The judgments of the Federal Court of Australia and the Full Federal Court in Sino Group International Limited v Toddler Kindy Gymbaroo Pty Ltd ^[1] provide important practical lessons arising from a misleading Deed of Company Arrangement (DOCA) proposal, its termination, and the subsequent appointment of a liquidator. Insolvency practitioners should remain vigilant in their presentation of information to creditors.

Key takeaways

The Federal Court and Full Federal Court has reinforced the principles that:

• Deed Administrators must take extra care when representing information to creditors as to the estimated returns when comparing DOCA and winding up scenarios. Providing misleading information is a ground upon which a Court may terminate a DOCA. Insolvency practitioners need to provide creditors with a detailed analysis of the low and high estimated range of returns across the different scenarios, and avoid making conclusive statements (such as that certain return will be received) wherever possible to avoid such statements being found to be incorrect or misleading (such as by adopting less committal language such as by saying that a certain return is likely to be received).

• Deed Administrators ought to be aware that where they defend a DOCA which is ultimately terminated by a Court, any conduct found to be improper or unreasonable (such as any misrepresentations) may mean an adverse costs order is made against them and might also disentitle them from recovering their costs and having their remuneration paid from the assets of the company.

• Following the termination of a DOCA, the Court may exercise its discretion to appoint a liquidator where a decision and agreement cannot be reached at a creditors’ meeting. Courts prefer to appoint an independent liquidator rather than appoint the liquidator nominated by directors.

Background

Toddler Kindy Gymbaroo Pty Ltd (Gymbaroo) provided neuro-developmental and sensorimotor movement programs for young children. Prior to entering administration, Gymbaroo had annual revenue of between $1.3 million to $1.7 million and operated 69 centres across Australia.

On 22 November 2021, Gymbaroo entered voluntary administration following an ongoing arbitration between Gymbaroo and two of its international creditors: Sino Group International Limited and Beijing Yingqidi Education and Technology Corporation Ltd (together, the Sino Creditors). In the administration, the Sino Creditors lodged a proof of debt for $5.9 million. Other creditors of Gymbaroo included its shareholders and directors (Related Party Creditors).

On 18 March 2022, one week before the second creditors’ meeting, the Administrators recommended a DOCA proposal and reported to creditors in their Administrators’ Report that the DOCA would provide creditors an estimated dividend of 100 cents in the dollar, which was contrasted to a winding up scenario that the Administrators estimated would likely result in a dividend to creditors in the range of 33 to 42 cents in the dollar. At the second creditors’ meeting on 25 March 2022, a majority of creditors voted in favour of the DOCA proposal. The Sino Creditors voted against the DOCA and the Related Party creditors voted in favour of the proposal.

A misleading Administrators’ Report

The day after the DOCA was executed, the Sino Creditors commenced proceedings in the Federal Court of Australia seeking orders terminating the DOCA under s 445D of the Corporations Act 2001 (Cth) (Act) (Original Proceeding). The Sino Creditors claimed that the DOCA should be terminated and Gymbaroo should be wound up because:

1. Gymbaroo would remain insolvent even after completion of the DOCA due to debts owed to the Related Party Creditors; and
2. the Administrator’s Report was misleading because it overestimated the return that creditors would receive under the DOCA.

The Sino Creditors were unsuccessful in the Original Proceeding and appealed to the Full Court of the Federal Court of Australia (Appeal Proceeding).

The Full Court ultimately found that the Administrators’ Report contained misleading information and came to this conclusion by considering how the Administrators presented competing scenarios of the DOCA and winding up of Gymbaroo.

The Full Court observed that the Administrators used the term “it is likely that” when qualifying the estimated return to creditors on a winding up of Gymbaroo, where no qualification of probability was used for the DOCA proposal. The Full Court held that this contrast ultimately left the reader with the impression that the DOCA estimate of 100 cents in the dollar was more than merely likely.

Further, the estimated return in the winding up scenario was expressed in a range of “33 to 42 cents in the dollar”, which provided creditors with the opportunity to compare the difference between the best and worst case scenarios for a winding up. No such range was provided for the DOCA scenario, leaving creditors with the impression that the worst case was not a likely outcome. The Full Court found that the worst case for the DOCA scenario was in fact 38 cents in the dollar, and the best case for the winding up scenario was 100 cents in the dollar; suggesting that the Administrators could have represented the DOCA and winding up scenarios better had a comparison table been included in the Administrators’ Report.

The Full Court further found that the Administrators’ Report failed to disclose continuing litigation between Gymbaroo and the Sino Creditors, which meant legal costs were not accounted for.

Discretion to terminate a DOCA

The Full Court noted that there are many factors that should be taken into account when considering whether to exercise its discretion to terminate a DOCA. Central to these factors is balancing the interests of creditors as a whole on the one hand, and the public interest on the other:

• Creditors interests: The fact that a majority of creditors favoured entering into the DOCA was given little weight by the Court. This was because the representation that creditors would have received 100 cents in the dollar if the DOCA was executed could have affected the outcome of the vote on the resolution to execute the DOCA.

• The public interest: The Full Court found that the public interest weighed in favour of terminating the DOCA to enable the affairs of Gymbaroo to be investigated by a liquidator, including in relation to the dispute as to the quantum of the debt to the Sino Creditors.

The Full Court ordered the termination of the DOCA under s 445D(1) of the Act, and ordered costs against the Administrators in relation to the Original and Appeal Proceedings.

A right of indemnity and reimbursement? Not so fast

Following the order to terminate the DOCA, the Full Court next considered whether the Administrators should enjoy their right of indemnity and/or reimbursement for their costs associated with the Original and Appeal Proceedings and held that that the right of indemnity and reimbursement was only available where an administrator acts properly and reasonably within their fiduciary duties. The Full Court found that the Administrators failed in this regard because:

1. they made insufficient submissions whilst defending the DOCA, thus incurring unreasonable costs;
2. their submissions contained omissions and were materially misleading; and
3. they continued to take an active and substantive resistance to the creditors’ appeal and maintained a defence against setting the DOCA aside.

In exercising its discretion on costs, and as supplemented by its power conferred by s 90-15 of the Insolvency Practice Schedule, the Full Court denied the Administrators recourse to the right of indemnity in respect of the adverse costs order and in respect of their own costs of and incidental to the Original and Appeal Proceedings.

Replacement liquidators

Following the termination of the DOCA, the Administrators became the liquidators of Gymbaroo pursuant to s 446AA of the Act. However, the Sino Creditors and one of the directors each sought to appoint their nominated alternative liquidators. The Administrators informed the Court that they proposed resigning as the liquidators, and considered themselves to be acting in a caretaker capacity until a new liquidator was appointed. The Court was accordingly asked to determine who to appoint as the liquidator of Gymbaroo.

The Court firstly considered whether it is appropriate for the Court to make a decision on the appointment of a new liquidator, or whether such a decision should be determined by a meeting of creditors. Because there was already a dispute regarding the preferred liquidator, the Court held that it was best place to make the decision because if the issue were left to a meeting of creditors, there would likely be disputed issues concerning voting rights, which would lead to delay and further potential disputation.

In determining which liquidator to appoint, the Court considered the fee proposals and experience of the alternative liquidators, however the deciding factor came down to the general policy against the appointment of a liquidator proposed by a director. This is because “it is considered to be in the interests of creditors that someone entirely independent undertake that role” and that “the selection by directors of the person who is to have the responsibility to investigate possible breaches of the law is against the policy of the Court”.^[2] Accordingly, the Court appointed the liquidator proposed by the Sino Creditors.

Conclusion

These decisions demonstrate the importance of insolvency practitioners using measured language and presenting information to creditors using analytical and objective methods. Creditors and other stakeholders will rely on the information presented in reports of external administrations for both their commercial and legal interests. Practitioners therefore must take extra care to ensure the accuracy of their reporting and to appropriately qualify their opinions based on the information that is available to them.