Vol 2 (2005) - Issue 5

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'Discriminate only to Rehabilitate': Commonwealth of Australia v Rocklea Spinning Mills Pty Ltd (Receivers and Managers Appointed) (Subject to a Deed of Company Arrangement) [2005] FCA 902

Australia’s principal formal restructuring procedures for companies are voluntary administration (‘VA’) and deeds of company arrangement (‘Deeds’). VA is invoked when the directors of a company resolve that, in their opinion, the company is insolvent or is likely to become insolvent at some future time and that an independent insolvency practitioner should be appointed. VA involves a moratorium period during which the voluntary administrator is temporarily appointed to assume control and investigate the affairs of the company. The voluntary administrator is required to hold two meetings of creditors and to provide a report to creditors about the company’s business, property, affairs and financial circumstances, together with a statement setting out his/her opinion as to whether it is in creditors’ interests for the company to execute a Deed, end the administration or be wound up.

Deeds can, and often do, discriminate between unsecured creditors, particularly when the purpose of the Deed is to rehabilitate the company. It may be considered necessary to offer some creditors a higher proportion of their claim as a dividend if their involvement is vital to the continued existence of the company, and offer other creditors less or even nothing if it is determined that their involvement is no longer required. Whilst unfair discrimination is a ground for termination of a Deed, the Full Federal Court of Australia in Lam Soon Australia Pty Ltd (adm apptd) v Molit (No. 55) Pty Ltd (1996) 22 ACSR 169 (‘Lam Soon’) confirmed that discrimination between unsecured creditors is not necessarily unfair, as long as no creditor receives a distribution under a Deed lower than they would be likely to receive in a winding up.

On 12 May 2005, Justice Finkelstein of the Victorian District of the Federal Court of Australia heard an application brought by the Commonwealth of Australia (‘Commonwealth’) to terminate a Deed which provided for funds contributed by the directors to be distributed in a manner radically different from the distribution which would have occurred in a winding up.

Rocklea Spinning Mills Pty Ltd (Rocklea)

Rocklea commenced business in the late 1940s and, for a time, was greatly profitable with an annual turnover of AUD 75 million and over 200 employees. GE Capital Finance Pty Ltd (‘GE’) provided Rocklea with funding for working capital, secured by a first ranking debenture charge over Rocklea’s assets.
However, after accumulating trade losses exceeding AUD 16 million during the financial years ending 30 June 2001, 2002 and 2003, GE was owed AUD 10.4 million and refused to extend any further funding to Rocklea. The directors of Rocklea appointed voluntary administrators on 20 October 2003 (‘Administrators’) and on the same day GE appointed receivers and managers (‘Receivers’).

The Commonwealth’s GEERS contribution

When the Administrators and Receivers were appointed, Rocklea’s employees were owed AUD 3.8 million in respect of various entitlements and were paid AUD 2.6 million in respect of those entitlements by the Commonwealth under the General Employee Entitlements and Redundancy Scheme (‘GEERS’). GEERS is a voluntary scheme developed by the executive arm of the government whereby certain entitlements, capped to a specified limit, are paid to employees following the insolvency of their employer. The Government then seeks to recover those payments from the company in its insolvency administration, by virtue of a series of priorities provided for in the Act. The priorities, detailed in s556(1) of the Act, allow employees to be paid certain claims in full, such as wages, leave, injury compensation and redundancy entitlements, in priority to the general body of unsecured creditors. Section 560 of the Act further provides where a third party advances money to a company in liquidation to pay debts, that third party will be entitled to the same right of priority for payment in respect of the debts as the creditor who received the payment.