Spotlight on Insolvent Trading and DOCA rulings

Seafarms Case – DOCA terminated 

One of the cases mentioned in Comlek Judgement was the Seafarms Case – where a DOCA was set aside, on the basis it was purportedly to avoid liability. In that case (and put very simply) Project Sea Farms, or PSD had borrowed funds from its parent company Sea Farms Group (SFG) to fund construction of aquaculture projects. Ultimately, disputes with a creditor (the Applicant) about building costs and then an arbitration/ adjudication resulted in a significant new and unexpected liability. 

Facing that liability, SFG decided not to fund the payment, PSD entered Administration and a DOCA was proposed, which provided payment for all creditors but minimal return of 10 cents to the Applicant. The Applicant challenged the DOCA seeking its termination on the basis that the real object of administration and proposing the DOCA was twofold:

• Avoiding having to fund payment of an adjudicator’s decision that went against PSD, and avoiding most of the debt owed to the Applicant; and 
• Avoiding scrutiny into possible insolvent trading by PSD over the previous two years, being scrutiny which might occur in a liquidation. 

The Primary Judge determined the DOCA was unjust and unfairly discriminatory (s445D(1)(e) and (f)) and that Pt 5.3A was not enacted to provide an avenue by which a corporate group might rearrange its affairs in order to expunge a particular trade creditor’s debt or to wipe the unwanted debts of an operating company before returning it to business as usual. 

The termination of the DOCA was upheld on Appeal. In that regard, the case raises several issues relevant to public interest.

Primary Judge’s view on Solvency 

The Primary Judge also made numerous observations about solvency. Briefly:

• There was limited evidence SFG was committed to providing the financial support to PSD into the future, and that it would not demand immediate repayment of a debt;
• No director was able to give such evidence in the circumstances that prevailed as at the time of the hearing, when SFG had ceased providing financial support and had submitted a proof of debt to the administrators
• Although it was deposed that a demand for payment would never be made by SFG and that it was commercially illogical and against commercial reality for the company to call up its loans to PSD while the Project was ongoing, the facts as they stand diminish the force of this evidence quite substantially, as that SFG did cause PSD to become insolvent
• The key difficulty that PSD and SFG faced in making out their case as to the solvency of PSD as being that, on their characterisation of the facts, funding from SFG was assured and PSD was therefore solvent until, upon the emergence of a particular debt that the SFG found intolerable, that was suddenly no longer the case
• The natural question to be asked is whether the funding was ever truly assured, and whether PSD was ever truly solvent, in circumstances where the state of affairs between it and its parent company could (and did) change instantly at the parent’s whim;
• The primary judge said that it seemed rather unsatisfying to ask whether a history of funding is sufficiently lengthy as to demonstrate solvency, in circumstances where there only exists a “history” to speak of because, by chance, the problem that ultimately arose did not arise sooner.

The Primary Judge considered PSD was insolvent from 2020 (several years before the entry into Administration)

The primary judge’s proposition was that “there must be more than a mere discretion on the part of the external funder in deciding whether to advance funds”. The funds advanced in the present case were not advanced on deferred terms, but were repayable on demand, which the primary judge referred to as an “immediate debt”.  The primary judge concluded that there was no sufficient assuredness of support by the provision of further funds.

Even though they upheld the original judgement in relation to DOCA termination, the Full Bench of the Appeal Court disagreed with the Primary Judge’s view that the Company was insolvent prior to VA.

The Appeal Decision can be found here Project Sea Dragon Pty Ltd (Subject to a Deed of Company Arrangement) v Canstruct Pty Ltd [2024] FCAFC 141

In disagreeing, the Appeal Judges (led by Ian Jackman) considered (in paragraphs 138 to 152 of the Judgement) that 

• The directors of PSD (incurring the liabilities) were essentially the same as the directors of SFG (the funder), and both companies had a congruent economic interest in the development of the Project. 
• SFG had the undoubted capacity to pay PSD’s liabilities in relation to the Project, having raised funds on the market for that purpose. 
• It followed as a matter of commercial common sense and rationality that liabilities knowingly and voluntarily incurred by PSD would be met by SFG;
• The common directors of both companies put in place a process for the funding of PSD’s liabilities by SFG to occur. That process was followed from mid-2020 until early February 2023. PSD’s employees, lessors and other trade creditors were paid (including the applicant). 
• The aged creditor analysis showed that as at the date VA appointment (February 2023), 98% of creditors were aged at 30 days or less
• The ability to pay debts as and when they become due and payable must be determined in the circumstances as they were known or ought to have been known at the relevant time, without intrusion of hindsight. 
• The later quantification of a significant liability at an unexpected level (which was the case here), may be excluded from consideration if the liability was properly unknown or seen to be in a lesser amount at the relevant time.
• The vulnerability of PSD in meeting its liabilities arose only in circumstances where there was a liability which was not knowingly and voluntarily incurred by it, such as a liability imposed by an external party over whom PSD and SFG had no control, in an unexpected amount.  It was only in that circumstance that there was a realistic possibility of SFG refusing to fund PSD for the liability. 
• For the liability that had been knowingly and voluntarily incurred, and there was a practical certainty that it would not be the subject of a demand for repayment;
• The administrators concluded that the company was insolvent the day the board of SFG resolved to withdraw funding. The Applicant argued that the circumstances giving rise to that might have happened earlier.  However, the solvency test under s 95A applies only to liabilities which are actually due and payable, not those which might hypothetically have arisen but did not in fact arise. 

Wexted Conclusions