The Full Federal Court in Project Sea Dragon Pty Ltd (Subject to a Deed of Company Arrangement) v Canstruct Pty Ltd [2024] FCAFC 141 has highlighted some of the litigation risks for deed of company arrangements (DOCAs) that discriminate against particular creditors. Of particular note, the Court has:

(a) reviewed the case law on when a DOCA is liable to be set aside as an abuse of Part 5.3A of the Corporations Act;

(b) clarified when a DOCA will be set aside for unfairly discriminating against a creditor;

(c) reviewed the adequacy of explanations for DOCAs which provider for a priority in favour of "Small Creditors"; and

(d) confirmed the 'materiality' of information required to be disclosed to creditors.

Following an adjudication in favour of the head contractor (Canstruct) who was working on a series of aquaculture projects, the parent company (Seafarms Group) decided not to extend further funding to Project Sea Dragon Pty Ltd (PSD) and the board proceeded to appoint voluntary administrators. The parent company ultimately proposed a DOCA to pay all arms-length creditors in full except for Canstruct.

Canstruct challenged the validity of the DOCA, which was terminated at first instance on the basis that it was unjust and unfairly discriminatory (S 445D(1)(e) and (f).). The Full Court has upheld this decision, finding that PSD was put into voluntary administration for the purpose of avoiding having to pay an adjudicator's determination in full.

In setting out its decision, the Full Court makes a number of important observations.

1. When is a DOCA liable to be set aside as an abuse of Pt 5.3A of the Corporations Act?

The DOCA was found liable to be set aside at first instance for abuse of process under Pt 5.3A as it was found that the purpose – to release the Company from all liability to a single creditor (Canstruct) and restart operations – was the predominant purpose of entering into voluntary administration.

The Full Court agreed, both as to the purpose of the administration and the DOCA, and that this purpose was not compatible with Part 5.3A. The Court observed that this case had a strong similarity with Re Academy Construction and Development Pty Ltd (subject to Deed of Company Arrangement) [2024] NSWSC 808 at [80]–[87], in which a party seeking to claim damages for defective building work against the deed company was singled out in the DOCA as having its claim subject to a cap in an arbitrary amount whereas other (smaller) claims were paid in full under the DOCA. The DOCA in the current case was seen as providing even a stronger case to be set aside as an abuse because there had been a determination on the merits of Canstruct’s claim, whereas in Re Academy Construction the DOCA was proposed and adopted before any such determination.

2. What constitutes unfair discrimination or prejudice? How can discrimination be justified?

Secondly, the DOCA proponent attempted to defend the DOCA on the basis that all parties were put in a better position than in a liquidation.

The Full Court reminds us that a DOCA can be oppressive, unfairly prejudicial or unfairly discriminatory even if it provides creditors with a better result than winding up. The unfair prejudice or unfair discrimination was established by the lack of justification for paying Canstruct (about) 10 cents in the dollar under the DOCA in contrast to paying other creditors in full.

The administrators' report had sought to justify the discrimination by suggesting the different treatment reflected the "priorities for small creditors in a liquidation as set out in the Act". The Court confirmed that this was a disingenuous justification and a "bizarre statement" because there is no such priority in favour of small creditors under the Act; the lack of validity in the justification itself being capable of constituting unfair prejudice or unfair discrimination.

The DOCA proponent also attempted to defend the discrimination on the basis that the "small creditors" were trade creditors whose assistance was needed in trading the business post administration. The Court noted that this justification was also unsatisfactory, in that the creditor list included the former solicitors who no longer acted for the company.

3. What needs to be disclosed to creditors? All things relevant and material

The Court also clarified what information is required to be disclosed to creditors before voting on a DOCA: being all material which is relevant, and either did or might have affected the decision to vote in favour of the DOCA.

That information was not limited to the types of information required by statute to be disclosed under s 438A of the Corporations Act and s 75–225(3) of the Insolvency Practice Rules, referring to cases such as Hagenvale Pty Ltd v Depela Pty Ltd (1995) 17 ACSR 139 at 148 (Cohen J); Le Meilleur Pty Ltd (subject to deed of company arrangement) v Jin Heung Mutual Savings Bank Co Ltd [2011] NSWSC 1115; (2011) 256 FLR 240 at [331] (Ward J); and Re Recycling Holdings Pty Ltd [2015] NSWSC 1016; (2015) 107 ACSR 406 at [33].

The relevant information in this case included (a) the purpose of the DOCA; and (b) a truthful explanation for the discrimination between creditors.

What is required to be disclosed is not just the outcome of the investigation of the company's business and circumstances to enable creditors to form an opinion about what outcome would be in the creditors' interests. Further, it is not a question of whether in fact any person was misled; in this case, the omissions from the report were sufficient for the Court to find a likelihood that creditors would vote in favour of the DOCA because of the misleading information.

4. Voting majority achieved by related creditors

Finally, the Court held the vote to approve the DOCA should be set aside under s75-41 of the Insolvency Practice Schedule because:

(a) the vote was only passed as a result of the vote cast by Seafarms Group;

(b) passing of the resolution caused prejudice to Canstruct to an unreasonable extent, having regard to the benefits to related creditors and the relationship between them and PSD, in particular the control of PSD by Seafarms Group, which was by far the largest creditor of PSD;

(c) the relevant prejudice included that Canstruct was to be paid only about 10 cents in the dollar under the DOCA whereas all other unrelated unsecured creditors were to be paid in full, and there was no principled justification for that discrimination or prejudice; and

(d) this view was said to be fortified by the fact that the related creditors were not in reality voting in their capacity as creditors, given that the DOCA gave them no return at all, but were voting to obtain a collateral advantage, namely a release of Canstruct’s debt before resuming normal business operations.

DOCAs to deal with litigation creditors are not uncommon, but should be designed by DOCA proponents and carefully explained by administrators with a view to minimising the risk of them being set aside. In particular, DOCAs which discriminate between creditors should be approached with caution, and their application to the actual creditor pool assessed in light of any putative justification. Finally, lawyers can play a useful role in tyre-kicking the adequacy of disclosures to creditors surrounding a DOCA proposal.