a tendency to expose them directly or indirectly to a civil penalty in respect of the subject matter of the proceeding, or to a criminal sanction. Contravention of s 588G(2) exposes directors to civil penalty orders (s 1317E(1)) and, if the person’s failure to prevent the company incurring the debt whilst insolvent was dishonest, criminal proceedings (s 588G(3)).

The Associate Judge dismissed their application, and the defendants appealed. Ferguson J held that the defendants had waived their rights to claim privilege, could no longer invoke those privileges to avoid filing fully responsive defences or make discovery, and must now plead defences and make discovery in accordance with the Rules.

Ferguson J reproduced, with approval, the relevant principles as distilled by Robson J in Re Australian Property Custodian Holdings Ltd (in liq)(recs & mgrs apptd) (No 2) [2012] VSC 576; (2012) 93 ACSR 130 (also cited as “Re APCH (No 2)“) – a judgment which I commend to you as providing an excellent and detailed consideration of the key relevant authorities – at [115] –

(a) In the case of self-incrimination privilege, the defendant must establish that the provision of information or the production of documents in the civil case leads to a real and appreciable risk of a criminal prosecution before the privilege can be invoked;

(b) In an action to recover a penalty it is not necessary for a defendant to establish that there is a risk the defendant will be subjected to a penalty by providing information to the plaintiff. the plaintiff is seeking the information for that very purpose.

(c) In civil actions, where no claim for penalty is made, the defendant must show that providing the information requested would tend to subject him to a penalty in separate proceedings before he can rely on the privilege.

(d) The privilege against exposure to a penalty is a common law right of privilege that may be availed of as of right and is enforced and protected by the Court.

(e) The privilege against the exposure to penalty may be relied on by a defendant to a civil procedure in which a penalty is not sought (“the non penalty civil proceeding”).

(f) The privilege against the exposure to penalty extends to the obligation upon a defendant to plead, give discovery and answer interrogatories in the non penalty civil proceeding.

(g) As a general rule, the privilege does not entitle a defendant to a non penalty civil proceeding to obtain an order in limine excusing him or her from giving discovery or answering interrogatories.

(h) In exceptional circumstances, a defendant may be entitled to such orders in limine.

(i) By extension, in exceptional circumstances, a defendant may be entitled to orders in limine that he may deliver a defence that departs from the Rules of Court only insofar as to protect his privilege against exposure to penalty.

(j) Exceptional circumstances may exist where the defendant to the civil proceeding is also the subject of separate civil penalty proceedings alleging the same or similar conduct.

(k) Where a defendant seeks to take the privilege against exposure to penalty in a defence, the proper course is to plead accordingly and – if challenged – the defendant will be required to justify that the privilege is taken in good faith and on reasonable grounds for the privilege to stand.

Her Honour added to this list a principle I will denote as “(l)” –

(l) The privileges can only be overridden by statutory authority, or waived and may not be abrogated by the purported exercise of a judicial discretion (see [10]).

Ferguson J considered the submissions put for the parties at [17], including the submission for the liquidators that the prospect of criminal prosecution of the defendants was remote, and that penalty privilege is of a lower order of importance. Her Honour observed that if the liquidators established their claims against the defendants, it was almost inevitable that the facts necessary for the imposition of a civil penalty would also be established. It would also be likely to establish at least some of the elements that would need to be proved in a criminal prosecution (although her Honour did not comment on the differing standards of proof). Her Honour indicated that in her view, here it could not be said that the risk of penalty or criminal proceedings was not so low as to be of no consequence.

However whether the defendants ought be excused from filing defences and providing discovery turned also upon whether they had waived any right to maintain the privileges in this proceeding. Ferguson J noted that there was no suggestion that by pleading their defences or providing discovery, the defendants would expose themselves to any different penalty or criminal proceeding to which they were not already exposed by virtue of having failed to claim privilege during the course of their public examinations. That information was already in the hands of the liquidators, and potentially ASIC or a prosecutor, and could be used by them without the restrictions that might otherwise have applied had a claim for privilege been invoked. Moreover, the defendants had had their rights explained to them at the beginning of their examinations by the Associate Judge. Having received that warning, they did not claim either privilege (see [30]).

Ferguson J found that the defendants had waived the right to claim the privileges in respect of the answers that they gave during their public examinations, and held that they should not be permitted to avoid properly pleading and providing discovery. If they were to be so excused, the outcome would be irrational. They had already lost the protection they now sought, and they did not submit that in pleading their defences and making discovery they would have to go beyond the information already provided during their examinations. There was no justification for relieving them of their obligations to comply with the pleading and discovery requirements.

Extension of time for PPS registration of circulating security interest: s 588FM Corps Act

Posted on July 11, 2013 by carrieromesievers

In an ex tempore judgment two weeks ago, Hammerschlag J granted an extension of time for registration of a circulating security interest under the Personal Property Securities Act 2009 (Cth) (PPSA) – In the matter of Apex Gold Pty Ltd [2013] NSWSC 881.

The plaintiff (RF Capital Pty Ltd as trustee for the RF Capital Trust) brought the application for extension of time under s 588FM(1) of the Corporations Act 2001 (Cth). Subsection 588FM(2) empowers the Court to make the order sought if it is satisfied inter alia that the failure to register it earlier was accidental, due to inadvertence or due to some other sufficient cause. His Honour, applying the reasoning of Black J earlier this year in In the matter of Cardinia Nominees Pty Ltd [2013] NSWSC 32, was satisfied by the affidavit evidence that the failure to register the security interest earlier was accidental or due to inadvertence on the part of the deponent or those acting under her supervision, and that the orders sought should be made (see [13]-[19]). It is notable that his Honour Black J in Cardinia, had reviewed key authorities dealing with the former s 266 of the Corporations Act, as well as UK judgments as to failures to register a security interest (see [14]-[17]), and their discussion of the concept of “inadvertence”.

Background

In 2012, the plaintiff gave financial accommodation to Apex Gold’s parent company Apex Minerals NL. There was an event of default. In January 2012 the plaintiff agreed to forbear from taking action to enforce its security against Apex Minerals in consideration for, amongst other things, Apex Gold providing security.

Thus on 2 January 2013, Apex Gold entered into the Apex Gold General Security Agreement with the plaintiff, under which it granted a circulating security interest to the plaintiff in its collateral, being all of its present and after-acquired property.

On 26 March 2013 the plaintiff registered its circulating security. As events transpired, this was too late, and this application was filed, heard and decided on 25 June 2013.

Consideration

There was evidence before the Court that Apex Gold (and Apex Minerals) may be or may be about to become insolvent, and that the plaintiff intended to exercise powers under its securities to appoint both a voluntary administrator and receivers to both companies.

Broadly, if an insolvency-related event of this nature occurs in relation to a company, s 588FL(2)(b) fixes a time by which a PPSA security interest granted by the company must have been registered under the PPSA failing which, under s 588FL(4), the security interest may vest in the company.

Here, the circulating security interest granted by Apex Gold to the plaintiff was not entered on the PPS Register until 26 March 2013. The last date for registration under s 588FL(2)(b)(ii) (being 20 business days after the security agreement was entered into) was 31 January 2013. The registration was, thus, out of time for the purposes of that section.

Hence the plaintiff brought this application under s 588M for an order fixing a later time (26 March 2013) for the purposes of subsection 588FL(2)(b)(iv).

His Honour gave consideration to what other security interests had been granted by Apex Gold since 2 January 2013. There had been a number of purchase money security interests granted, but between 2 January 2013 and 26 March 2013 there was just one other (non PMSI) security interest granted to a company named Dyno Nobel Asia Pacific Pty Ltd. The orders his Honour made provided for the priority of the Dyno security to be unaffected by his grant of extension of time (at [15]-[17]).

Interestingly, his Honour noted at [18] that he was informed from the Bar table that the company that was the object of the orders sought, Apex Gold itself, had not been given notice of these proceedings. He proceeded to make the orders sought nonetheless, and included an order reserving liberty for Apex Gold (or any liquidator, administrator, deed administrator or unsecured creditor of Apex Gold) to apply to vary his orders within set periods of time.

Lesson

Quite simply, delay in registering PPS security interests at your peril.

As the Explanatory Memorandum to the 2010 amending Bill explains, section 588FL was intended to vary section 266 of the Corporations Act. Section 266 had required that a security interest be registered within 45 days of being created, or before 6 months of the commencement of an administration, liquidation, or DOCA. Section 588FL(2) instead provides (broadly) that if such an insolvency event occurs, a security interest must have been registered within 20 business days of being created, or before 6 months of such an insolvency event (or such later time as ordered by the Court).

I leave you with the examples set out in the Explanatory Memorandum, illustrating how s 588FL was intended to operate. However in reading these examples, note this caveat: at the time of the EM, the proposal was “20 days”, not the “20 business days” that appears in the Corporations Act –

Example:
           CompanyA grants FinanceA a security interest in its all present
           and after acquired property.  FinanceA registers its security
           interest 15 days after the creation of the security interest.
           CompanyA becomes insolvent 30 days after the security interest
           is granted.  FinanceA would retain their security interest,
           because FinanceA registered the security interest within the
           required 20 day period.
           Example:
           CompanyA grants FinanceA a security interest in its all present
           and after acquired property.  FinanceA registers its security
           interest 25 days after the creation of the security interest.
           CompanyA becomes insolvent 30 days after the security interest
           is granted.  The security interest would vest in CompanyA
           because FinanceA did not register the security interest within
           the required 20 day period or within the six month period prior
           to the critical time.
           Example:
           CompanyA grants FinanceA a security interest in its all present
           and after acquired property.  FinanceA registers its security
           interest 25 days after the creation of the security interest.
           CompanyA becomes insolvent eight months after the security
           interest is granted.  FinanceA would retain its security
           interest because it registered its security interests prior to
           the six month period before the critical time.
           Example:
           CompanyA grants FinanceA a security interest in its all present
           and after acquired property.  FinanceA registers its security
           interest 15 days after the creation of the security interest.
           CompanyA becomes insolvent 5 months and 25 days after the
           security interest is granted.  The security interest would not
           vest in CompanyA because FinanceA registered the security
           interest within the required 20 day period (despite the fact
           that the registration was also made within 6 months before the
           insolvency).

Carrie Rome-Sievers, Barrister

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