Court agrees with administrators’ decision to reduce proof of debt from $5 million to $1

In a recent decision of the Federal Court of Australia (Sino Group International Limited v Toddler Kindy Gymbaroo Pty Ltd [2022] FCA 630), the directors were found to have validly admitted a claim of $5 million for a face value of one dollar.

The case is a timely reminder of the importance of properly proving debts, particularly for the purposes of creditors’ meetings to determine next steps.

Key points to remember

  • Indefinite damages claims against a business do not result in a liquidated debt without proof and must be clearly specified for the purpose of presenting proof of debt.
  • For the purposes of creditors’ meetings in the context of external administration, the administrators are authorized to admit claims and reduce them to a nominal value in the event of insufficient information. This can have significant impacts for creditors when decisions are ultimately made on how to distribute funds and determine next steps.
  • When deciding whether an administrator has not adequately investigated a matter for the purposes of a report to creditors, the Court will consider the time constraints imposed on the administration process.

Background

Sino Group International Limited and another company (together, the Sino creditors) had been involved in an arbitration with Toddler Kindy Gymbaroo Pty Ltd (TKG). In 2020, the arbitrator determined that TKG was liable for Sino creditors’ costs after various requests for termination of proceedings were denied. In 2021, the arbitrator issued a partial final award in favor of the Sino creditors, for which they could recover costs.

The external directors (the Administrators) were later named for TKG. At that time, the remaining claims in the arbitration proceeding had not been heard or determined, and no evidence or submission regarding damages payable for the alleged breaches had been filed.

On November 30, 2021, the Sino Creditors filed proof of debt of $5,964,197.15. Of this debt, $5 million corresponded to a claim for unspecified damages resulting from the breach of the contract subject to arbitration. The remaining amount was the combined costs ordered by the arbitrator. For the purposes of voting at meetings of creditors of TKG, the Directors:

  • admitted the debt for costs ordered in the arbitration (with a significant reduction); and
  • allowed the claim for damages but reduced it to a nominal amount of one dollar.

A resolution was then passed at TKG’s second meeting of creditors to execute a deed of partnership arrangement (DOCA), although Sino creditors unanimously voted against.

The app

The Sino creditors have filed for termination or cancellation of the DOCA under Section 455D of the Companies Act 2001 (Cth) (the act). Under Section 455D of the Act, a court may terminate a DOCA in various circumstances. Relevant here, this includes situations where the disputed act is the result of false or misleading information included in the report to creditors, or there has been an omission of material information from the report to creditors. A court may also terminate a DOCA if it is oppressive, unfairly prejudicial or discriminatory against a group of creditors.

Among other things, the Sino creditors alleged that the outside directors failed to adequately investigate the company and its affairs. This error would have led the Directors to assess the claim for damages at the nominal amount of one dollar. The Sino creditors alleged that this error infected the reports to creditors that led to the DOCA, which would have been unfairly prejudicial, discriminatory or oppressive.

Applicable law

Judge Anderson acknowledged that whether a director produced an error-infected report is partly determined by reference to whether he complied with his legal obligations under Section 438A of the Act. to properly investigate the affairs of a company.

His Honor has held that the standards applicable to an administrator’s investigation are necessarily influenced by the time constraints of the outside administration process. This meant that Sino Creditors’ request had to be considered in the context of the information available at the time the DOCA was entered.

Additionally, Anderson J considered that the Insolvency Practice Rules (Companies) 2016 (Cth) were relevant insofar as they identified creditors’ right to vote at creditors’ meetings. His Honor notably underlined the distinction between ruling on the right to vote at meetings (as was the case here) and ruling on proof of debt for dividend purposes.

What did the Court decide?

The Court dismissed the request.

Anderson J noted that the information available to the Directors regarding the amount of damages was insufficiently specific. In light of the evidence, this could only be described as a “mere assertion”.

Judge Anderson referred to the directors’ evidence that:

  • Sino creditors had described the debt as “approximately $5,000,000”;
  • spreadsheets purporting to break down this figure could not be reconciled to a total of $5 million; and
  • there was no objective evidence by means of a forensic accountant or other expert report.

The debt was therefore an unliquidated conditional debt.

The directors were found to have acted in accordance with authority in admitting the debt in the face amount of one dollar for the purposes of admitting Sino creditors to vote at the meeting of creditors. Anderson J concluded that the report to creditors was therefore not misleading or did not suffer from material omissions. This conclusion seeped into His Honor’s reasons for dismissing the other reasons, which were based in part on the allegation that the Sino creditors had been denied a “very substantial claim for damages against [TGK]’.

Comment

This case is a useful reminder that proof of debts must be duly attested. A court or arbitration finding that a party is liable for a breach will not automatically result in a liquidated claim for damages in sufficient detail to give rise to proof of debt. When considering proof of debt in situations like this, creditors should consider notifying forensic experts and carefully drafting their documentation.

In fact, parties should be aware of the significant influence of creditors’ meetings. Although the debt in this case was admitted for the purposes of the meetings of creditors, it ultimately influenced the decision to execute a DOCA. It is therefore essential to remember (and consider) the downstream effects that insufficiently specified proof of debt can have on the interests of a creditor.

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