Australian Securities and Investments Commission v Midland Hwy Pty Ltd

Defendant) D Krochmalik/H Zhao (Second Defendant)

Solicitors: Results Legal (Plaintiffs) Bridges Lawyers (First Defendant) HWL Ebsworth Lawyers (Second Defendant) File Number(s): 2019/348698

Nature of the application and chronology

1. By Originating Process filed on 6 November 2019, the Plaintiffs, Action Scaffolding & Rigging Pty Ltd (in liq) ("Action") and its liquidators, Mr Park and Ms Trenfield, sought orders under s 445D(1)(e)-(f) or s 447A of the Corporations Act 2001 (Cth) that a deed of company arrangement ("DOCA") dated 17 April 2019 between the First Defendant, Citadel Financial Corporation Pty Ltd (subject to deed of company arrangement) ("Citadel") and Mr Timothy Cook as its deed administrator (to whom I refer as Mr Cook, by contrast with Mr DL Cook who appears with Mr Rose for Citadel) be terminated and that Citadel be wound up in insolvency. The basis of that application was elaborated by a Statement of Claim, as amended, dated 17 April 2020.
2. I first set out a brief chronology of events, drawn from the Plaintiffs' chronology, the Statement of Claim and the documents in evidence. It appears that Citadel's business was to provide loans, largely to its related entities and entities related to its sole director, Mr Maiolo (Cook 15.5.20 [8]) and that it ceased operating around 2015 (Cook 15.5.20 [9]). On 13 March 2019, Action and the liquidators obtained judgment against Citadel in proceedings in the Federal Court of Australia. Citadel was then placed into voluntary administration and Mr Cook was appointed as its voluntary administrator, and Citadel's holding company, Gemaveld Pty Ltd ("Gemaveld") paid $50,000 to Mr Cook as a contribution toward the costs of the voluntary administration. On 3 April 2019, Mr Cook entered into an agreement with Gemaveld by which it indemnified him in respect of the costs of an appeal against the judgment of the Federal Court, which was subsequently brought and was unsuccessful.
3. Gemaveld proposed a DOCA in respect of Citadel and Mr Cook's evidence is that, in negotiating that proposal with Gemaveld, he requested that the proposed DOCA include a "top-up" clause so that the Deed Fund would not fall below the specified amount but Gemaveld rejected this request (Cook 15.5.20 [35]). On 9 April 2019, Mr Cook issued his report under s 439A of the Corporations Act ("s 439A report") to Citadel's creditors. The s 439A report recorded, inter alia, that Citadel was likely insolvent as early as June 2015, that it had ceased trading by June 2015 and that it subsequently wrote off debts of $2,466,589 owed to it in June 2017. That report also noted the possibility that, on a winding up, Citadel's liquidator might have claims for insolvent trading against a director of Citadel, Mr Maiolo, and against Gemaveld, although it also noted uncertainty as to the prospects of that claim in respect of Mr Maiolo's financial position, Gemaveld's financial position and the possibility that any insolvent trading claim would be defended. Mr Cook assessed the then likely return to the three Participating Creditors under the proposed DOCA, namely the Deputy Commissioner of Taxation ("DCT") (with a debt of $1,418,455.59), Action (with a debt of $131,747) and Citadel's solicitors, Bridges Lawyers (with a much smaller debt of $1,457.50) as 1.97 cents in the dollar.
4. By letter dated 16 April 2019, the solicitors for the Plaintiffs identified concerns as to the s 439A report, including concerns that Mr Cook had undertaken insufficient investigations and had taken the books and records maintained by Citadel at face value despite certain matters which they contended should give rise to concern as to their accuracy. They also referred to the observations of Brereton J in Re Sales Express Pty Ltd (admins apptd) [2014] NSWSC 460, to which I refer below, and contended that the position in respect of the proposed DOCA in this case was analogous to that referred to in Sales Express, and that the only person who would benefit from the proposed DOCA was Mr Maiolo, who, they contended, would avoid examination of his conduct as a director of Citadel; dispose of debts owed to Citadel's unrelated creditors whilst preserving the claims of related and friendly creditors; and regain control of Citadel. That letter foreshadowed that, if the proposed DOCA was adopted, the Plaintiffs would carefully consider an application to terminate the DOCA under s 445D of the Act, which they have now brought.
5. On 17 April 2019, Citadel's creditors resolved at the second meeting of creditors that Citadel execute the DOCA and that Mr Cook be appointed as deed administrator. That resolution was approved on the voices. Action and the DCT opposed the DOCA resolution (McKnoulty 18.2.20 [29.1]). The DOCA provided, in cl 2.1, for conditions precedent, including the entry into a Deed of Deferral by Deferred Creditors (as defined) and the payment of a Contribution (as defined) to Citadel. The "Deferred Creditors" were 12 named companies and persons, which were largely associated with Citadel, Gemaveld or Mr Maiolo, who would not receive a payment under the DOCA and whose claim would not be extinguished by the DOCA. Clause 5.1 provided that the Deed Fund would comprise the Retained Cash (as defined) and the Contribution (as defined). The amount of the Retained Cash was any amount contained in the administrator's account as at the Commencement Date (as defined). It appears that that amount had been exhausted by the time of the commencement of the DOCA. The "Contribution" was defined as an amount of $65,000.
6. Clause 6.2 of the DOCA set out the priority in which the Deed Fund would be distributed, namely, first to the payment of the administrator's and deed administrator's disbursements, plus GST; second, to the payment of the administrator's remuneration, plus GST; third, to payment of Priority Creditors and any Subrogating Employee Creditors (as defined); fourth, pro rata to Participating Creditors, with any balance to be refunded to the Company. Since the Deed Fund would not be increased by any top-up arrangement, it followed that, if the amount of the administrator's and the deed administrator's disbursements and remuneration exceeded the amount of the Contribution, namely $65,000, then Participating Creditors would receive no financial benefit from the DOCA. Clause 8.2 of the DOCA further provided that: "If the Deed Administrator has paid to the Participating Creditors their full entitlements under this Deed, all claims of the Creditors (other than the Deferred Creditors) are released in full and extinguished. Creditors (other than the Deferred Creditors) must accept their entitlements under this Deed in full satisfaction and complete discharge of all Claims."
7. A Deed of Deferral, which was a condition precedent to the DOCA, in turn provided that Deferred Creditors (as defined) would not make any claim against the Deed Fund in respect of the Deferred Claims (as defined) during the Deferment Period (as defined) and acknowledged that their claims against the Company with respect to the Deed Fund would be barred during the Deferment Period. Deferred Creditors also agreed that, on the expiry of the Deferment Period, they would forebear from seeking repayment of all or some of the unpaid balance of their claims until the Company had capacity to pay any such repayment and forebear from enforcing any securities which they had against the Company. There is no evidence of any activities of the Company, since the DOCA was implemented, which would allow any capacity for repayment of the Deferred Creditors. After the DOCA was signed, the control of Citadel was returned to Mr Maiolo under cl 10.1 of the DOCA and it opposes the termination of the DOCA.
8. By letter dated 9 July 2019, the solicitors for the Plaintiffs sought an undertaking from Mr Cook that he would not effectuate the DOCA, pending resolution of an application to terminate the DOCA. That undertaking was ultimately given, on the basis of an undertaking as to damages given only by Action (which was, of course, in liquidation) and not by the liquidators personally.
9. By letter dated 17 March 2020, the solicitors for Mr Cook wrote to the solicitors for Citadel noting that the administrator's and deed administrator's remuneration and disbursements now exceeded the amount of $65,000 that had been contributed to the Deed Fund. They noted that: "Accordingly, the present position is such that if no further contribution is made to the Deed Fund, the distribution to Participating Creditors will be zero. Such an outcome would ultimately provide no better outcome to creditors than the immediate winding up of the Company and would necessarily favour the setting aside of the DOCA given that the Plaintiff in the Proceeding has indicated a willingness to fund its proposed liquidator to conduct further investigations into the affairs of [Citadel]."
10. Mr Cook's solicitors there suggested that a further contribution be made by Citadel or a third party to restore the Deed Fund to an amount that would permit the dividend estimated to be paid to Participating Creditors as contemplated by the proposal approved by creditors and that the deed administrator be indemnified for his further costs and expenses of the proceedings. That request was rejected by letter dated 24 March 2020 from Citadel's solicitors. By that date, the Deed Fund established under the DOCA was exhausted by Mr Cook's claims for remuneration (capped at $15,000 plus GST) and disbursements (which were over $68,000, exclusive of GST) although Mr Cook attributes that to the existence of this dispute (Cook 15.5.20 [48]-[50]).

Affidavit evidence

1. The Plaintiffs rely on the affidavit dated 3 October 2019 of Ms Trenfield, one of Action's liquidators. Ms Trenfield there criticises the s 439A report on the basis that it did not provide any value of the claims available against Mr Maiolo or Citadel's holding company, Gemaveld, and contended (in evidence admitted as submission only) that Gemaveld had cash at bank or at least had access to funds that allowed it to indemnify the deed administrator in respect of the costs incurred in unsuccessfully prosecuting the appeal against the Federal Court's judgment. Ms Trenfield also addressed the effect of the DOCA, to which I have referred above, and noted that the DOCA would not bring about any return to Participating Creditors if (as is now plainly the case, at least by reason of these proceedings) the costs and disbursements incurred by the deed administrator exceeded $115,000. (In fact, as I noted above, that result arose once those costs and disbursements exceeded $65,000). Ms Trenfield also noted, without further elaboration, that the Australian Taxation Office ("ATO") had agreed to provide financial assistance to her in support of this application in the form of an indemnity for costs.
2. By an affidavit dated 28 October 2019, Mr Henry, a solicitor acting for the Plaintiffs, referred to the proceedings between Action and its liquidators on the one hand and Citadel on the other in the Federal Court of Australia, the history of the administration and the deed administration, and correspondence between the Plaintiffs' solicitors and the liquidators' solicitors in respect of the Plaintiffs' concerns as to the DOCA. Mr Henry also exhibited company searches which disclosed the relationships between several of the Deferred Creditors and Mr Maiolo and Gemaveld. Mr Henry also referred to concerns he had expressed as to the DOCA at the second meeting of creditors, in evidence which was admitted as evidence of what was said and not as proof of the asserted facts.
3. By an affidavit dated 18 February 2020, Mr McKnoulty, who is employed in the Significant Debt Management section in the ATO in Brisbane, referred to the orders sought by the Plaintiffs in the proceedings and gave evidence in support of those orders. Mr McKnoulty referred to a formal proof of debt or claim lodged by the DCT in Citadel's administration, to the s 439A report and to his attendance by telephone at the second meeting of creditors. Mr McKnoulty's evidence was that both the ATO and Action voted against the entry into the DOCA, and he also led evidence of the relationships between the Deferred Creditors and Mr Maiolo and persons associated with him. Mr McKnoulty's evidence, admitted as a submission only, was that the DCT was concerned that, unless the DOCA was set aside, unrelated creditors who did not vote for it would receive a comparatively small distribution whereas parties who voted in favour of it, largely related to Mr Maiolo, would not be bound by it and their debts would continue to exist after the DOCA was finalised. Mr McKnoulty also identified, in evidence also admitted as a submission only, the DCT's concern that Citadel would be insolvent, after the DOCA was effectuated, because it had ceased most of its trading in the year ended 30 June 2015 but would continue to have Deferred Creditors with claims against it of over $9,000,000.

Applicable principles

1. I will address the applicable legal principles and the parties' submissions in respect of each of the grounds on which the Plaintiffs relied together, since there was a degree of overlap in the parties' submissions in that regard. I will then turn to further evidence led and submissions made after the hearing, by leave, in respect of the availability of funding to a liquidator appointed to Citadel.
2. First, the Plaintiffs seek an order terminating the DOCA under s 447A of the Corporations Act. The Court plainly has jurisdiction to make such an order in an appropriate case. In Joseph Khoury & Sons v Zambena Pty Ltd [1999] NSWCA 402; (1999) 217 ALR 527, in a passage quoted with approval by Campbell J in Bidald Consulting Pty Ltd v Miles Special Builders Pty Ltd [2005] NSWSC 1235; (2005) 226 ALR 510, Fitzgerald JA (with whom Beazley JA and Davies AJA agreed) observed that: "… the Court should not encourage the notion that 'anything goes' provided only that a deed of company arrangement provides some benefit for dis-satisfied creditors. Commonly, companies proposing deeds of company arrangement are insolvent and what is proposed involves some benefit for unsecured creditors. That cannot be permitted to be used by those who promote such proposals as a critical factor which warrants the Court's refusal to terminate or declare void such deeds, especially when different groups of unsecured creditors are treated differently."
3. In Blacktown City Council v Macarthur Telecommunications Pty Ltd [2003] NSWSC 883; (2003) 47 ACSR 391, Barrett J terminated a voluntary administration where a company's sole director placed the company in voluntary administration with a view to adopting a deed of company arrangement by a decision of creditors (being himself and two persons allied with him) of doubtful value that would bar particular claims already being litigated against the company. In Public Trustee (Qld) v Octaviar Ltd (subject to deed of company arrangement) (recs and mgrs apptd) [2009] QSC 202; (2009) 73 ACSR 139 at [182], McMurdo J noted that a winding up may serve the public interest where investigations and recovery proceedings are likely to be funded and could realistically lead to persons who engaged in suspect transactions being brought to account.
4. In Re Sales Express Pty Ltd (admins apptd) above, Brereton J reviewed the scope of the Court's power to terminate a voluntary administration under s 447A of the Act and observed (at [19]) that: "It is clear from s 447A(2)(b) that the Court may make an order that an administration end, if the administration provisions of the Corporations Act are being abused. In Workers Compensation Nominal Insurer v Perfume Empire Proprietary Ltd [2011] NSWSC 379, Barrett J, as his Honour then was, observed (at [22]) that the cases in which the Court had intervened under that provision to terminate a voluntary administration were cases in which there had been what might be termed as some ulterior element or purpose. His Honour referred to cases in which the directors had put the company into administration not for a purpose envisaged by the legislation but with a view to installing an administrator who might be more compliant than the provisional liquidator already in office [Aloridge v Christianos (1994) 13 ACSR 99]; where a secured creditor had imposed an administrator when an appeal by the company was pending against the dismissal of its application for an order setting aside a statutory demand served by that creditor [Spacorp v Australia Pty Ltd v Fitzgerald [2001] VSC 61; (2001) 19 ACLC 1979]; where a sole director imposed voluntary administration with a view to the adoption of a deed of company arrangement by a decision of creditors (being himself and two persons allied with him) of doubtful value, which would bar particular claims already being litigated against the company [Blacktown City Council v Macarthur Telecommunications Pty Ltd [2003] NSWSC 883; (2007) 47 ACSR 391]; and where an administrator was imposed by the sole director in the face of a pending winding up application, in order to manipulate the relation-back day to his own personal advantage [St Leonards Property Pty Ltd v Ambridge Investments Pty Ltd (2004) 210 ALR 265; (2004) 50 ACSR 443; [2004] NSWSC 851]. His Honour distinguished (at [25]) the case then under consideration from one in which there had been an attempted distortion or manipulation or one where any enhancement of the return to creditors generally would be at the expense of persons who had been innocent bystanders in the event leading to voluntary administration and ultimate winding up."

The parties' submissions

1. Mr Simpkins, who appears for the Plaintiffs, submits that the DOCA should be terminated under s 447A of the Act on the basis that it benefits Gemaveld and Mr Maiolo by avoiding the winding up of Citadel and the consequent investigation of Citadel's affairs by a liquidator, including in respect of insolvent trading claims; does not materially affect the interests of the Deferred Creditors; was executed despite the objections of the majority of Participating Creditors; and was proposed and would be effected, unless terminated, without a proper investigation into the conduct of Citadel's affairs. The Plaintiffs also contend that Citadel was insolvent; did not continue to trade; and would remain insolvent if the DOCA was effectuated, by reason of the claims of the Deferred Creditors, and that the DOCA was an abuse of the processes of Part 5.3A of the Act.
2. Mr Simpkins also relies on Australian Securities and Investment Commission v Midland Hwy Pty Ltd (admin apptd) above to submit that the DOCA should be terminated on the basis that it will not restore Citadel to financial health; has the purpose or effect of quarantining Mr Maiolo, Gemaveld and other related creditors of Citadel from investigation and recovery proceedings, and provides no benefit for creditors. The first of these propositions is plainly now correct, and the second is likely correct, where there was no apparent other benefit to be obtained by Deferred Creditors from voting in favour of the DOCA, since there was then no indication that Citadel would recommence its business so as to generate returns for them, and it did not do so.
3. Mr Simpkins also submits that the DOCA is oppressive and unfairly prejudicial to Participating Creditors because it was carried on the vote of creditors associated with Citadel, Gemaveld or Mr Maiolo and has been imposed upon the majority of Participating Creditors against their will and was then likely to produce no more than a nominal dividend and, in the events that have occurred, produce no dividend for Participating Creditors, and would release Citadel from claims of Participating Creditors but not from claims of Deferred Creditors. Mr Simpkins also submits the DOCA is contrary to the interests of creditors of Citadel as a whole, because the Deferred Creditors who voted in favour of it will receive no benefit from it, the Participating Creditors oppose it and, I would add, they initially stood to receive a minimal financial benefit from it and will now receive no benefit from it. I would be inclined to accept these submissions, if it were necessary to do so in order to determine the matter.

Further evidence and submissions as to the availability of funding for a liquidator

1. Mr DL Cook put significant weight at the hearing on the availability of funding arrangements for any liquidator appointed to Citadel. Because of the potential significance of this matter, I made orders at the conclusion of the hearing, for the reasons set out in a separate judgment, that allowed liberty for the Plaintiffs to advise the position as to the funding of a liquidator's investigation and of any consequential proceedings, and allowed the parties an opportunity to be heard further as to the implications of that advice.
2. The Plaintiffs filed three further affidavits on 26 June 2020 pursuant to that leave. By an affidavit dated 26 June 2020, Mr Thomas, who is Director in the Debt and Lodgement Management Team in the Service Delivery Business Line in the ATO, led evidence that the DCT was prepared to provide initial funding of $30,000 to a registered liquidator nominated by the Plaintiffs who is appointed to Citadel. Mr Thomas referred to the legislative constraints on the expenditure of public funds and indicated that, in his opinion, the DCT was unable responsibly to provide further initial funding until a further report to creditors had been issued, but observed that: "This does not detract from the DCT's strong view that the affairs of [Citadel] warrant a proper investigation by a liquidator and the DCT will favourably consider any reasonable request from a liquidator of [Citadel] for additional funding."
3. Mr Thomas also offered an undertaking, on behalf of the DCT, on the basis of his delegation and authority with respect to funding arrangements, that: "(a) Subject to the DCT entering into a suitable funding agreement with a liquidator appointed to [Citadel] the DCT undertakes to provide initial funding to a liquidator of up to $30,000. (b) The DCT undertakes to favourably consider any further, reasonable request for funding made by any liquidator appointed to [Citadel]."
4. The Plaintiffs also read a further affidavit dated 26 June 2020 of Mr Staatz, who is a registered liquidator with substantial experience in insolvency and restructuring, who has consented to appointment as liquidator of Citadel. Mr Staatz referred to the steps that he would take to discharge his statutory and regulatory duties if appointed as liquidator of Citadel, including investigating and reporting to creditors as to its affairs, and indicated that he was prepared to undertake those responsibilities, including the preparation and issue of a statutory report, without funding. He also noted that, in his experience, Court-appointed liquidators would generally not obtain creditor or third party funding until some investigations had been undertaken, and usually after the issue of the statutory report which would allow prospective funders to assess the merits of any request for funding. Mr Staatz also outlined the circumstances in which he would seek funding from creditors or third parties in Citadel's liquidation, and noted that he had pursued successful claims for the benefit of creditors in other litigation without the benefit of funding.

Determination, orders and costs

1. I have concluded that the DOCA should be set aside under s 447A of the Act and Citadel should be wound up. I have largely addressed the reasons for that result in dealing with the parties' submissions above. In summary, the only significant creditors of Citadel who would benefit in a minimal way from the DOCA, at the point it was executed, opposed it and they will now not benefit from it in any event. The only creditors of Citadel who voted in favour of the DOCA were associated with Citadel, Gemaveld or Mr Maiolo which would receive no apparent benefit from it, other than any collateral advantage obtained by Mr Maiolo or Gemaveld of deferring or avoiding any claims against them. The DOCA did nothing to promote the continued operation of Citadel's business, which had ceased, or the welfare of its employees, since there is no evidence that it had any. The entry into the DOCA was an abuse of the process of Pt 5.3A of the Act and it should now be set aside. It does not matter, for that purpose, whether the ATO will fund further investigations or proceedings brought by a liquidator of Citadel, since this order can and should be made to preserve the integrity of Pt 5.3A of the Act. It is not necessary to decide whether an order terminating the DOCA would be made under s 445D(1)(e) or s 445D(1)(f) of the Act, where I have held above that the DOCA should be terminated under s 447A of the Act.
2. Costs should follow the event and Citadel should pay the Plaintiffs' and Mr Cook's costs of the proceedings. I have not neglected Mr DL Cook's and Mr Rose's further submission that, if the Court concludes that the further evidence as to the funding of a liquidator discloses sufficient benefit for creditors to justify a termination of the DOCA, then the Plaintiffs should pay Citadel's costs in the proceedings by reason of the lateness of that evidence. I do not accept that submission, where the Plaintiffs' application would have succeeded in any event, for the reasons noted above, and without regard to that further evidence.
3. I make the following orders: 1. The DOCA dated 17 April 2019 between the First Defendant, Citadel Financial Corporation Pty Ltd (subject to deed of company arrangement) and the Second Defendant, Mr Timothy James Cook, be terminated. 2. The First Defendant be wound up in insolvency. 3. Mr Steven Staatz be appointed as liquidator of the First Defendant. 4. The First Defendant pay the Plaintiffs' and the Second Defendant's costs of the proceedings.

Amendments 21 July 2020 - Amendment to Representation. DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 21 July 2020