In recent years, Australian courts have seen an increase in cases where companies have been misusing the structure of a DOCA to further its own interests, often at the expense of its creditors.

Accordingly, this article will analyse these three cases, exploring why each failed and outlining the key factors that companies will need to consider to ensure the success of its DOCA:

1. Commissioner of State Revenue v Gleeson, in the matter of Dalma Form Specialist Pty Ltd (subject to deed of company arrangement) [2024] FCA 908;
2. In the matter of Academy Construction & Development Pty Ltd (subject to Deed of Company Arrangement) [2024] NSWSC 808; and
3. Project Sea Dragon Pty Ltd (Subject to a Deed of Company Arrangement) v Canstruct Pty Ltd [2024] FCAFC 141.

Case 1: Dalma Form: Improper use of a DOCA as a shield to conceal company misconduct

On 21 December 2023, Dalma Form was placed into voluntary administration (VA), and Bruce Gleeson and Daniel Robert Soire were appointed as voluntary administrators. Dalma Form, a company that provided formwork services on construction projects, fell into VA following an investigation by the Australian Taxation Office (ATO) into a suspected pay as you go (PAYG) tax fraud.

The ATO's preliminary investigations suggested that Dalma Form was part of a group of over 30 companies that had, over the past 15 years, allegedly defrauded the ATO of $150~180 million in unpaid taxes. Jason Ivan Andrijic, the sole director and shareholder of Dalma Form and Incline Hire Pty Ltd (a related company of Dalma Form), made proposals for a DOCA.

In the administrators' second report to creditors the creditors were informed that it would be in their interest for Dalma Form to be wound up as:

• the DOCA proposal did not provide creditors with a return greater than an optimistic liquidation scenario; and
• investigations into the company's affairs could only be conducted should Dalma Form be placed into liquidation.

Despite the recommendation of the administrators, a resolution was passed at the second creditors' meeting approving an amended proposal for a DOCA. Proceedings were commenced by the Chief Commissioner of State Revenue (Chief Commissioner), with apparent support from the Deputy Commissioner of Taxation, to set aside the DOCA claiming it would cause injustice, and unfairly prejudice or discriminate against one or more creditors.

In agreeing with the claims of the Chief Commissioner, Justice Markovic held that the DOCA was flawed on multiple levels.

1. Preventing insolvent companies from continuing in business: Dalma Form's business model primarily involved contracting with major builders and outsourcing all work to subcontractors, as it had no direct employees. The company ceased active trading well before entering VA, casting doubt on whether the DOCA was genuinely intended to facilitate ongoing operations.
2. Voting bias: The majority of creditors who voted in favour of the DOCA were either related to, or otherwise connected with, Dalma Form.
3. Better returns: The Court held that the DOCA should be set aside as the administrators were of the view that a winding up was more likely to provide a better return to creditors than the DOCA.
4. Public policy objectives: The Court ruled that careful consideration must be given to both the interests of the creditors and the broader public interest.

Setting aside the DOCA would not only increase the potential returns to creditors, but also serve important public policy goals. These included preventing an insolvent company from continuing to operate and ensuring that the company's director would not evade public examination, as the continuation of the DOCA would impede these investigations and shield Mr Andrijic from accountability.

Case 2: Academy Construction: DOCA cannot be oppressive, or unfairly prejudicial or discriminatory

Around late 2014 or early 2015, Academy Construction completed the design and construction of a strata property situated in Botany, New South Wales, for The Owners – Strata Plan 90889 (Owners Corporation). In March 2021, the Owners Corporation commenced proceedings against Academy Constructions (and others) alleging that the building had defects arising from residential building works performed by Academy Constructions. Academy Constructions, in denying these claims and pleading that they were commenced outside of the relevant statutory warranty period, sought advice from an insolvency practitioner, Andrew Spring.

During the course of this discussion, Mr Spring advised the accountant and in-house legal advisor of Academy Constructions that he would "assess the position and provide a summary of potential insolvency options, should the claim be borne out or as a defensive strategy on commercial grounds…" In early August 2023, Academy Constructions opted to enter into VA due to the costs associated with the litigation process, and Mr Spring, along with Peter Moore were appointed as voluntary administrators.

The Owners Corporation submitted a claim for $7,127,600, (excluding GST), along with legal and expert costs. Mr Spring, under the instruction of Academy Construction's in-house legal advisor, prepared a draft DOCA which provided for payments to the following classes of creditors:

• Class "A" creditors (comprising all creditors other than the Owners Corporation) to be paid in full;
• Class "B" creditors (comprising the Owners Corporation) to receive a dividend capped at $200,000 following costs and expenses of the VA and to provide third-party releases against any party related to Academy Constructions; and
• Several parties associated with Academy Constructions which were not to participate in the deed fund and defer their claims against the company.

This meant that the Owners Corporation was the only creditor that did not receive full payment, with its dividend amounting to approximately 2.4 cents in the dollar. Under this proposal, the effect of the proposed release (if lawful) meant the Owners Corporation would also be prohibited from pursuing potential legal actions against related parties of Academy Construction, including its current and former directors.

At the second creditors meeting, all creditors except for the Owners Corporation voted in favour of the DOCA, resulting in the resolution being passed by number but not by value as the Owners Corporation's claim represented nearly 90% of the total value of admitted creditor claims. Mr Spring, as chair of the meeting, exercised his casting vote in favour of Academy Constructions entering into a DOCA. Against this background, the Owners Corporation applied to the court for an order that the DOCA be terminated under section 445D of the Corporations Act 2001 (Cth) (Corporations Act).
In terminating the DOCA, the Honourable Justice Black found:

1. Lack of justification: No attempts were made by Academy Constructions and the administrators to establish a pari passu (equal footing) distribution amongst the creditors (despite all creditors being unsecured), nor did they provide any rational or commercial justification for differentiating between the Owners Corporation and its other creditors. With no objective explanation, the DOCA was deemed as oppressive, unfairly prejudicial and unfairly discriminatory towards the Owners Corporation. Additionally, the administrators were found to have significantly understated the potential returns available to creditors in a liquidation scenario, further undermining the credibility of the DOCA.
2. Unfair discrimination: In response to the administrators' Counsel arguing that the DOCA should not be terminated because creditors other than the Owners Corporation would "definitely" fare worse in a liquidation, the Court held that this was not sufficient grounds to refuse to exercise its jurisdiction to terminate the DOCA. His Honour emphasised that where the structure of the DOCA involved a high level of oppression and discrimination against one particular creditor, such inequity could not be overlooked, regardless of the potential outcomes for other creditors.
3. Improper third party releases: The DOCA was invalid under Part 5.3A of the Corporations Act, as it sought to release directors and related parties of Academy Constructions, and not just the company itself. This overreach violated the provisions of the Corporations Act, which do not permit such third-party releases within a DOCA. His Honour further rejected the argument that the problematic clauses could be severed or that the DOCA could be varied under section 447A of the Corporations Act, due to the clause being a fundamental component of the DOCA of which the creditors voted in favour. Provided the DOCA's core structure was oppressive and contrary to public interest, it could not be salvaged by simply severing the invalid provisions.

Case 3: Project Sea Dragon: The stalking horse strategy

Project Sea Dragon (PSD) was incorporated as a special purpose vehicle to establish and operate a large-scale prawn aquaculture project in northern Australia. Since its incorporation, however, it had not generated its own revenue stream nor amassed substantial assets. Instead, it relied on the ad hoc funding from its parent company, Seafarms Group Limited (Seafarms), a publicly listed company and the head of the corporate group known as the "Seafarms Group". At all relevant times, the directors of Seafarms and PSD were the same, and there was no formal agreement as to how funding was to be provided from the parent company to its wholly owned subsidiary.

PSD accrued substantial liabilities and debts to Seafarms and to related companies in the corporate group. It also accrued a significant liability to the plaintiff, Canstruct Pty Ltd (Canstruct), a contractor engaged by PSD to carry out various construction works for the aquaculture project. In 2022, PSD fell into dispute with Canstruct regarding the amount it owed for the work completed by Canstruct.

On 3 February 2023, Canstruct obtained an adjudication determination in its favour under the Construction Contracts (Security of Payments) Act 2004 (NT) in the amount of approximately $14 million, including GST and interest. PSD and Seafarms disputed the quantum owing and released an announcement to the ASX stating that whilst Seafarms had the capacity to pay the whole amount owing, it was "extremely disappointed" with the adjudicator's decision and believed the determination to be "excessive".

As found by the Federal Court and Full Federal Court, PSD and Seafarms pursued a strategy by which the former company could avoid the majority of its liability to Canstruct via a process of VA and DOCA.

The strategy employed by PSD and Seafarms to limit the amount payable to Canstruct consisted of 4 main steps. The elements were these:

• Seafarms ceased funding PSD, rendering PSD immediately insolvent.
• PSD entered into VA.
• PSD entered into a DOCA proposed by Seafarms under which all arm's-length creditors of the company were to be paid in full, except for Canstruct which would receive approximately 10 to 11 cents in the dollar.
• With the anticipation of the DOCA being implemented, PSD was to resume its ordinary operations, in essentially the same position it was in before its entry into the DOCA, minus its liability to Canstruct.

The Full Federal Court upheld the decision made in the Federal Court to rule in favour of Canstruct, finding that the DOCA should be terminated and PSD should be wound up:

1. Abuse of Part 5.3A of the Corporations Act: The DOCA was unfairly prejudicial and unfairly discriminatory against Canstruct, given that the "actual intention" (and therefore the predominant purpose) of the DOCA was not to achieve a better return for the company's creditors and members than they would if the company was wound up. Rather, the VA and DOCA process was a "stalking horse" tactic aimed at favouring PSD by avoiding payment to Canstruct, releasing it from its liability, and ensuring the survival of Seafarms Group. Whilst it is not uncommon for a DOCA to be prejudicial or discriminatory to certain classes of creditors whose interest might diverge from the majority, any discrimination must not be "unfair".
2. No assurance of financial support: As PSD was a company with no substantial assets or income stream, there was a real question of insolvent trading from when PSD started accruing significant debt. Despite Seafarms' financial support to PSD since its inception, there was no concrete agreement between the two companies raising a genuine concern as to the sufficient assuredness of financial support available. As shown here from Seafarms' denial to assist PSD to discharge its debt to Canstruct, the commitment by Seafarms was not only illusory but also violated any assurance, commitment or expectation which it had generated. The Court further held that the administrators failed to investigate the obvious key questions relating to PSD's insolvency, rendering their views unreliable.
3. Misleading information: In their report circulated to creditors voting on the DOCA, it stated that priority was given for small creditors in liquidation under sections 556, 560 and 561 of the Corporations Act. Creditors with claims of $300k or less were classified as "Small Claim Creditors", which turned out to be all non-related creditors except Canstruct. The Court held that no such differentiation existed in the Corporations Act and that the statement was intentionally made to provide some justification for the differential treatment of Canstruct as compared to the claims of other unsecured creditors. The misinformation was material to the creditors' decision to vote in favour of the DOCA and therefore gave rise to the discretion to terminate the DOCA.
4. Material omissions: The Court held that the report failed to advise creditors of three key matters:

a. the real and intended purpose of the DOCA was to avoid paying the adjudicated amount to Canstruct, save for 10 cents in the dollar, whilst continuing with the maintenance of the project;

b. there was a real question as to whether PSD had been trading whilst insolvent for several years, which could warrant investigation by a liquidator, and that such an investigation could explore potential recovery actions against both Seafarms and the directors for the debts incurred; and

c. the reason for the substantial difference in the treatment between Canstruct and the other unrelated, unsecured creditors, was to incentivise the other creditors to vote in favour of the DOCA.

DOCAs can be an effective tool to preserve a company's operations or deliver better return to creditors than an immediate winding up. However, where a DOCA discriminates between creditors, careful scrutiny is required. These cases underscore the Court's vigilance against DOCAs that serve as mechanisms to either disadvantage or prioritise specific creditors unjustly. While some level of prejudice may be inherent in any compromise, a DOCA must not cross the line into unfair prejudice or discrimination.