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CREDITORS’ COMPROMISE MISSES THE CUT?
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The Court of Appeal has confirmed that failing to provide for a separate class for insider creditors was fatal to a Part 14 compromise.

Trends Publishing v Advicewise [1] was an appeal against the High Court’s decision to set aside a creditors’ compromise that had been proposed by Trends. Parties associated with Trends controlled more than 75% of the creditors’ vote by value (referred to in the litigation as the ‘Insider Creditors’) which was the majority required to approve the compromise. [2] The Court of Appeal upheld the High Court’s determination that the Insider Creditors should have been separated into their own class of creditors for voting purposes because their economic interests were distinct from other creditors, and this lack of separation amounted to unfair prejudice to the non-related creditors under Part 14 of the Companies Act 1993. [3]

Background 
 
Trends carried on business in the print and digital media industry and experienced significant revenue downturn and financial difficulty following the GFC. In 2015, Trends put a Part 14 compromise proposal to 62 unsecured creditors whose debts totalled approximately $4.27 million. [4] The unsecured creditors included the three Insider Creditors who were owed $3.23 million (or 75.7% of the total unsecured debt). The proposal left all major creditors with a substantial shortfall. The Insider Creditors were not to receive any payments under the compromise but maintained the right to vote on it. The compromise was ultimately approved by the requisite majorities and bound all affected creditors regardless of their vote. Advicewise, Callaghan Innovation, Mediaworks and Webstar (‘Challenging Creditors’) voted against the compromise and successfully challenged it in the High Court, where Heath J held that Trends had manipulated the voting process by including the Insider Creditors in the same class as other creditors, resulting in prejudice to the Challenging Creditors.

Court of Appeal
 
Trends argued that the High Court erred in taking a broad approach to the classification of creditors based on legal rights and economic interests. [5] Trends claimed that the purpose of Part 14 of the Act was to provide an inexpensive alternative to liquidation and that considering commercial interests for the purposes of creditor classification would make the process commercially impractical and unduly complex. [6] Trends advocated a test for classes based solely on legal rights.
 
The Court of Appeal emphasised that, in Part 14, it is important that classes are correctly defined. If they are not, the Court may intervene. It endorsed the High Court’s more flexible approach to determining classes, emphasising the importance of considering both legal rights and economic interests. Focus on legal rights alone could lead to parties who have irreconcilably different commercial goals (such as the Insider Creditors and Challenging Creditors here) being required to vote together in a ‘serious conflict of interest situation'. [7] It would be inconsistent with the broad discretion of the court under Part 14, where it may intervene if a compromise is unfairly prejudicial to a person or group, to have a rigid rule limiting separate classes on the basis only of different legal rights. [8]

Unlike the High Court, the Court of Appeal considered that Trends’ failure to provide a statement of the company’s financial position meant creditors could not properly assess the merits of the compromise and was a material non-disclosure amounting to an irregularity.
 
The Court of Appeal agreed that the compromise was unfairly prejudicial to the Challenging Creditors and that the High Court was right to set the compromise aside.

Our comments
 
The Court of Appeal sensibly upheld the High Court’s decision in a well-reasoned judgment. Companies should be careful to ensure correct process is followed if proposing a compromise to creditors. The Court of Appeal’s decision emphasises the need to consider both legal rights and commercial interests of creditors when separating creditors into different classes for voting purposes. Consideration of legal rights alone is not enough. Taking the time to ensure classes of creditors are established up front (where necessary) will be crucial in balancing a company’s desire to enter a compromise swiftly against the courts’ ability to take such action as it thinks fit (including setting aside a compromise) where a compromise is found to be unfairly prejudicial.
 
If you would like to know more about the Court of Appeal’s decision, please contact us.
 
Our thanks to Sarah Redding, solicitor, for assisting with this article.

[1] Trends Publishing International Ltd v Advicewise People Ltd [2017] NZCA 365 [24 August 2017].
[2] at [1].
[3] at [2].
[4] at [8].
[5] at [3].
[6] at [20].
[7] at [54]-[55].
[8] at [51].

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