To carry out no or little investigation and to say nothing is not an option – a warning to insolvency practitioners

The Federal Court has issued a warning to insolvency practitioners, involved in voluntary administrations, to ensure adequate investigation and reporting occurs of matters that have the potential to materially affect the outcome of the administration. In Adelaide Brighton Cement Limited, in the matter of Concrete Supply Pty Ltd v Concrete Supply Pty Ltd (Subject  to Deed of Company Arrangement) (No.4),Besanko J set aside a deed of company arrangement due to inadequate investigations and reporting. The inadequate investigations and reporting lead to the second report to creditors containing false or misleading information to creditors’ decision to adopt the DOCA.

Background  

Over a 9-year period up to late 2017, Concrete Supply Pty Ltd (the Company) received cement with a value of $32.6M from Adelaide Brighton Cement Limited (Adelaide Brighton), but paid only $20.1M for it.

Adelaide Brighton discovered that its records recorded this debt as $2.1M when the real figure was $12.5M. The difference was due to fraud by an employee of Adelaide Brighton (apparently without complicity of the Company).

In response to a demand for payment of $12.5M, the Company asserted a right to a rebate of between 30% and 35% on the sales, reducing the debt to $2.1M (the Alleged Rebate).

On 14 November 2017, the Company entered voluntary administration, and on 19 December 2017, its creditors resolved it should enter a DOCA. Adelaide Brighton, by far the largest creditor by value, voted against the resolution, which was passed on the casting vote of one of the Administrators as chairperson of the meeting.

Adelaide Brighton sought to have the DOCA be set aside on the basis that the second report to creditors contained false or misleading information or omissions that could reasonably be expected to have been material to creditors of the Company in deciding whether to vote in favour of the resolution that the company execute the DOCA.

The Alleged Rebate

The Court noted that the Alleged Rebate a number of unusual features, including:

1. 1. there was no written or oral agreement providing for it;
   2. the amount of the rebate was very substantial;
   3. the rate of the alleged rebate was a range of percentages;
   4. the Company applied the Alleged Rebate by paying some invoices and not others, rather than applying a fixed amount to all invoices; and
   5. the Company’s practice was to correctly recording each liability for cement and then considerably later, at a time determined by it, cancel cheques made out to Adelaide Brighton for payment and adjust its records.

The Administrators’ investigations of the Alleged Rebate

The Court noted that although the Administrators became aware of the unusual features of the Alleged Rebate through preliminary investigations, they decided that the Alleged Rebate did not need to be investigated further. This was on the basis that they:

1. 1. were confident they could estimate the date of insolvency even on the assumption that the Alleged Rebate was not genuine;
   2. had included the full amount of Adelaide Brighton’s alleged debt in their estimates of the returns of the proposed DOCA and a winding up included in their second report to creditors; and
   3. the Act provided short timeframes for investigations before the second meeting of creditors must be held.

The Court held that:

1. 1. proper investigations may have had a significant effect on issues of solvency, tax, keeping of correct records and possible breaches of duty and law by the directors
   2. the significance of these potential effects meant the Administrators should have:
      1. undertaken further investigations of the Alleged Rebate; and
      2. applied for an extension of the convening period for the second meeting or creditors sufficient to allow them to carry out the investigations.

The Court strongly criticised the Administrators’ investigations and reporting and remarked that “to carry out no or little investigation and to say nothing is not an option.”

Setting the DOCA aside

The Court held that the DOCA be set aside because:

1. 1. the second report to creditors contained false or misleading information or omissions likely to affect creditor decisions to adopt the DOCA, because it did not include analysis of the Alleged Rebate;
   2. the DOCA was adopted in circumstances where:
      1. the major creditor by value voted against it; and
      2. it was passed on the impugned casting vote of one of the Administrators; and
   3. it was in the public interest that the unusual features of the Alleged Rebate, as well as potential claims against the directors, be thoroughly investigated by a liquidator.

Key takeaway

If a voluntary administration raises complicated matters that have the capacity to significantly affect the administration and the vote of creditors at a second meeting of creditor, those matters must be properly investigated before the second report to creditors is issued.

If necessary, an administrator must apply to the Court for an extension of the convening period to conduct investigations.

“To carry out no or little investigation and to say nothing is not an option!”

Authored by:

Guy Edgecombe, Partner
Craig Melrose, Solicitor