Standing outside in the rain: secured creditor’s rights diminished by a DOCA for which it didn’t vote

To the extent that there exists a general understanding that secured creditors stand outside a deed of company arrangement (DOCA) unless they vote for it, the decision in Re Bluenergy Group Ltd (subject to a Deed of Company Arrangement) (admin apptd)[1] (Bluenergy) reminds us that the position is more nuanced. As Bluenergy illustrates, while a secured party’s rights might in theory be preserved where it does not vote for a DOCA, in practice those rights may be significantly circumscribed. The extent to which they are affected might inform a secured creditor’s decision whether or not to seek to terminate a DOCA.

The facts

Keybridge Capital Ltd (Keybridge) advanced $300,000 to Bluenergy Group Ltd and took what Bluenergy Group agreed would be a first-ranking, a charge over its present and future assets. Bluenergy Group did not make good on that promise and Keybridge’s registered security interest ranked behind a charge registered by First State Pty Ltd (a company with directors common to Bluenergy Group) when administrators were appointed to Bluenergy Group 7 months later.

A DOCA providing for a debt-for-equity swap was propounded by a company associated with First State Pty Ltd. Keybridge did not vote in favour of the resolution accepting the DOCA.

The DOCA incorporated a release and discharge from all claims (including future claims) against Bluenergy Group. It also separated the deed fund established by the DOCA (which did not form part of the assets of Bluenergy Group) from certain excluded assets which remained Bluenergy Group’s property. The DOCA also provided that the administrators would use their best efforts to procure releases of all security interests from Bluenergy Group’s secured creditors.

Keybridge appointed an administrator to Bluenergy Group on the basis that it still held a security interest over all of Bluenergy Group’s assets (which consisted principally of its listed shell). At that time, Keybridge’s view seemed to be that, as a result of the DOCA, only it and the former administrators remained creditors of Bluenergy Group, all other creditors having participated in the debt-for-equity swap. In particular, it considered that First State Pty Ltd had compromised its interest in Bluenergy Group by voting for the DOCA and participating in the scheme created by it.

The deed administrator applied to court for the removal of the “second” administrator appointed by Keybridge.

Section 444D of the Corporations Act

Unravelling the parties’ respective rights in light of the above facts required the court to consider the interaction between subs 444D(1) and (2) of the Corporations Act 2001 (Cth). Section 444D(1) is to the effect that a DOCA binds all creditors. Section 444D(2) provides that subs (1) does not (subject to a court order) prevent a secured creditor from dealing with its security interest unless the DOCA so provides and the secured creditor voted in favour of the resolution approving it.

The DOCA provided for the extinguishment of Keybridge’s debt, along with all other creditors’ claims. While the extinguishment of a debt might seem inconsistent with the maintenance of a security interest, for the purposes of s 444D of the Corporations Act, that isn’t necessarily the case.

The court in Bluenergy found that notwithstanding the release of its debt, with the effect that Keybridge was no longer (strictly speaking) a creditor, Keybridge’s security interest remained as it was at the point at which the debt would otherwise have been released by the DOCA. In other words, the present existence of the debt was not necessary for the maintenance of the security interest. Subsequent to the execution of the DOCA, the debt the subject of the security interest became a “notional” debt.

It is worth noting that that proposition is consistent with s 153(3) of the Bankruptcy Act 1966 (Cth), which unpacks the concept by expressly deeming the secured debt to continue notwithstanding its release upon the discharge of a bankrupt, so as to facilitate a creditor’s dealings with the secured property.

What steps are available to a secured notional creditor?

While the separation of a security interest from its debt might be expected to circumscribe the enforcement options available to a secured notional creditor subsequent to the entry into a DOCA, the appointment of an administrator remains an option, at least in theory.

Section 436C of the Corporations Act confers the right to appoint an administrator on a person entitled to “enforce” a security interest. The court in Bluenergy found that there was no distinction between “realising” or “dealing with” a security interest (as those expressions are used in s 444D(2)) and enforcing it.

However, the preservation of the right to appoint an administrator may be illusory because that administrator is susceptible to removal pursuant to s 447A of the Corporations Act. This was the case in Bluenergy for three reasons.

First, the continuation of the appointment was found to be inconsistent with the purposes of Pt 5.3A of Corporations Act, principally by reason of prejudice to the deed proponents and the creditors who voted in favour of it. The court considered that those parties would likely have formed a different view of the desirability of the deed proposal had they contemplated its disruption by a second administration. It might be expected that such prejudice would exist whenever DOCA was entered into unless it was adverted to by the secured creditor prior to its approval.

Second, there was found to be no utility in the second administration where Keybridge is not a creditor in it (due to its debt being extinguished in the first administration).

Third, the former administrators were the only creditor in the second administration and they opposed the appointment.

Section 444F(2) of the Corporations Act is a further potential restraint on the exercise of a secured creditor’s rights following the execution of a DOCA. That provision permits a court to order that a secured creditor be retrained from realising or dealing with its security interest. The particular circumstances considered in Bluenergy diminished the utility of the making of an order under s 444F(2).

Lessons for secured creditors

The outcome in Bluenergy demonstrates that, while the rights of a secured creditor that does not vote in favour of a DOCA may theoretically continue, in practice those rights may be circumscribed to such an extent that they are worth very little. Secured creditors in a position similar to Keybridge might consider an early application to terminate the DOCA in circumstances where the DOCA is considered prejudicial to the secured creditor’s interests.