Financial Services Alert - An Imperfect Storm

On Thursday 26 March 2009 the Federal Court of Australia ordered the winding up of Storm Financial Limited ("Storm") [1]. It did so only 1 clear business day prior to a proposed meeting of creditors convened to determine whether Storm be wound up or execute a Deed of Company Arrangement(DOCA) with its creditors as proposed by Storm's directors (Mr and Mrs Cassimatis). Why the Court ordered Storm to be wound up, and the significance of its orders, are the subject of this article.

Background

Storm carried on the business of financial planning. The audited financial reports for the year ended 30 June 2008 demonstrated that Storm achieved, amongst other things, a profit before tax of $37.5 million, an increase of 263% from 2008. A little more than 6 months later, and on 8 January 2009, the directors of Storm resolved to appoint administrators. On 15 January 2009, the Commonwealth Bank of Australia appointed Receivers and Managers to Storm, pursuant to security it held in consideration for moneys advanced to Storm.

The administrators, when calling the second meeting of creditors, recommended that Storm be wound up. Concurrently they provided to creditors the detail of a DOCA proposed by the directors of Storm. This procedure reflected a fundamental tenet of Australian insolvency law: that when a company is placed in administration, it is ordinarily the creditors who ought decide its fate.

And yet, prior to this meeting of creditors, ASIC applied to the Federal Court of Australia for Storm's winding up. The fact that Storm was in administration did not preclude it from doing so. However, what was hotly contested (by Storm's directors) was whether ASIC's application for the winding up of Storm ought be adjourned, particularly given the impending meeting of creditors.

Why did ASIC seek orders for the winding up of Storm?

After consideration of the proposed DOCA, ASIC formed the view that it was in the interests of the creditors to decide the fate of the company. However, a week prior to the meeting of creditors, ASIC became apprised of a document published on the website maintained by the directors of Storm and entitled "A Simple English explanation of the DOCA" and "Storm Financial Limited - The Simple Solution" ("the Information Memorandum") and other commentary on the proposed DOCA by the directors.

In correspondence to the directors' solicitors prior to the bringing of its application, ASIC contended that the Information Memorandum did not "provide a fair and balanced summary of the essential terms of the DOCA as it purports to do, and is misleading in a number of respects"; and was contrary to the statutory procedure mandated by Part 5.3A of the Corporations Act (the Act). ASIC sought a winding up of Storm on the basis that is was just and equitable to do so and on the basis that Storm was insolvent (a fact not contested by the directors).

Should ASIC's application to wind up Storm have been adjourned?

The principal issue for consideration by the Court was, naturally enough, whether the application to wind up Storm ought be adjourned to allow the creditors to vote on the proposal.

Section 440A (2) of the Act provides as follows:

(2) The Court is to adjourn the hearing of an application for an order to wind up a company if the company is under administration and the Court is satisfied that it is in the interests of the company’s creditors for the company to continue under administration rather than be wound up.

The Court observed that the section makes it clear that it is for those who contend for the adjournment of a winding up application of a company in administration to satisfy the court that an adjournment is in the interests of creditors. If they are able to do so, the application must be adjourned. If not, the Court might still adjourn the winding up application if it considers it appropriate to do so.

Relevant factors

In argument, ASIC intimated that if the creditors voted for the DOCA at the creditors' meeting it was "highly likely" that ASIC would seek an order terminating the DOCA pursuant to section 445D of the Act. The Court stated that this was a factor to be taken into account in determining whether an adjournment is in the best interests of the creditors.

The DOCA sum

As is often the case with a proposed DOCA, the directors proposed to establish a fund for the benefit of creditors that would ordinarily (so they contended) not form part of the moneys available to creditors in a liquidation. For example, directors usually agree to contribute personal funds to a DOCA fund. That is what the directors of Storm contended they were doing.

However, as was noted by the Court, the DOCA sum ($2mil held in an account controlled by the directors) is the subject of Supreme Court litigation. Presently there is an injunction against the proposed payment of the DOCA sum to the directors, authorised on the eve of the administration of Storm. The directors proposed to inject these funds into a fund to be established upon approval by the creditors of the DOCA, which would be used to fund investigations into the circumstances leading to Storm's financial difficulties and to fund litigation against the Commonwealth Bank, whom the directors have publicly blamed for Storm's present predicament (and that of its clients).

As the Court noted, the DOCA sum was not presently available to creditors, and may never have become available under the DOCA proposed by the directors.

What of the imminence of the creditors' meeting?

The close proximity of the creditors’ meeting was also not sufficient to convince the Court to adjourn the winding up application. It was not"persuaded that an adjournment would serve either of the objects of Pt 5.3A. It is no part of the intendment of the DOCA that it will preserve Storm Financial’s business or, other than after highly conjectural recoveries, the company itself. As already noted, the creditors are not shown to be better off…”

As to whether, despite this view, the Court ought nevertheless permit the creditors to decide whether they might be better off, the Court stated that:

“In this regard, it is relevant in my opinion, in assessing the interests of creditors for the purposes of s440A(2) of the Act, to take into account the terms of the Information Memorandum."

The "Information Memorandum" - a bridge too far

After noting that the Information Memorandum was a "remarkable document" the Court stated as follows in relation to the assertions made therein (keeping in mind that it purported to reflect the DOCA as a "simple solution"):

"..it is not correct to describe the DOCA as a “simple solution”. Mr and Mrs Cassimatis may believe that but, objectively, that seriously misdescribes not only the contingencies that attend the payment of the DOCA sum either within the maximum time allowed under the DOCA or at all but also the difficulties that will attend recovering monies for the benefit of creditors.…

Neither, objectively, is it correct to describe the DOCA proposal as “generous”. The worth of what is offered under the DOCA is not quantifiable, either relatively or absolutely, for the reasons given by the administrators in their report and by Mr Worrell [one of the administrators] in his affidavit.”

The Court noted that notwithstanding its criticisms of the Information Memorandum it could nevertheless order the removal of the Information Memorandum from the directors' website and make other remedial orders. Yet the Court was simply not convinced that the DOCA proposed offered the prospect of a better return to creditors as opposed to liquidation. It is worth setting out the conclusions of the Courtin some detail:

'"Were I persuaded that the DOCA did offer the prospect of a better return to creditors than a liquidation even though false or misleading statements had been made concerning it, this alternative would carry greater weight. However, the more I reflect upon this DOCA, the more it seems to me that it is a chimera; creative, but hardly constructive insolvency. …creditors are being asked to decide to wait 60 days or perhaps 120 days to see whether the DOCA sum will emerge as available for ECA to pay from litigation closely contested for reasons good enough to constitute a serious question to be tried. …

The DOCA requires Mr and Mrs Cassimatis to co-operate with the administrators in respect of all matters done under it (cl 28). The DOCA consigns to Mr and Mrs Cassimatis a role in relation to litigation other than as witnesses. It is not, it must be said, an unfettered role.

In my opinion, the present proceedings, including the separate application made by Mr and Mrs Cassimatis, are eloquent as to the prospects of their co-operation and dispute in relation to litigation decisions in the DOCA.”

Just and equitable ground

As noted at the outset of this article, ASIC also sought a winding up of Storm on the basis that it was "just and equitable” to do so. The Court noted that legislation under which ASIC was created intended to invest in ASIC the role of a "scrutineer of the public interest". The Court noted that Storm had failed spectacularly and that the administrators had recommended its winding up; and that they had observed that there were a great many matters which required investigation, particularly with a view to determining who or whom might bear legal responsibility for the losses suffered by Storm, their investors and their creditors. The Court found that it was in the public interest and therefore just and equitable for Storm to be wound up.

Conclusion and Discussion

In the end then, Storm was wound up on the grounds of insolvency and on the just and equitable ground.

The directors were not able to satisfy the Court that it was in the interests of creditors that ASIC's application to wind up Storm ought be adjourned. Many interesting issues arise from the Court’s decision - both in terms of what the Court said and the issues traversed - for the insolvency sector generally. In no particular order they are:

For proponents of the adjournment of a winding up

1. Whether a winding up application ought be adjourned when a company is in administration requires the Court to be satisfied that there is evidence suggesting that an adjournment is in the interests of creditors as a whole. Whilst the court would retain the discretion to nevertheless adjourn the application absent that evidence, the prospects of it doing so without any evidence appears to us to be minimal;

2. if the applicant for an adjournment is the administrator, he or she should, in theory, have access to sufficient information to provide the Court with a reasoned decision. If the applicant is someone other than the Administrator, eg the directors, they may well face a tougher time proposing an adjournment, particularly in circumstances where the Administrator has concluded that it is in the creditors’ best interests that the company be wound up anyway;

3.that an applicant for a winding up has both the means and standing to apply for the termination of any DOCA that might be approved by creditors if a winding up application is adjourned, is a factor which a Court will take into consideration when considering any application to adjourn a winding up application against a company in administration;

For the proponents of a DOCA

4. any proponent of a DOCA ought limit themselves to the wording of a proposal to be distributed by administrators prior to the creditors' meeting to decide the company's fate and ensure that any proposal is detailed and accurate. What awoke ASIC's interests in this instance was the publication of a document, which in seeking to "simplify" or explain the DOCA proposal glossed over substantive and complex issues and which did not reflect the contingencies of the DOCA proposal upon which the administrators had passed comment and upon which the creditors had been asked to vote;

5. proponents ought ensure that any proposal offers a true alternative to the benefits of liquidation. Part of the difficulty for the directors of Storm in their bid to have ASIC's winding up application adjourned was that they were unable to convince the Court that a DOCA would clearly result in a better outcome for all creditors;

For administrators

6. given the compressed time frame for reporting to creditors, administrators will not always (if ever) have the luxury of producing a detailed recommendation to creditors as to the comparative returns available in a liquidation as opposed to a DOCA, particularly where there are complex issues involved in identifying an entitlement to, and the potential quantum of, any action to recover assets. That is not a basis though for other parties contending that any recommendation is flawed or unreliable;

Generally

6. ASIC, as corporate regulator, has demonstrated a willingness to intervene in circumstances where it considers creditors are being misled. To the extent that it is able to establish that misleading information is being disseminated by the proponents of a DOCA, there is likely to exist a strong public interest argument against an adjournment of a winding up application;

7. One of the fundamental objects of Part 5.3A is to offer creditors alternatives as to the ongoing management of insolvent companies. Winding up a company during an administration may not conflict with this object, particularly in circumstances where the proposed alternative (a DOCA) is simply not in the interests of the creditors. What this case shows is that where there is a perception that a proposed DOCA offers an illusory alternative for creditors or its contents or potential outcomes are couched misleadingly, ASIC may intervene to ensure the best interests of creditors are secured and the Court is willing to entertain and grant the orders sought.