Compromise proposals fail to convince Court

Summary

There were a number of significant irregularities in the debtor companies' compromise proposals. The Court held that it was not appropriate to ratify or grant compromises in these circumstances.

Impact of decision

The decision is a helpful and thorough analysis of the various creditors' compromise provisions of the Companies Act 1993.

Facts

This summary is in respect of two related decisions that were delivered contemporaneously. The FM 1 decision is a companion judgment to the Atlas decision, and the two decisions should be read together. The proceedings were in respect of compromises proposed by the companies with their creditors under Part 14 and/or 15 of the Companies Act 1993 ("the Act").

The proceedings involve seven companies owned and controlled by the same person. Four of the companies (the Atlas companies) are involved in the hospitality industry. The other three (the FM 1 companies) are no longer trading, but were previously property-owning companies.

The Commissioner applied to liquidate each of the companies on the grounds that they were unable to pay their debts. The companies then proposed compromises with their creditors under Parts 14 and/or 15 of the Act.

Atlas companies

The Commissioner had a number of concerns with the compromises:

• He was classified together with secured creditors, which was inappropriate.
• A secured creditor's debt was grossly overstated, and was contingent.
• A number of companies related to the Atlas companies were permitted to vote on the compromises.
• The timeframe for payment was too long and that the likelihood of payment was uncertain.
• The compromises purport to contract out of the statutory interest (ie UOMI) and penalty regime.
• The terms of the compromises were irreconcilable with the Commissioner's obligation to uphold the integrity of the tax system.

The Commissioner voted against the compromises, but the compromises were purportedly accepted by the creditors in relation to two of the four companies. The compromises were rejected by creditors in relation to the other two companies.

The Commissioner applied for orders under section 232 of the Act that he not be bound by the two compromises that were purportedly passed, on the grounds that there were material irregularities in the compromises and/or the compromises were unfairly prejudicial to the Commissioner.

The four Atlas companies each applied to the Court for orders under section 236 of the Act approving the compromises.

FM 1 companies

The Commissioner had a number of concerns with the FM 1 companies' compromises. While there were multiple creditors, the only creditor whose debt was being compromised was the Commissioner. The other creditors were to take no part in the compromise, and receive nothing under it. They retained all their rights. Additionally:

• the compromises provided that penalties and interest would not accrue on the outstanding debt which was not possible;
• the debts owed to the Commissioner arose from transactions which indicated a cynical disbursement of proceeds to defeat the Commissioner's claims;
• the Court and the Commissioner could have no confidence that the compromises would be performed on their terms because of the "untidy" way in which the proposals were presented and advanced and because of the commercial uncertainty surrounding the proposed repayment arrangement over a five-year time frame;
• that the affairs of the three applicant companies and the actions of their directors in and about August 2008 warranted investigation and this was best able to be achieved through the making of liquidation orders and the appointment of liquidators;
• public policy considerations militated against granting the applications as each of the three companies was insolvent, with no recent trading history and no legitimate interest to protect;
• the proposal to pay $1,000,000 over a five-year time frame represented only a modest proportion of the core debt (about 62%).

A meeting of creditors was scheduled to consider and vote on the proposed compromises. After the Commissioner drew the companies' attention to apparent defects in the compromises, the meeting was cancelled. The companies then applied for orders under section 236 of the Act that the compromises be approved.

Decision

Material irregularities with Atlas companies' applications

The Court was satisfied that the Atlas companies' applications were affected by material irregularities. In particular, the Court held that the Commissioner as a preferred creditor should not have been placed with secured creditors but in a separate class; that a large-contingent creditor should have been placed in a separate class (not the secured class) and should have had the value of its debt (incorrectly stated) discounted; that related parties who were not to receive anything under the compromise should have been separately classified and their votes discounted in full.

Compromises unfairly prejudicial to the Commissioner

Based upon the findings made regarding material irregularities and the overlap with the section 236 arguments, the Court had no difficulty in establishing that the compromises were unfairly prejudicial to the Commissioner and he could not be bound by them.

Atlas companies' section 236 applications

The Court was not persuaded to grant the Atlas companies' section 236 applications. The Court held inter alia that aside from the Atlas and Schwartz (one of the other applicants) applications being tainted by material irregularity pursuant to section 232 the four section 236 applications failed due to a lack of reliable evidence. The Court was reasonably scathing about the manner in which the applications had been presented:

• [74] The findings I have already made in relation to material irregularities remain relevant in the present context. For the reasons already discussed I do not consider there is reliable evidence available as to the true level of creditor support for the compromises. In addition, the section 236 applications have been presented in a most informal manner. Creditors are not directly apprised of the revised terms of the compromises, rather they have been invited to make further inquiry if they see fit. Mr Forbes argued that because the amendments serve to improve the proposed terms of compromise the process employed should not be viewed as a matter of concern. I do not agree. To my mind I am being asked to approve four compromises absent a proper and adequate opportunity for creditors to have an informed input.

The Court also held grave concerns regarding the continuing role played by the director of most, if not all, of the relevant companies. The Commissioner argued that of the 64-odd companies presently registered with Inland Revenue under his control, 90% of income tax returns from those 64 companies were outstanding. In response to defaults by these companies, the Commissioner had issued 28 statutory demands and filed 13 liquidation proceedings, in addition to filing 44 District Court applications seeking orders requiring various companies to file overdue returns. The Court's view on the suitability of the director's control of the relevant companies particularly as it related to overseeing the proposed repayment proposal was stark:

• [95] In my view [his] position as the director of all relevant companies and as the person responsible for the implementation of the compromise proposals, is untenable.

FM 1 companies section 236 applications

The Court formed a clear view that the proposals should not be approved, essentially because it would not be fair and equitable to do so. The Court was influenced by the following matters:

• Where a solitary creditor is affected by a compromise and it is proposed that he should only receive a proportion of his debt, there would need to be highly persuasive considerations in favour of the applicant company continuing in existence before approval would be appropriate.
• There weren't any good reasons for not liquidating the applicant companies.
• The Court viewed that the affairs of the applicant companies warranted investigation which may be best achieved by liquidation.