Vero Workers Compensation v Ferretti [2006] NSWSC 292

Reported Decision : 57 ACSR 103 (2006) 24 ACLC 454

New South Wales Supreme Court

CITATION : Vero Workers Compensation v Ferretti [2006] NSWSC 292

HEARING DATE(S) : 20 March 2006

JUDGMENT DATE : 13 April 2006

JURISDICTION : Equity

JUDGMENT OF : Austin J

DECISION : Application for termination of winding up denied

CATCHWORDS : CORPORATIONS - winding up in insolvency - voluntary administration - liquidator appoints himself, with leave, as administrator - deed of company arrangement executed - whether court should order termination of winding up on liquidator's application - interests of creditors, liquidator, contributories and the public - purported deferral of directors' claims as creditors, by deed and undertakings to court - relevance of objects of Part 5.3A

LEGISLATION CITED : Corporations Act 2001 (Cth), ss 435A, 436B, 437A, 437C, 444G, 482, 563C

Mercy & Sons Pty Ltd v Wanari Pty Ltd (2000) 35 ACSR 70 Re Data Holmes Pty Ltd [1971] 1 NSWLR 338 CASES CITED : Re Nardell Coal Corporation Pty Ltd (2004) 49 ACSR 110 Re Nature Springs Pty Ltd (1994) 13 ACSR 50 Sutherland v Rahme Enterprises Pty Ltd (2003) 46 ACSR 458

Vero Worker's Compensation (NSW) Ltd (P) PARTIES : Ferretti Pty Ltd (in liq) (D) John Frederick Lord as liquidator of Ferretti Pty Ltd (in liq) (A)

FILE NUMBER(S) : SC 4229/05

COUNSEL : Ms V Whittaker (A)

SOLICITORS : Kemp Strang (A)

IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORPORATIONS LIST

AUSTIN J

THURSDAY 13 APRIL 2006

4229/05 VERO WORKER'S COMPENSATION (NSW) LTD V FERRETTI PTY LTD (IN LIQ) JUDGMENT 1 HIS HONOUR: John Frederick Lord is the liquidator and deed administrator of Ferretti Pty Ltd (in liq) (subject to a deed of company arrangement) ("the Company"). In his capacity as liquidator of the Company, Mr Lord applies ex parte for an order under s 482(1) of the Corporations Act 2001 (Cth) terminating the winding up of the Company. I shall refer to Mr Lord as "the Liquidator" or "the Administrator" in appropriate contexts. 2 Although the application is made on an ex parte basis, the facts do not reveal that there is any interest that should be represented and has not been notified of the application. The creditors as a group have approved a deed of company arrangement, which was put forward on the basis that this application would be made. ASIC has indicated in writing that it neither consents to nor opposes the application and does not wish to appear. The Deputy Commissioner of Taxation and the petitioning creditor for winding up have both been notified of the application and have not appeared. The contributories of the Company support the application. In my view, it is appropriate to proceed on an ex parte basis. 3 The Company was registered on 24 February 2000. Its business was to provide subcontracting services for the hospitality industry. Its issued capital is 100 ordinary $1 shares. Aleksandra Gacic holds 49 shares and Ljiljana Gacic holds 51 shares. Aleksandra and Ljiljana Gacic ("the Directors") are the directors of the Company. 4 On 22 September 2005, the court ordered that the Company be wound up in insolvency and that Mr Lord be appointed liquidator, on the application of Vero Workers' Compensation (NSW) Ltd ("Vero"). Vero's application was based on a statutory demand for an unpaid invoice of $4834. Aleksandra Gacic has given evidence that she negotiated with Vero to pay the invoice by instalments and did not receive the originating process for the winding up of the Company. But the Company did not apply to set aside the statutory demand. 5 The Directors provided their report as to affairs to the Liquidator on 17 November 2005, and also provided him with books and records of the Company. The report as to affairs identified only one asset, a cosmetics and skin-care products business, with an estimated realisable value of nil. According to the report, there are ordinary unsecured creditors of the Company in the sum of $1,094,041.51. Of this sum, $993,335.34 was owing to the Directors. The major non-related creditor was the Deputy Commissioner of Taxation, whose debt was quantified in the report at $58,284.08. Employees' claims for unpaid superannuation contributions for 2004 and 2005 amounted to $21,461.78. Other creditors, as set out in the report as to affairs, are summarised in the affidavit of Aleksandra Gacic sworn on 16 March 2006. 6 The report as to affairs identified secured creditors, namely the lessors under two motor vehicle leases in favour of the Company. The leases for these vehicles have subsequently been transferred and the Company has been released from its obligations. 7 It appears that the Directors developed a proposal for a deed of company arrangement, and presented it to the Liquidator. On 29 November 2005, the Liquidator appointed himself as administrator of the Company under s 436B(2), having obtained the court's leave on 28 November 2005. 8 The Administrator prepared a report in accordance with s 439A(4)(a) of the Corporations Act. He recommended that the creditors enter into a deed of company arrangement (" DOCA") in the form proposed by the Directors, on the ground that the unsecured creditors would receive a dividend of approximately 100 cents in the dollar, whereas in liquidation their dividend was likely to be nil. The Directors' proposal was made on the basis that an application would be made to terminate the winding up after the DOCA had been executed. 9 The creditors of the Company accepted the Administrator's recommendation at their meeting on 21 December 2005, resolving that the Company enter into the proposed DOCA. They did so even though, at the meeting, the Administrator advised that the estimated dividend under the deed would be approximately 74 to 75 cents in the dollar rather than 100 cents. It appears that the Administrator's revised estimate was made when the Deputy Commissioner of Taxation filed a proof of debt for an amount larger than given in the report as to affairs, namely $95,008.08. 10 The resolution to enter into the DOCA was unanimous. The DOCA was executed by the Company, the Directors and the Administrator on 21 December 2005. 11 The DOCA contains the following provisions: (a) a Deed Fund is established under clause 5, in an amount sufficient to cover the costs of the Administrator and the petitioning creditor, the amount of the Company's trading deficiency, the amount owing to Priority Creditors (as defined), and the amount to which the administrator has admitted the proofs of debt of the Participating Creditors (capped at $70,000); (b) "Participating Creditors" is defined so as to exclude the claims of the Directors, which are subject to a deed of deferral (clause 1.1(ii)); (c) Alexandra Gacic is required under the deed to pay the amount of the Deed Fund (less $20,000 already paid) by monthly instalments of $7,000 commencing on 1 March 2006 and concluding on 1 July 2007, with any remaining balance to be paid on 1 August 2007 (clause 5.2); (d) the Deed Fund will be distributed to Priority Creditors and Participating Creditors in accordance with clause 7.1; (e) the claims of Participating Creditors will be extinguished when they receive payment of their full entitlement under the deed (clause 8.2); (f) if any breach of the DOCA or the deed of deferral occurs, the Administrator may call a meeting for the purpose of, inter alia, terminating the deed or proceeding to wind up the Company (clause 10.1); (g) the DOCA may be terminated by notice given to the Australian Securities and Investments Commission once the Administrator has received and distributed the Deed Fund (clause 10.2); (h) the control of the Company returned to the Directors upon the execution of the DOCA (clause 11.1); (i) Aleksandra Gacic is required to make payments under the car lease agreements entered into by the Company until they are satisfied or paid in full (clause 4.3); (j) under clause 12.2(b), the Directors undertook to ensure that the Company would complete and file any outstanding business activity statements, income tax returns and payment summary statements, and lodge them within 8 weeks of execution of the deed. 12 The contemporaneous deed of deferral, entered into by the Company, the Liquidator/Administrator and the Directors, contains provisions generally to the following effect: (a) a covenant by the Directors not to make any claim against the Company in respect of the " Deferred Claims" as defined or any other amount which may be owing, during the "Deferment Period", defined as the period from the date of execution of the DOCA until its termination (clause 3.1); (b) an acknowledgement and agreement by the Directors not to make any claim against the Company "until such time as the Company is able to pay such claim or any part thereof", and that the Company "only has an obligation to pay [the Directors] to the extent that the Company is able to make payment of such claims" (clause 3.3); (c) a covenant by the Directors not to claim to participate in the distribution of the Deed Fund (clauses 4.1 and 4.2). 13 Evidence has been given designed to show that the Directors have complied with their obligations under these two deeds to date. The Administrator has received the payments required by the DOCA for his costs and for the first $7,000 instalment, which was due on 1 March 2006 (the instalment due on 1 April 2006 had not fallen due when the application was heard). The Deputy Commissioner of Taxation has lodged a revised proof of debt reducing his claim to $69,739.26, and the Administrator now estimates that the return to Priority Creditors (the employees) will be 100 cents in the dollar and the return to ordinary unsecured creditors will be 95 cents in the dollar. There is evidence that the Directors have complied with their obligation to lodge outstanding taxation-related documents. 14 The Directors have given undertakings to the court regarding the preservation of the deferral of their debts and the subordination of those debts to any future creditors of the Company. The Directors also consent, as contributories, to the application for termination of the winding up. The terms of their undertakings: given in Exhibit A6, are important and should be set out in full: We, Aleksandra Gacic and Ljiljana Gacic of [address] each undertake to the Supreme Court of New South Wales that: 1. We will not, at any time, amend, seek to amend or breach the Deed of Deferral entered into between us, Ferretti Pty Ltd (in liquidation) ("the Company") and John Frederick Lord on 21 December 2005 ("the Deed of Deferral"). 2. We will not at any time cause or permit the Company to breach, amend or seek to amend the Deed of Deferral. 3. We will not, at any time make demand for, sue or in any way seek to recover or cause or permit the Company to pay to us the Deferred Debts the subject of the Deed of Deferral, or interest in future accruing thereon (or any part thereof), except out of profits of the Company. 4. We will only cause or permit the Company to pay us the Deferred Debts or interest in future accruing thereon (or any part thereof) the subject of the Deed of Deferral in the following circumstances: (a) after all creditors of the Company at that time have been paid; and (b) when the Company is otherwise able to pay all of its debts (presently owing or contingent) when they fall due." The relevant law 15 Section 482(1) of the Corporations Act empowers the court, on application, to make an order terminating the winding up of a company on a day specified in the order. Subsection (1A) permits an application for termination to be made, inter alias, by the liquidator of the company. 16 The Corporations Act contemplates that voluntary administration may supervene upon the process of winding up the company. Section 436B expressly empowers a liquidator of a company to appoint an administrator, and permits the liquidator to appoint himself or herself as administrator with the leave of the court. That may occur in circumstances where the liquidator believes that the interest of the creditors will be better served by developing a proposal for a deed of company arrangement, than by continuing with the winding up process. The effect of the appointment of a voluntary administrator is that the administrator obtains control of the company's affairs (s 437A(1)) and the liquidator's functions and powers are suspended (s 437C(1)). But the liquidation remains in place, and if the administration does not lead to a deed of company arrangement the winding up will resume (see Mercy & Sons Pty Ltd v Wanari Pty Ltd (2000) 35 ACSR 70; Re Nardell Coal Corporation Pty Ltd (2004) 49 ACSR 110). If the administration leads to a deed of company arrangement, the liquidator's powers are no longer suspended by virtue of s 437C(1), but he or she is bound, as an officer of the company, by the terms of the deed (s 444G(b)). 17 The principles that apply to the termination of a winding up of a company that is subject to a deed of company arrangement were considered by me in Mercy v Wanari and Re Nardell Coal Corporation, and by Barrett J in Sutherland v Rahme Enterprises Pty Ltd (2003) 46 ACSR 458. They may be summarised as follows: (i) the court has a discretion as to whether the winding up should be terminated; (ii) in exercising its discretion, the court considers the interests of: · creditors of the company (including future creditors); · the liquidator, particularly with respect to costs; · the contributories; · the public, including the public interest in matters of commercial morality, and the public interest that insolvent companies should be wound up. 18 In the present case, counsel for the Liquidator placed some emphasis on the objects of Part 5.3A, which are set out in s 435A (see also Mercy v Wanari at [53]). She submitted that there is a difference between cases where termination is sought of the winding up of a company that is subject to a deed of company arrangement, and cases where there is no such deed in place. In cases of the latter kind, solvency is highly significant in the consideration of the public interest, whereas in cases of the former kind, the public interest must be viewed in the context of the purposes of Part 5.3A. I agree. Specifically, it is relevant to consider whether the arrangements adopted in the deed of company arrangement are likely to maximise the chances of the company, or as much as possible of its business, continuing in existence (see s 435A(a)). In assessing these matters, there is no absolute rule that a winding up cannot be terminated as long as one or more debts of the company remain undischarged (Mercy v Wanari at [48]). 19 Having regard to these principles, it is appropriate to consider, respectively, the interest of creditors, the liquidator, contributories and the public. The interests of creditors 20 The following matters have persuaded me that the interests of present creditors will be served by terminating the winding up: (i) the creditors who attended the second meeting of creditors in the administration of the Company voted unanimously in favour of execution of the DOCA; (ii) Priority Creditors (employees) will receive a dividend of 100 cents in the dollar and ordinary creditors are likely to receive a dividend of about 95 cents in the dollar, whereas (according to the Liquidator's estimate) creditors will receive no dividends in a liquidation; (iii) although the Deed Fund will be established only by a series of periodical payments and therefore there is a default risk, the claims of creditors will not be extinguished until all payments have been made (clause 8.2). 21 However, I am not satisfied that the interests of future creditors will be adequately protected. Their position raises issues about the public interest in the solvency of trading companies, and is considered below. The interests of the liquidator 22 The following circumstances persuade me that the interests of the Liquidator will be met if the winding up is terminated: (i) the Liquidator is the applicant and he has expressed the view that a termination order should be made; (ii) the Liquidator is bound by the terms of the DOCA under s 444G(b), including clause 11.1 under which the control of the Company is returned to the Directors; (iii) if the DOCA is terminated, the Liquidator will be obliged to investigate and report as to the affairs of the Company, with no obvious source of payment; (iv) there is no discernible utility in leaving the liquidation to co-exist with the deed administration until the distribution of the Deed Fund is completed in August 2007. The interests of the contributories 23 The contributories of the Company are the Directors, who are the proponents of the DOCA and have accepted obligations under it. They both support the termination of the winding up and have consented to the making of the order. The public interest 24 Here there is no issue of commercial morality in the sense in which that expression is used in the cases. The court made an order for the winding up of the Company on the basis of a statutory demand for a small amount of money, payment of which (according to the evidence of Aleksandra Gacic) was under negotiation. According to Ms Gacic's evidence, the originating process for the winding up application was not received by the Company. Under the DOCA, the Directors are contributing sufficient funds to pay all of the Priority Creditors and to pay ordinary unsecured creditors approximately 95 cents in the dollar. 25 There is, however, an important issue regarding the solvency of the Company. Once the obligations set forth in the DOCA have been fulfilled and the DOCA is terminated, the Company may have no assets and no current liabilities. It will not be insolvent in the statutory sense because the very large liabilities it has to the Directors will be subject to the deferral arrangements that I have described. The question is whether the continued existence of the Company's liability to the Directors should lead the court to conclude that termination of the winding up would be contrary to the public interest, notwithstanding the deferral arrangements. 26 The solvency of a company is fundamental to the exercise of the court's discretion to terminate an order for winding up in insolvency, as Barrett J observed in Sutherland v Rahme Enterprises at [9]. That general concern about solvency is combined, in the cases, with a specific concern about saddling future creditors with the risk of dilution of their claims by pre-termination claims: Re Data Holmes Pty Ltd [1971] 1 NSWLR 338 (and on appeal, [1972] 2 NSWLR 22); Re Nature Springs Pty Ltd (1994) 13 ACSR 50. In the present case, the issue is whether the preservation of the Directors' claims, subject to the deferral arrangements that I have described, should be regarded as contrary to the interests of future creditors and the public interest. Deferral of the Directors' claims 27 The Directors have very large claims against the Company, in the total amount of over $993,000. It appears that the Company has no assets. Unless there are adequate arrangements to protect future creditors by effectively deferring the Directors' claims to creditors' claims in all circumstances, the Directors' large claim will hang over the Company's dealings with new trade creditors, and dilute the creditors' claims to any assets in the event of a future external administration, to such an extent as to be tantamount to eliminating any prospect for the creditors to recover their debts. In other words, the termination of the winding up will amount to "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" (Sutherland v Rahme Enterprises at [27] per Barrett J). 28 It is therefore necessary to consider whether the arrangements in the deed of deferral and the undertakings to the court amount to effective deferral of the Directors' claims. 29 In Re Data Holmes Pty Ltd [1971] 1 NSWLR 338 (and on appeal, [1972] 2 NSWLR 22), Street J made the following observations about a subordination agreement (at 341): "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." 30 The last point, relating to the solvency of the company, may not be a specific concern here. In the present case, the solvency of the Company is arguably assured by the deed of deferral and the undertakings to the court, even if they are not sufficiently watertight to satisfy the court's concern about the interests of future creditors. This is because, according to the modern case law applying the definition of solvency in s 95A, the issue of solvency involves a pragmatic assessment of the company's ability to pay its debts as and when they become due and payable, as a matter of commercial reality, and firm declarations of the intention of a creditor not to press the payment of its debt when other debts are due for payment may be sufficient (see Ford's Principles of Corporations Law (LexisNexis, looseleaf) at [20.100]). The view I take about the interests of future creditors makes it unnecessary to me to decide about present solvency. 31 Street J's first point, a general apprehension about subordination arrangements that were relatively novel in 1971, has evaporated, because (as McLelland CJ in Eq said in Nature Springs at 52), a subordinated debt can no longer be described as a "new species" of monetary obligation. 32 His second point, about the ranking of the deferred claim in winding up, now has a statutory answer in s 563C of the Corporations Act. But the concern about the efficacy of subordination arrangements vis-a-vis future creditors, expressed by Street J and by Mason JA on appeal, was clearly not restricted to a doubt, prior to the introduction of s 563C, about the effectiveness of a subordination agreement in winding up (see Nature Springs at 52). 33 Street J's third point was to ask by whom and how would the deferment be enforceable. McLelland CJ in Eq in Nature Springs (at 52) regarded this point as a cogent reason for treating a subordination agreement as failing to provide a sufficient mechanism for the protection of future creditors. In the present case the deed of deferral would be enforceable only by the Company and the Administrator, who are the other parties to it, and not by future creditors. In all probability, the question of the efficacy of the deed would arise well after the termination of the DOCA and the retirement of the Administrator, and at a time when the Company would probably be under the control of the Directors. Possibly a future creditor could make an application to the court designed to enforce the undertakings given by the Directors. But the issue may arise well in the future, at a time when there would be little likelihood that a future creditor would be aware of the existence of the undertakings. It therefore seems to me that Street J's third point is a problem in the present case. 34 Street J's fourth point was to ask what would happen if the new owner were to disregard the deferment. That was also regarded by McLelland CJ in Eq (Nature Springs at 52) as a cogent reason for regarding a subordination agreement as an inadequate protection for future creditors. It is true that breach of the deed of deferral would trigger the termination provisions in the DOCA (clause 10.1), but issues of the efficacy of the deferral are likely to arise after the DOCA has been terminated in the ordinary course, at a time when clause 10.1 is no longer relevant. 35 There are various problems. One is that the only constraint on the Directors under the deed of deferral after termination of the DOCA is their "acknowledgement and agreement" in clause 3.3. It is odd to describe that provision as involving an "acknowledgement", a term that implies recognition of something that is already the case. If the clause is treated as an agreement or undertaking by the Directors, it is in very vague terms. One issue is what is meant by "able to pay such claim". Will the Company be able to pay the Directors' claim if it has the cash resources to do so even though other creditors are clamouring for payment? What is meant by "able to pay such claim or any part thereof"? Are the Directors relieved of their undertaking as soon as the company is able to pay $1 out of the total claim of over $993,000? How, if at all, does the undertaking to the court qualify this language? 36 Further, clause 3.3 is not, in terms, an agreement to subordinate the Directors' claims. Consequently there is some doubt, in my view, as to whether the clause amounts to a "debt subordination" for the purposes of s 563C(2). Arguably the clause is not an agreement or declaration that the Directors' claims "will not be repaid until other specified debts that the company owes are repaid to a specified extent". Para 4 of the undertakings to the court goes further than the deed of deferral and appears to satisfy the definition in s 563C(2), but that raises a question about the relationship between the deed and the undertaking to the court. Why is one obligation different in scope from the other, and with what consequences? 37 In summary, it seems to me that there are some real difficulties in regarding the deed of deferral, considered together with the undertakings to the court, as sufficient to protect future creditors from the risk of being unacceptably prejudiced by legacies of the Company's former life (Sutherland v Rahme Enterprises at [27] per Barrett J). 38 In Nature Springs, McLelland CJ in Eq said (at 51-52): "It is a long established principle that it is contrary to the public interest to terminate the winding up of a company if after the termination the company would remain insolvent in the sense that its liabilities will substantially exceed its assets, even if there is a contractual subordination of all existing debts to future debts." 39 If his Honour's statement expresses a principle of law to be applied without exception, one would have to conclude that a termination order should never be made in reliance on subordination arrangements. Although, as I have said, it is arguable that the company is solvent when one takes into account the effect of the deed of deferral and undertakings to the court, it is plain that the company is insolvent if those matters are disregarded, for there is an enormous debt owing to the Directors that would appear to be payable on demand but for their undertakings. The thrust of his Honour's statement is that one should disregard the contractual subordination of the Directors' claim. 40 In my opinion, however, the passage I have quoted from Nature Springs should not be regarded as a statement of a proposition of law applicable without exception in modern times, after the introduction of Part 5.3A. 41 Nature Springs was a case where contributories had paid out current creditors and substituted themselves as creditors in equivalent amounts, and had entered into a deed with the company for the subordination of their claims on the company to the claims of all other creditors. McLelland CJ in Eq's observation was therefore not made in a case where termination of the winding up would leave the company under a deed of company arrangement, under which the company's creditors would receive a distribution substantially in excess of what they could expect if the winding up were allowed to continue. Not being made in an administration context, the observation did not take into account the statutory objective of maximising the chances of the company continuing in existence, articulated in s 435A. 42 In the present case, to allow the DOCA to be performed so that the unsecured creditors receive a distribution, and to permit the company to resume its business free of external administration of any kind if the DOCA is performed, gives effect to the objectives of Part 5.3A and the interests of creditors. If the liquidation is not terminated, it seems likely that the Company will be unable to trade and the creditors will receive no dividend. In my opinion, notwithstanding the McLelland CJ's in Eq's observation, it is appropriate for the court to take these considerations into account when assessing whether to exercise its discretion to terminate the winding up. 43 What emerges, in my view, is that the court must carry out a balancing exercise when deciding whether to terminate the winding up, as so often happens when there is a judicial discretion to be exercised. Here, I must weigh up the advantages to present creditors, the liquidator and contributories, and the prospect of fulfilling the objectives in s 435A, against the risk of prejudice to future creditors and the public interest in companies trading solvently. 44 In my view there are occasions when the proper balance is for the court to make a termination order if there is an agreement or undertaking to the court purportedly having the effect of subordinating related creditor claims to the claims of all future creditors. Applications for termination of a winding up (not involving an overlaid voluntary administration) are very common in the Corporations List, typically involving small companies and relatively small related creditor claims, and such subordination agreements or undertakings to the court are occasionally accepted by the Corporations Judge. But there is always a risk that the subordination arrangements will be ineffective or will have been forgotten by the time any issue arises, and further, and it remains true that the court should not "sponsor the circumstances" that give rise to such arrangements (Data Homes at 341), especially where there is a more secure alternative available (though no doubt less efficacious in income tax terms), namely the capitalisation of the related party debt (see Collins v G Collins & Sons (984) 9 ACLR 58). 45 In the present case, I have decided that the problems with the subordination arrangements that I have outlined, coupled with the fact that the related creditor claims are for a very large amount and the company has no assets, are considerations which outweigh the advantages to existing creditors, the liquidator and contributories that would be obtained by implementing the scheme as presently proposed. The Directors might have chosen the alternative route of capitalisation of their debts and they have not done so. On balance, the risks to future creditors are too great and the application for termination of the winding up should be refused.