Australia: High standards - challenging a DOCA that compromises a litigation claim

In brief

The Full Court of the Federal Court has affirmed the high standard to be met by any challenge to a Deed of Company Arrangement (DOCA), where the DOCA compromises a commercial dispute with a third party. The court emphasised the DOCA must be shown to be contrary to the interests of the creditors in light of all relevant circumstances. More needs to be shown than a "not unrealistic prospect of a better outcome" if the DOCA were to be terminated and the litigation pursued by a liquidator.


Key takeaways

In the past, some judges have suggested a DOCA can be terminated at the comparatively low threshold that a liqudiator may be "potentially" successful in litigating a claim. This is clearly now not the test. A higher standard is to be welcomed in discouraging opportunistic creditors from challenging DOCAs which have been accepted by creditors, delaying more certain returns under DOCA proposals.

In formulating their recommendation to creditors, administrators should take into account not only the prospects of the company's own case, but also the potential for a prima facie defence, whether they can obtain funding, delays in any recovery, and any difficulties with enforcing any judgment. This is especially the case where that recovery must be pursued internationally under foreign law.

Aggrieved creditors need to prove more than just a realistic prospect of success in litigation about the compromised claim. They should not delay in bringing any application to challenge the DOCA.
Parties formulating DOCA proposals to compromise disputes should consider emphasising all benefits to creditors, including that of a prompt, inexpensive, and certain outcome, especially where disputed questions of international law arise.

In more detail

Road to the DOCA

China Railway Construction Group Co. Ltd (CRCG) is a Chinese State owned enterprise and one of the largest engineering firms in the world.

CRCG sought first to enter the Australian construction industry as part of a joint venture with a local construction company in the Brisbane residential unit construction market. It did so through an incorporated vehicle, CRCG-Rimfire Pty Ltd (Joint Venture Company). By late 2017, after encountering difficulties, the Joint Venture Company was placed into voluntary administration.

Builders in Queensland are required to hold sufficient assets to meet minimum financial requirements before they are given a licence to undertake construction work. Where an applicant company (Applicant Builder) cannot meet those requirements from its own resources, it can rely on a "Deed of Covenant and Assurance" from a closely related entity (the Assuring Entity). This document effectively guarantees debts of the Applicant Builder up to a specific amount rated against its anticipated annual earnings. That amount is payable to a liquidator in the event the Applicant Builder enters liquidation. There were at the time two key documents needed for this option: a Deed of Covenant and Assurance given by the Assuring Entity; and a separate document, submitted by the Applicant Builder, indicating the amount committed to be paid (supported by the net assets of the Assuring Entity) in the event the Applicant Builder enters liquidation.

The Joint Venture Company had relied financially on CRCG to get approval for the level of its building licence from the Queensland Building and Construction Commission (QBCC).

CRCG contended that there were serious anomalies as to how its joint venture partner had represented to the QBCC that CRCG was prepared to commit its assets. It disputed the document provided to the QBCC as a Deed of Covenant and Assurance had been authorised by CRCG. It said it had no knowledge of the representations made by Joint Venture Company to pledge CRCG's entire balance sheet, in the event of the Joint Venture Company's liquidation.

This dispute formed the backdrop to the Deed of Company Arrangement proposed to creditors. The vote by creditors split with a substantial majority in value supporting the deed, but an even split in the number of creditors voting for and against the DOCA. The administrator exercised a casting vote in favour of the DOCA.

Path to the Appeal

Over 6 months after the second meeting of creditors, the now deed administrators had largely completed their adjudication of the proofs of debt submitted. They were close to making distributions of the DOCA fund to creditors. In reaching that point, they rejected the proofs of debt of the applicants (subsequently the appellants) (Challenging Creditors). The Challenging Creditors sought to challenge that adjudications (points which still remain to be finalised by the trial judge), as well as the DOCA. The attack on the DOCA was that, in substance, it was unfairly prejudicial to the creditors of the Joint Venture Company as a whole (section 445D Corporations Act 2001 (Cth)).

The basic contentions of the Challenging Creditors were that obtaining a judgment under the Deed of Covenant and Assurance was relatively straightforward, and that it could be readily enforced against CRCG in China. The deed administrators and CRCG disagreed.

The trial judge, Justice Reeves, rejected the challenge to the DOCA. He noted the evidence that CRCG had a prima face defence (meaning there was risk in any proceedings in Queensland), and it would be difficult and expensive to seek to enforce a judgment under those circumstances in China. That supported a conclusion it was not in the interests of creditors to terminate the DOCA. His Honour noted the delay by the Challenging Creditors in bringing their application, and the support for the DOCA by the largest creditor by value and the Australian Taxation Office. Weighing up discretionary factors, his Honour said he would also have refused to exercise the discretion to set the DOCA aside, were he to have found that the DOCA was prejudicial.
 

Dead End for the Challenging Creditors

In appealing that decision, the Challenging Creditors pointed for the first time to developing case law in Australia aiding the conclusion that judgments of Australian courts might be recognised in China1. This, they said, would result in a better return to creditors than had been considered to be the case by the administrators. 

Both Australian judgments they relied upon had been published at the time of the hearing before Justice Reeves. As this argument was a novel point raised on appeal, the Challenging Creditors were refused leave to rely on those cases. CRCG also showed that if those cases were raised at trial, it would have led expert evidence as to why a judgment in this matter would have faced additional problems being enforced in China. 

The Full Court otherwise assessed the reasoning of the trial judge, and found no error in his conclusions. In doing so, it emphasised that the critical test when seeking to set aside a DOCA remains whether it is contrary to the interests of the creditors as a whole in light of all relevant circumstances. Contentions that there is "not an unrealistic prospect" that a Queensland Court might make orders against CRCG are not enough. A creditor attacking a DOCA on the basis that there is a credible right to pursue a claim, especially against a foreign entity, needs to address whether the better alleged recovery by litigating is substantially better or only a little better than the DOCA; the delays that might be experienced in pursuing that return when compared with the DOCA; the risks in achieving the return (including the existence of defences), the risks of obtaining funding, and uncertainties about foreign law.


1 Two Australian courts have recognised and enforced Chinese judgments under principles of general international law: Liu v Ma (2017) 55 VR 104 and Suzhou Haishun Investment Management Co v Zhao [2019] VSC 110. Reciprocity in a foreign jurisdiction is acknowledged as one criteria in the Civil Procedure Law of the People's Republic of China needed for Chinese courts recognising another country's court orders. It is not the only requirement of a foreign judgment.

Contact Information

Copyright © 2024 Baker & McKenzie. All rights reserved. Ownership: This documentation and content (Content) is a proprietary resource owned exclusively by Baker McKenzie (meaning Baker & McKenzie International and its member firms). The Content is protected under international copyright conventions. Use of this Content does not of itself create a contractual relationship, nor any attorney/client relationship, between Baker McKenzie and any person. Non-reliance and exclusion: All Content is for informational purposes only and may not reflect the most current legal and regulatory developments. All summaries of the laws, regulations and practice are subject to change. The Content is not offered as legal or professional advice for any specific matter. It is not intended to be a substitute for reference to (and compliance with) the detailed provisions of applicable laws, rules, regulations or forms. Legal advice should always be sought before taking any action or refraining from taking any action based on any Content. Baker McKenzie and the editors and the contributing authors do not guarantee the accuracy of the Content and expressly disclaim any and all liability to any person in respect of the consequences of anything done or permitted to be done or omitted to be done wholly or partly in reliance upon the whole or any part of the Content. The Content may contain links to external websites and external websites may link to the Content. Baker McKenzie is not responsible for the content or operation of any such external sites and disclaims all liability, howsoever occurring, in respect of the content or operation of any such external websites. Attorney Advertising: This Content may qualify as “Attorney Advertising” requiring notice in some jurisdictions. To the extent that this Content may qualify as Attorney Advertising, PRIOR RESULTS DO NOT GUARANTEE A SIMILAR OUTCOME. Reproduction: Reproduction of reasonable portions of the Content is permitted provided that (i) such reproductions are made available free of charge and for non-commercial purposes, (ii) such reproductions are properly attributed to Baker McKenzie, (iii) the portion of the Content being reproduced is not altered or made available in a manner that modifies the Content or presents the Content being reproduced in a false light and (iv) notice is made to the disclaimers included on the Content. The permission to re-copy does not allow for incorporation of any substantial portion of the Content in any work or publication, whether in hard copy, electronic or any other form or for commercial purposes.