Third party claims and deeds of company arrangement: The Lehman Brothers DOCA failsAuthor : Jane O’Neill

Directors and Officers

Introduction

The High Court has dismissed an appeal against the judgment of the Full Court of the Federal Court of Australia which found the deed of company arrangement (DOCA) approved by the creditors of Lehman Brothers Australia Limited (Lehman Australia) was void and of no effect.

In short, the decision confirms that a DOCA cannot be used to compromise the rights of creditors to pursue claims against third parties (that is, entities other than the company the subject of external administration).

Background

On 26 September 2008 administrators were appointed to Lehman Australia.  Based on recommendations made by the administrators, the majority of creditors of Lehman Australia passed a resolution that Lehman Australia execute a DOCA.

On 12 June 2009 the DOCA was executed.  The effect of the DOCA was (relevantly):

+     to release not only Lehman Australia but also all other Lehman entities from all claims which any creditors of Lehman Australia may have against them; and

+     to preclude creditors from pursuing insurance claims against the insurers of Lehman Australia and other Lehman entities.

A group of 40 local councils (the Councils) contested the validity of the DOCA and, in particular, its ability to extinguish their rights to sue other Lehman entities.

The Councils claimed that the release set out in the DOCA was not within the scope of Part 5.3A of the Corporations Act 2001 (Cth) (Corporations Act) and that they were therefore not bound by the DOCA.  Part 5.3A of the Corporations Act sets out the procedures for the administration of a company culminating in the execution of a DOCA.

On 25 September 2009 the Full Federal Court found that the DOCA was void and of no effect and ordered that Lehman Australia be wound up.  The Court agreed that the DOCA purported to extinguish the Councils’ rights to sue other Lehman entities and, in doing so, went beyond the scope permitted by Part 5.3A.

Lehman Brothers Asia Holdings Limited (being Lehman Australia’s biggest creditor) and Lehman Brothers Holdings Inc were granted special leave to appeal that decision to the High Court.

The High Court’s decision

The appeals were dismissed by the High Court on 30 March 2010.  The High Court has released a statement that its reasons for decision will be delivered at a later date.

The High Court’s decision confirms that the DOCA remains void and sets the scene for potential actions against other Lehman entities, including its overseas entities.

We understand the potential claims by creditors are likely to include allegations by shareholders of misleading and deceptive conduct committed by Lehman entities with respect to the issuing of securities.  Such shareholder claims were recently recognised by the High Court in its decision in Sons of Gwalia v Margaretic [2007] HCA 1 (although it has been suggested the effect of this decision may be addressed through legislative intervention).  Such causes of action against the Lehman entities had previously been barred by the terms of the DOCA.

Implications

The High Court’s decision confirms that a DOCA cannot operate to release third parties from claims which may be brought against them by company creditors.

The High Court upheld the Full Court’s decision that there was no statutory purpose supporting an extension of the operation of a DOCA beyond governing the rights and obligations of the company in administration and its creditors alone.

This position can be contrasted with the decision in Re Opes Prime Stockbroking Ltd (Receivers and Managers Appointed) (In Liquidation) (2009) 258 ALR 362 which dealt with a Scheme of Arrangement under Part 5.1 of the Corporations Act.  In that case, the Federal Court held that a Scheme of Arrangement could validly release a creditor’s claim against third parties provided there was an adequate œnexus between the release and the relationship between the creditor and the insolvent company.

This decision was approved by the Full Federal Court in Fowler v Lindholm [2009] FCAFC 125 which considered that Part 5.1 of the Corporations Act was designed to promote a flexible mechanism to facilitate compromises and arrangements between insolvent companies and their creditors.

The collective effect of these decisions is that a Scheme of Arrangement will be a much more effective mechanism to deal with creditors’ claims against third parties.  In recent times, Schemes of Arrangement have been œout of vogue given their more stringent requirements which invariably adds cost and complexity to the administration (as compared with the DOCA process).

A Scheme of Arrangement “ as opposed to a DOCA “ should provide administrators with more flexibility to facilitate a compromise of creditors’ rights against third parties who have some relationship with the insolvent company.

This should in turn provide insurers, which may insure all entities within a corporate group, with greater certainty when it comes to dealing with claims made against one of the entities within the corporate group which is subject to external administration.

 

For more information contact Jane O’Neill (03) 9604 7932 or Nick Lux (03) 9604 7902.

01/04/2010