DOCAs under judicial microscope

The Australian restructuring landscape has evolved in recent years, shifting from a focus on debt enforcement as a tool for asset sales, to deleveraging by way of debt for equity swaps.

The growth of “private capital” investors in the market has introduced additional tools and techniques for dealing with distressed credits, including the super-priming of rescue capital, safe harbour reforms and relative abolition of ipso facto triggers. These have refocused directors and management on developing and then executing on turnaround plans, as opposed to forcing a company into early insolvency proceedings.

While Deeds of Company Arrangement (DOCAs) remain a key restructuring tool, they are facing increased judicial scrutiny. Recent cases highlight that creditors must be treated fairly, with rational justification for differing repayment terms. Courts have set aside DOCAs perceived as vehicles for avoiding legitimate creditor claims or undermining public policy.

For example, in Canstruct Pty Ltd v Project Sea Dragon Pty Ltd (Subject to a Deed of Company Arrangement) (No 4) [2024] FCA 112, the Court set aside a DOCA for a special purpose vehicle (SPV) after determining it was designed to avoid the special purpose vehicle paying a creditor pursuant to an adjudication determination. The Court found the DOCA was an abuse of Pt 5.3A of the Act, was unfairly prejudicial and was entered into after false or misleading information was given to creditors.

Similarly, in Academy Construction & Development Pty Ltd (Subject to Deed of Company Arrangement) [2024] NSWSC 808, a DOCA set aside where the Court considered there was a lack of rational basis for the disproportionate treatment of the Owners Corporation and other unsecured creditors. This is notwithstanding the fact the DOCA may have provided a better return to unsecured creditors under the DOCA than a liquidation.

The key takeaways from these decisions are as follows:

(a)    It will not sufficient to say that creditors are “better off” by dollar value in a DOCA than a liquidation.

(b)    If there are differences in the returns to different creditors under a DOCA, these differences must have a rational basis.

(c)    A DOCA should not be used as a vehicle to avoid the payment of judgment or other debts following a litigation process – the court will consider whether the predominant purpose aligns with the objects of Part 5.3A of the Corporations Act (ie. the voluntary administration process).

(d)    While not always applicable, the court may consider the public policy, including potential allegations of fraudulent activity.