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The Last Word on Lehman Brothers - But Questions Remain

By Glen Ryan, Associate and Blair Williams, Senior Solicitor of Duncan Cotterill
First published in The NZ Lawyer 31 May 2010

Many companies wishing to enter a compromise with creditors may have third parties liable for the same or associated debts – most obviously, guarantors and directors.  To what extent, if any, may such third parties be released from liability through a Deed of Company Arrangement (DOCA) agreed through a voluntary administration?  The Australian High Court recently grappled with this issue in Lehman Brothers Holdings Limited v City of Swan & Others [2010] HCA 11.  The decision is potentially an important one for New Zealand.

A key objective of voluntary administration is to maximise the chances of the company under administration, or its business, continuing in existence.  The primary measure for achieving this is through execution of a DOCA by the company and the requisite majority of creditors.  The DOCA will frequently provide for compromise of the company’s debts.  But there is no provision in the Companies Act expressly prohibiting the DOCA from releasing third parties.  Section 239ACW provides that a DOCA that releases the company from a debt does not release a guarantor.  But what about a DOCA that expressly releases a guarantor?

Contractual release of third parties is common, but the difference under a DOCA is that the release, if allowed, can be enforced on dissenting creditors (up to 50 percent in number and 25 percent in value).  In the case of some potentially exposed third parties – for example, directors who are central to the survival of the company under the DOCA – this may be defensible.  But the High Court held that the Australian regime does not bind creditors to accept third party releases. 

The facts in Lehman Brothers

On 30 March 2010, the High Court of Australia in Lehman Brothers unanimously held that a DOCA under the Australian voluntary administration regime (Part 5.3A of the Corporations Act 2001) cannot preclude creditors from pursuing legal action against third parties.

Administrators had been appointed to Lehman Brothers Australia Limited (“Lehman Australia”) pursuant to a directors’ resolution.  In May 2009, Lehman Australia and one of its largest creditors, Lehman Brothers Asia Holdings Limited , proposed a DOCA whereby Lehman Australia’s creditors, including several councils, would receive between 2 and 13 cents in the dollar.  Related entities of Lehman Australia would receive returns estimated between 47 and 100 cents in the dollar.

The DOCA provided that investor creditors who asserted claims against Lehman Australia:

(i)     retained their rights against the special purpose companies that had borrowed the money from those investors;

(ii)     compromised their claims against Lehman Australia; and

(iii)     released other companies related to Lehman Australia, and its insurers, from claims arising from their investment.

The DOCA was executed, with the vote being carried by companies related to Lehman Australia.  The majority of councils voted against it, and some commenced proceedings in the Federal Court, arguing that the purported extinguishment of their claims against the related entities and insurers was not permitted, and that they were not bound by the DOCA.

On 25 September 2009, the Full Court of the Federal Court found that the DOCA was void , because of its purported release of third parties.  Lehman Australia and Lehman Holdings were granted special leave to appeal to the High Court. 

On 30 March 2010, the High Court dismissed the appeal.  The Court confirmed that a DOCA cannot release third parties from claims that creditors bound by a DOCA may wish to bring against them.  The High Court also held that the DOCA failed as a whole.  This was for the reason that no party had submitted to the High Court that the remainder of the DOCA should be treated as valid.  It seems the High Court would have considered an application to validate the balance of the DOCA if such an application had been made.

The High Court decision allows creditors of Lehman Australia to make claims against other related entities and insurers to seek to recover over $600,000,000 in alleged losses.  These claims include claims in negligence, false, misleading or deceptive representations, breaches of fiduciary duty, and claims under guarantees. 

The relevant provisions

The High Court based its decision almost entirely on statutory interpretation.  Given the similarities with the statutory provisions in this country, and the fact that our voluntary administration regime was based on the Australian model, this should make the decision persuasive here.  The High Court considered a number of provisions.  These are worth comparing with their New Zealand equivalents.

First, s 444A(4) (which finds its almost identical equivalent in s 239ACN Companies Act), provides for matters which the DOCA must specify, including “to what extent the company is to be released from its debts”.  

Secondly, s 444A(5) (cf s 239ACN(3)) provides that prescribed provisions are included unless the DOCA specifies otherwise.  The Australian prescribed provisions stipulate that creditors must accept their entitlements under a DOCA in satisfaction of all their claims against the company.  The New Zealand provisions are too inconsistent to provide any assistance.    Reg 5 of the Companies (Voluntary Administration) Regulations 2007 provides that each creditor of the company accepts their entitlement under the DOCA in satisfaction of all claims payable to the creditor.  However, reg 6 says that payment of the creditor’s entitlement under the DOCA extinguishes all claims due by the company.  In any event, by virtue of s 239ACN(3), the prescribed provisions may be excluded by the DOCA.  They cannot really provide much support to either side of the argument. 

Having analysed these provisions, the High Court stated that “to ask whether particular provisions of a DOCA are ‘authorised’ by Part 5.3A, or are ‘valid’, tends to divert attention from the critical question of statutory construction”.  Having so decided, the issue rested on s 444D, which provides that: “A DOCA binds all creditors of the company, so far as concerns claims arising on or before the day specified in the deed under paragraph 444(4)(i))”.  The New Zealand equivalent (s 239ACT(1)) provides very similarly, though refers to “creditors” rather than “creditors of the company”.   Read in the context of Part 15A however, the term can only mean creditors of the company.  Accordingly, the relevant provision is, in important respects, the same.

The High Court noted the “critical observation” that s 444D(1) limits the binding nature of the DOCA only “so far as concerns claims” arising before a specified date.  This was apparently seen as significant to a more general intent to limit the binding nature of the DOCA to claims against the company. 

More generally, the Court noted that the premise of Part 5.3A was that “effect is to be given to the will of the requisite majority” (notably, 50 percent in number and value, compared with 50 percent in number and 75 percent in value here).  In the High Court’s view, it is to be emphasised that the regime enforces the decision of the majority on dissentients.  In a separate judgment, Heydon J relied on the principle enunciated in Mabo v Queensland [No 2][that “clear and unambiguous words [must] be used before there will be imputed to the legislature an intent to expropriate or extinguish valuable rights relating to property without fair compensation”.  Having so found, His Honour turned the enquiry onto the parties supporting the DOCA to show clear and unambiguous words supporting the conclusion that rights against third parties could be extinguished.  He robustly concluded that such enquiry was “not fruitful”.  There is no clear wording supporting third party release.

Will the New Zealand courts follow this decision?

A number of DOCAs executed in New Zealand to date have also purported to release third parties.   

The reasoning of the High Court is such that there is scope for the New Zealand courts to find reason to disagree with it and to come to a different conclusion.  However, a significant factor at play, which supports the likely adoption of the result of Lehman Brothers, is that the New Zealand voluntary administration regime is largely based on the Australian one.  While the statutory language is not identical, the relevant provisions here are in large part based on the Corporations Act.  One of the reasons mooted for adoption of the regime was the economic benefits of New Zealand having a voluntary administration regime as similar as possible to that in place in Australia, with consequent benefits for business certainty and trans-Tasman alignment.  This incentive extends to aligning common law on the regime as closely as possible with Australia, much as has happened with the Fair Trading Act and its Australian equivalent.

Implications

Until it is known in New Zealand whether Lehman Brothers will be followed, the uncertainty raises a number of difficult issues for those advising creditors and debtors in respect of DOCAs.

Despite the decision, debtor companies and their directors might still seek to release third parties through a DOCA, because there are other potential advantages even if Lehman Brothers is followed.  In Surber & Anor v Lean & Ors (2001) 19 ACLC 369, the Federal Court of Australia said that a DOCA had contractual force between the administrator and the company.  The Federal Court decision in Lehman Brothers also acknowledged some potential overlap with contract law, such that it might still be argued that an approving creditor has contractually agreed to release third parties.  Also, there might be situations where a third party could argue that a creditor who agreed to release them through a DOCA was estopped from subsequently pursuing a claim (eg if there was detrimental reliance by the third party providing further funding for the company).

For those who don’t agree to a third party release but find themselves subject to a DOCA that purports to grant one, the case will provide added confidence to challenge such DOCA under s 239ACX.  Under that section, the Court can vary a DOCA even if it declares a provision void, thus potentially validating the balance of the DOCA despite the voidability of the third party release. 

Arguably voluntary administration loses a potential attraction for debtor companies and related debtors if Lehman Brothers is followed here.  They may be more inclined to follow the classic statutory compromise procedures under Parts 14 and 15 of the Companies Act.

However, there are many potential advantages of administration over those procedures.  Third parties debtors seeking greater certainty would be well advised to obtain separate Deeds of Release from creditors to whom they are potentially bound and who would otherwise approve the DOCA.  If creditors are prepared to release third parties by approving the DOCA, they may be prepared to execute a separate Deed of Release doing so, thus putting the issue beyond doubt and avoiding the risk of subsequent invalidation of the DOCA.  However, this may raise added complications and encourage debtors seeking release to run the risk of relying solely on a release under the DOCA.  Further comfort might be obtained by including a clause providing that invalidity of any term of the DOCA does not invalidate the balance.  Though a Court would not be bound by such a clause, it might well be relevant to the exercise of its discretion to validate.  The Lehman Brothers decision should not be taken as authority for the proposition that a DOCA containing third party releases should always be void.

Conclusion

In the interests of consistency, Lehman Brothers should and probably will be followed here.  Those using voluntary administration should now exercise even more caution before recommending purported release of third parties.  Even if it is followed, significant issues remain to be tested.

Glen Ryan is an Associate and Blair Williams a Senior Solicitor at national and trans-Tasman firm Duncan Cotterill. glen.ryan@duncancotterill.com; b.williams@duncancotterill.com