Reported Decision : (2003) 46 ACSR 458 (2003) 21 ACLC 1385 New South Wales Supreme Court CITATION : Sutherland v Rahme Enterprises [2003] NSWSC 673 revised - 25/07/2003 HEARING DATE(S) : 21/07/03 JUDGMENT DATE : 23 July 2003 JURISDICTION: Equity Division Corporations List JUDGMENT OF : Barrett J DECISION : Termination of winding up refused CATCHWORDS : CORPORATIONS - winding up - application for termination of winding up following execution of deed of company arrangement - deed extinguishes some debts but leaves substantial related party debts - purported contractual subordination - contract terminable or variable by mutual consent - whether future financial stability sufficiently assured LEGISLATION CITED : Corporations Act 2001 (Cth), ss.444A, 444B, 444D. 444G, 445C, 482 Brolrik Pty Ltd v Sambah Holdings Pty Ltd (2001) 40 ACSR 361 Collins v Collins & Sons Pty Ltd (1984) 9 ACLR 58 Re Data Homes Pty Ltd (1971) 1 NSWLR 338; (1972) 2 NSWLR 22 CASES CITED : GIO Workers' Compensation (NSW) Ltd v Advance International Pty Ltd [2002] NSWSC 261 Mercy & Sons Pty Ltd v Wanari Pty Ltd (2000) 35 ACSR 70 MYT Engineering Pty Ltd v Mulcon Pty Ltd (1999) 195 CLR 636 Re Nature Springs Pty Ltd (1994) 13 ACSR 50 PARTIES : Roderick Mackay Sutherland - Plaintiff Rahme Enterprises Pty Ltd (In Liquidation) - Defendant FILE NUMBER(S) : SC 2736/03 COUNSEL : Mr D R Stack - Plaintiff SOLICITORS : Nash O'Neill Tomko Lawyers - Plaintiff IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORPORATIONS LIST BARRETT J WEDNESDAY 23 JULY 2003 2736/03 - RODERICK MACKAY SUTHERLAND v RAHME ENTERPRISES PTY LTD (IN LIQUIDATION) JUDGMENT 1 By an originating process filed on 9 May 2003 the plaintiff, Mr Sutherland, as liquidator of the defendant, Rahme Enterprises Pty Ltd, sought two substantive orders: first, and order that he have leave to appoint himself administrator of the defendant; and, second, an order that the winding up of the defendant be terminated. 2 The application for the first of these orders was heard by Austin J on 10 June 2003. His Honour made the order as sought. He did so in circumstances where an entity associated in a general sense with the principals of the defendant had communicated an intention of proposing a deed of company arrangement which, on the face of things, would produce a better return for creditors than a winding up. 3 The shares in the defendant company are held by Mr Maroun Rahme and his wife. They are the only directors. Mr Rahme is a bankrupt. Mr Rahme and Mrs Rahme are parties to proceedings in the Family Court. The person who has been instrumental in proposing the deed of company arrangement is Mr Maroun Rahme's father, Mr George Rahme, whom I shall call "Mr Rahme Sr". 4 The company has debts of some $1.3 million, of which $1.13 million is owed to related party creditors and $188,000 is owed to creditors who are not associated with the company or its principals. The possible outcomes for creditors were dealt with in paragraph 6 of Austin J's judgment of 10 June 2003: "He [the plaintiff] has produced a report to creditors dated 3 April 2003. In that report, after analyzing potential causes of action, he reached the conclusion that if funding were available to pursue all of the claims he thinks may lead to recoveries, he would be able to distribute about four cents in the dollar to unsecured creditors including the related party creditors. However, if the proposed Deed of Company Arrangement, to which I shall refer, were put in place, then there would be a distribution of 13 cents per dollar to unsecured creditors other than the related unsecured creditors." This paragraph refers to claims the plaintiff, as liquidator, may have. These claims are claims against Mr Rahme and Mrs Rahme on directors' loan accounts, possible claims in respect of a property at Pyrmont against a company called Spincast, of which Mr Rahme Sr is a director, and a potential claim in respect of a property at Double Bay. There are also potential insolvent trading claims against Mr Rahme and Mrs Rahme and a potential voidable preference claim against Mr Rahme Sr. 5 Under the deed of company arrangement proposal, all these claims would be given up, with the exception of the loan account claims against Mr Rahme and Mrs Rahme. The propounding party, Cavalock Pty Ltd, a company associated with Mr Rahme Sr, would make a contribution of $140,000 for the benefit of creditors (or, as will be seen presently, some of them). It is on that basis that the deed of company arrangement is estimated to produce 13 cents in the dollar for unsecured creditors as distinct from an estimated four cents if winding up continues. The latter figure takes into account the fact that the liquidator will have no funds to pursue the various recovery possibilities as well as obstacles that are considered to confront some of those possibilities. 6 A meeting of creditors was held on 7 July 2003 after the applicant had appointed himself as administrator. The meeting had before it three possibilities: execution of the proposed deed of company arrangement, ending of the administration, and winding up of the company. Of 188 creditors listed for the purposes of making up an attendance schedule, six attended in person or by proxy. Of these, two, accounting for $32,700, were parties not connected with the Rahme interests and the other four were related party creditors accounting for what appears to be the whole or substantially the whole of the related party debts of $1.13 million. Those related party creditors were all represented at the meeting by Mr Rahme Sr. The meeting resolved unanimously that the company execute the deed of company arrangement. The proposal was thus approved by two out of apparently 182 non-associated creditors and all six related party creditors. The significant point is that there was no dissent. 7 Executed counterparts of the deed are in evidence. It is appropriate that I outline its terms. A useful summary appears in paragraph 9 of Ms Woods' affidavit of 17 July 2003: "In summary, the Deed provides that: (a) Sutherland to be appointed administrator of the Deed – clause 2.1; (b) Cavalock Pty Limited to pay an amount of $140,000 to the Deed's administrator, which amount to be paid in the priorities set out in sub-paragraph (g) below – clause 41.; (c) Related Creditors (as defined) will not lodge a proof of debt with the Deed's administrator but will remain bound by the moratorium provisions contained in clause 9 of the Deed – clause 5.2; (d) Related Creditors will be entitled to repayment of their debts only from monies then immediately available to the Company and provided that after payment (or part payment) of the debts then due to them, the Company will still be able to pay as and when they fall due all or any liabilities the Company may then (actually or contingently) owe any other creditor of the Company – clause 5.2; (e) The amount of $140,000 to be paid by Cavalock Pty Limited is not to constitute a debt payable by the Company – clause 6.1; (f) The Company and Sutherland in his capacity as Administrator, Deed's administrator and Liquidator releases any claims it or he may have with respect to: (i) the property situated at 45 Murray Street, Pyrmont, New South Wales; (ii) the property situated at 1 William Street, Double Bay, New South Wales; (iii) any voidable preference within the meaning of Section 588 of the Corporations Act; and (iv) any insolvent trading by Maroun George Rahme pursuant to Part 5.7B, Division 3 of the Corporations Act – Clause 7.1; and (g) The Deed Fund to be distributed in the following priority: (i) First – G & N Developments Pty Limited's costs and expenses in making an application to the Court to wind up the Company; (ii) Second – the Liquidator's costs and expenses (including legal costs) incurred during the liquidation period; (iii) Third – the Administrator's costs and expenses (including legal costs) of acting as the administrator of the Company pursuant to provisions of Part 5.3A of the Corporations Act; (iv) Fourth – the Deed's Administrator's remuneration and expenses (including legal costs) under this Deed; and (v) Fifth – the Claims of the Creditors, except Related Creditors, in the priority set out in Section 556 of the Corporations Act as if references to the winding up of the Company were references to the administration of this Deed of Company Arrangement – Clause 13.1." 8 It is also provided by the deed of company arrangement that Mr Rahme Sr or his nominee will become the company's sole director. Mr Maroun Rahme and his wife will apparently remain the shareholders. 9 The application now before the court is the application for termination of the winding up, pursuant to s.482 of the Corporations Act. The plaintiff, in his capacity as liquidator, is a competent applicant under that section. The central issue upon any such application is whether the company has been restored to or exists in a state of financial stability sufficient to enable it to be safely returned to the mainstream of commercial life. The principal determinant of that is whether the company is solvent and likely to remain so. 10 In the present case, termination of the winding up, if granted, will mean that the company continues under the deed of company arrangement until the scheme for payment and extinguishment envisaged by the deed has been fully implemented. Once that point is reached, the deed will terminate, Mr Sutherland will no longer be the deed administrator and the company will no longer be under any form of external administration. 11 The effect of the deed will be to extinguish the claims of the creditors who are not related party creditors. They will receive so much of the deed fund of $140,000 as remains after claims of higher order in the deed's scale of priorities have been met out of that fund. The related party creditors will stand apart from this. They will not participate in the deed fund and their claims will not be extinguished. Rather, those claims will, it is envisaged, continue to subsist, although subject to an ongoing subordination regime set out in the deed of company arrangement. 12 Clause 5 of the deed of company arrangement contains certain subordination provisions expressed to be binding on the "Related Creditors". The expression "Related Creditors" is defined in clause 1.1: "' Related Creditor ' means any person who is a related entity to the Company with the meaning ascribed to that term by Section 9 of the Corporations Act and the term Related Creditor includes, without limiting the generality of the foregoing, each of George, Cavalock, Mark Rahme, Nu-Rock Technology, Nu-Rock Corporation and G & N Developments." It is clear that while this definition refers to certain named persons and corporations as within the expression "Related Creditors" - specifically Mr Rahme Sr, Cavalock Pty Ltd, Mark Rahme & Associates Pty Ltd, Nu-Rock Technology Pty Ltd, Nu-Rock Corporation SARL and G&N Developments Pty Ltd - it also extends to other unnamed persons falling within a described class, being "any person who is a related entity to the Company within the meaning ascribed to that term by s.9 of the Corporations Act". The six named entities I have mentioned are included as parties to the deed and have executed it. Anyone else who may exist and come within the related creditor definition is not included as a party and has not executed. 13 Under s.444D of the Corporations Act, a deed of company arrangement binds all creditors so far as concerns claims arising on or before the day specified in the deed pursuant to s.444A(4)(i), in this case 19 December 2002. Under s.444G, a deed of company arrangement also binds the company, its officers and members and the deed's administrator. The deed's binding force, as regards all such persons, is wholly statutory and derives from the two acts of execution which, by s.444B(6), cause a particular instrument to be a deed of company arrangement. These matters are discussed and confirmed in the High Court's decision in MYT Engineering Pty Ltd v Mulcon Pty Ltd (1999) 195 CLR 636. The binding force of a deed of company arrangement, being wholly statutory, is therefore of conceptually the same kind as the binding force of a scheme of arrangement under s.411. 14 Under s.445C, termination of a deed of company arrangement occurs when the court makes a termination order under s.445B (s.445C(a)), when the creditors pass a resolution of a particular kind (s.445C(b)) or, if the deed itself specifies circumstances in which it is to terminate, in those circumstances (s.445C(c)). The effect of such a termination is not described or explained by the Act, except to the limited extent in s.445H. That section says that termination does not affect the previous operation of the deed. Implicit in the termination concept, however, must be the notion that the several persons initially bound by the deed, by force of the statute, cease to be bound as to their future conduct, rights and liabilities. 15 The deed of company arrangement in this case contains provisions as to its termination which are relevant to the operation of s.445C. It acknowledges that termination will occur in the events specified in s.445C(a) and (b). It acknowledges the possibility of termination by resolution of creditors and compels the deed's administrator to convene a meeting for that purpose if he determines that it is no longer practicable or in the interests of creditors to carry out the deed. There is also machinery by which the deed administrator can, by lodgment with ASIC, terminate the deed when the arrangement it embodies has been effectuated, that is, when "all parties to this deed have fulfilled their obligations in full and the deed fund has been distributed to creditors in accordance with this deed". 16 It is against this background that the provisions of the deed of company arrangement concerning related creditors must be approached. Those provisions are in clause 5 which I now set out, with parts of particular relevance emphasized: " 5 SUBORDINATED CLAIMS 5.1 Cavalock and/or George [ie, Mr Rahme Sr] must procure that neither it nor him, nor any Related Creditor lodges a proof of debt with the Deed's Administrator for the purposes of participating in a distribution of the Deed Fund. 5.2 The Related Creditors hereby acknowledge and agree that they will not seek to lodge a proof of debt with the Deed's Administrator in respect of their respective Claims for the purpose of receiving a dividend although the Related Creditors will remain bound by the moratorium contained in clause 8 during the continuation of this Deed. After termination of this Deed in accordance with clause 14, the Related Creditors will still be entitled to repayment of monies owed to them by the Company as at the Fixed Date, however, their recourse and/or right of payment with respect to such debts will be limited and the Company will be liable to repay those debts only: 5.2.1 From monies then immediately available to the Company; and 5.2.2 Provided that after payment (or part payment) of the debts then due to the Related Creditors, the Company will still be able to pay as and when they fall due all or any liabilities the Company may then (actually or contingently) owe to any other creditor of the Company. 5.3 In the absence of agreement between the Related Creditors any payment (or part payment) to be made by the Company to Related Creditors after termination of this Deed, in accordance with this clause must be paid from the then immediately available cash pro rata to the amounts then due to each Related Creditor. 5.4 The Related Creditors acknowledge and agree that the intention behind this clause 5 is to ensure that the debts owed to the Related Creditors by the Company do not adversely affect the solvency of the Company after termination of this Deed and that when interpreting this clause 5, recognition shall be given to this intention. 5.5 This clause 5 will survive termination of this Deed." 17 The first thing to note in clause 5 is the statement in clause 5.5, that the clause as a whole will survive the termination of the deed. While the Corporations Act does not spell out in detail the consequences of termination of a deed of company arrangement, the briefly worded provision in s.445H must, as I have said, be taken to indicate that the deed has no effect or operation after termination so as to affect, as to the future, the rights and obligations of persons who became statutorily bound by the deed. There is therefore no scope, so far as the statutorily binding force of a deed of company arrangement is concerned, for any of its provisions to subsist in operative form as to the future, after the deed has terminated. If clause 5.5 has any operation at all, it operates at a contractual level only. 18 The particular way in which clause 5 says it will continue to operate after termination of the deed is set out in clause 5.2. That clause says, that, after termination, the related creditors will no longer be bound by the deed's moratorium provisions so that their debts as at 19 December 2002 will remain undiminished and unaffected. Those debts will continue to be payment obligations of the company but, according to clause 5.2, particular contractual provisions will apply to the related creditors' "recovery and/or right of payment" with respect to such debts. That recovery or right will be "limited" and the company will be liable to pay those debts only in accordance with clauses 5.2.1 and 5.2.2 which envisage payment only from "moneys immediately available to the company" and a prohibition on payment unless, after payment, the company will still be able to pay, as and when they fall due, all or any liabilities of the company then actually or contingently owing to any other creditor. This regime, even if effectively created by contract, cannot possibly affect any related creditors except the six named in the "includes" part of the clause 1.1 definition of "Related Creditor". But as those six appear to account for the whole of the $1.13 million of related party debts to which I have referred, nothing turns on that. 19 The subordination purportedly affected by clause 5 is, at best, contractual. Putting upon it the construction most favourable to the plaintiff's case, the position after the termination of the deed will be that creditors to the extent of $1.13 million, being Mr Rahme Sr and entities associated with him, will continue to be owed $1.13 million and that sum will be payable according to whatever were the pre-existing contractual terms, qualified however, by clause 5.5. Mr Rahme Sr or his nominee will, at that point, be the sole director of the company, that being another element of the deed of company arrangement. 20 At a contractual level, it will be open to the parties at any time to alter this regime by a form of mutual assent in which Mr Rahme Sr is likely to be the sole human decision maker. It was submitted by Mr Stack of counsel, who appeared for the plaintiff, that Mr Rahme Sr, acting conscientiously, could not sanction a contractual alteration of or departure from the subordination provisions if to do so would mean that the company was not able to pay its debts as they fell due. If he took such action, it was said, Mr Rahme Sr would face a situation where, as director, he had to seek immediately an appropriate form of external administration, because otherwise he would face serious personal liabilities under the insolvent trading provisions. This may be theoretically true, but such a basis is scarcely a satisfactory one on which to re-launch an insolvent company into the mainstream of commercial life. 21 There is also the point that the formulation in clause 5 turns upon an objective determination whether the company will be able to pay its other debts as and when they fall due, which is apparently left, in a practical sense, in the hands of the director or directors being, at least for the time being, the person who is one of the relevant creditors and it seems the controller of or a significant influence within the other creditors. 22 In Re Nature Springs Pty Ltd (1994) 13 ACSR 50, McLelland CJ in Eq took the view that a simple contractual subordination between the company and creditors intended to be deferred did not provide a sufficient or safe mechanism for the protection of future creditors of a presently insolvent company so as to justify termination of its winding up. His Honour described the relevant contract as being "inherently susceptible to being varied or discharged by a further agreement between the same parties, or to being simply ignored". That is the position here also. 23 McLelland CJ in Eq also referred to the established principle that it is contrary to the public interest to terminate the winding up of a company if, after termination, it will remain insolvent in the sense that its liabilities will substantially exceed its assets. He referred to authorities collected and discussed in Collins v Collins & Sons Pty Ltd (1984) 9 ACLR 58, in particular the passage from the judgment of Mason JA, with whom Holmes JA and Hardie AJA agreed, in Re Data Homes Pty Ltd (1972) 2 NSWLR 22 at 27: The question here is whether the Court should grant a stay in circumstances where, although the company will not be insolvent in the sense that it will be unable to pay its debts as they fall due, and there may be no prejudice to future creditors because they will receive a priority over existing creditors, the liabilities of the company (including those which are contingent) will substantially exceed its assets. In my opinion that question should be answered in the negative and it matters not whether the reason for that answer is expressed in terms of commercial morality or public interest." 24 Also pertinent are remarks of Street J at first instance in Data Homes (1971) 1 NSWLR 338 at 341: "The present scheme has been formulated upon the basis that the existing debts will be assigned, but that they will rank after any newly arising debts incurred by the company under its new ownership. It is sought to contend that this will meet the objections stated in the Mascot Home Furnishers and Denistone Real Estate cases. Such an argument has already been presented to me in another matter earlier this year, and I have declined to accede to it. I do not look with favour upon the creation of a new species of monetary obligation. How is the so-called 'deferred claim' to rank in the statutory administration in the event of the company being subsequently wound up? By whom and how is the 'deferment enforceable? What is to happen if the new owner disregards the deferment? These and other questions may be answerable. But I take the view that the court should not sponsor the circumstances that may give rise to them. And in any event the company will remain insolvent and thus will infringe the generally stated precepts enunciated in the Mascot Home Furnishers and Denistone Real Estate cases." 25 The appropriateness, in s.482 circumstances, of purely contractual subordination or deferral, reversible entirely at the discretion of debtor and creditor, was mentioned in Brolrik Pty Ltd v Sambah Holdings Pty Ltd (2001) 40 ACSR 361. In the circumstances of that case, the court was prepared to conclude that an unacceptable risk of financial instability after termination of winding up would be sufficiently resolved by undertakings given to the court by the related party creditors and their controller that the related party debts would not be called up while any sum remained owing to any other creditor. In GIO Workers' Compensation (NSW) Ltd v Advance International Pty Ltd [2002] NSWSC 261, a like undertaking given to the court was accepted, but on the basis that it was a temporary measure to be replaced in due course by an appropriate subordination arrangement of such a kind that, if the debt continued, its contractual basis was altered so that subordination restrictions not only applied but were so structured that an amending contract of the parties could not undo them. 26 It was submitted by Mr Stack that these approaches to termination of winding up and the need to see clear and unambiguous solvency into the future require some reassessment in the light of the 1993 legislative amendments on corporate insolvency and in particular the introduction of Pt 5.3A. Mr Stack pointed to observations of Austin J in Mercy & Sons Pty Ltd v Wanari Pty Ltd (2000) 35 ACSR 70: "If the company applies for an order terminating the winding up after its creditors have approved a deed of company arrangement, the objectives of Pt 5.3A are relevant matters and in many cases they will be matters of great importance. Young J acknowledged their importance in Re Depsun , for example. Section 435A cannot be disregarded where the question of termination of a winding up arises in an administration context, whether the issue is presented under s 482 or under some provision of Pt 5.3A, such as s 447A. The concerns reflected in the case law, including the pre-1993 case law which was mainly decided in the context of creditors' schemes of arrangement, will remain, but the court will evaluate the application for termination in light of all the facts, including the terms and effect of the deed." 27 Part 5.3A's objective of obtaining for creditors a better return than they would receive in an immediate winding up may be accepted as a factor to be taken into account in a case where a deed of company arrangement is promoted and termination of winding up forms part of the overall plan in which the deed of company arrangement plays a part. But it seems to me that the public interest factors of the Data Homes kind are in no way relegated when the application to terminate the winding up eventually comes before the court. The interest of creditors (or, as it is here, a section of them) in obtaining a more favourable return through the deed of company arrangement cannot, to my mind, justify the court's re-launching a company which, viewed alone and in the context of its future activities or likely activities, presents a potential for a new group of creditors to be unacceptably prejudiced by legacies from its former life. In the present case, the company is said to have tax losses, so that it may be expected that it will undertake activities with a view to generating profits against which the losses can be offset. The prospects of new debts being incurred are therefore virtually certain. 28 Since 1998, the corporations legislation has made available simplified procedures for the reduction and repayment of share capital. The legislature has drawn what it considers to be an appropriate balance between the interests of shareholders and the interests of creditors in that sphere. Sanctions for contravention by repayment of share capital effected inconsistently with the statutory provisions may be visited upon officers and others involved. Capitalisation of related party debts in contexts of the present kind does not today see funds in any sense irretrievably locked up and, at the same time, ensures safeguards for creditors if any proposal to release such funds comes under consideration. Capitalisation of that kind avoids altogether the kind of difficulty at issue in this type of case. 29 The form of contractual subordination envisaged by clause 5 of the deed of company arrangement in the present case, even assuming that it will be effectively continued in place as a contractual matter between the company and the named "Related Creditors" after termination of the deed of company arrangement, does not represent a sound basis on which to order termination of this winding up. The application for an order under s.482 is therefore refused. ********** Last Modified: 07/28/2003 DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated.