Australia: Insolvency practitioners reminded of their obligations to exercise care and closely monitor any third party fees incurred

FACTS

The directors of Joe & Joe Developments Pty Ltd (the Company), were Mr Tony Elias and Mr Joseph Kossaifi. The Company's shareholders were the directors and their families.

In late 2005, the Company purchased land in Narrabeen, NSW and constructed commercial and retail units on that land. Differences between the directors as to what should be done in respect of the completed development emerged from early 2007 and had grown into a substantial dispute by 2008.

This dispute resulted in the appointment of Mr Richard Albarran and Mr Blair Pleash as voluntary administrators of the Company. The parties then executed a DOCA, appointing Mr Albarran and Mr Pleash as deed administrators of the DOCA (the Deed Administrators). However, the DOCA's progress was impeded both by continuing disputes between the two families and issues regarding the DOCA's operation and effect.

In an early report to creditors, it was predicted that, after the sale of the Company's assets (which included an unencumbered property) and payment of creditors and the administrators, $2.09 million would be returned to the shareholders.

However, due to the length and difficulties with the administration and the costs of the administrator's remuneration and expenses incurred, there was a shortfall of over $550,000.

The shareholders of the Elias family (Elias Shareholders) applied to the Supreme Court for a declaration pursuant to section 447E of the Corporations Act 2001 (Cth) (Act) that the Deed Administrators had managed the Company's affairs in a way that was prejudicial to the Company's creditors and shareholders.

The Elias Shareholders also made allegations that the Deed Administrators had unreasonably incurred legal costs and paid invoices without checking them as to whether the amounts claimed by their former solicitors were properly and reasonably claimed.

This article will focus on the Court's comments on the obligations of insolvency practitioners with respect to expenditure on third parties, such as legal professionals, which are often the largest component of an administrator's costs.

DECISION

Justice Black referred to the approach taken by the Courts with respect to the review and payment of legal invoices by receivers and liquidators.

His Honour noted that liquidators bear the onus of justifying their disbursements, and since they can only recoup from the estate if they have acted properly in instructing and paying third parties, they should subject the bills received from them to critical scrutiny.

In this instance, the need for further inquiry arose both in respect of the amount charged for particular attendances and because of a wider pattern of very many attendances for periods of at least twelve minutes.

Mr Pleash gave evidence that he understood a manager or senior manager would initially conduct a line-by-line review of any invoice before a cheque requisition was requested. However there were no records within the firm's system of time that such a task was undertaken and, in cross-examination, a significantly less detailed review of invoices was revealed. The evidence indicated that, when an invoice was received, it would either be processed without further detailed review or returned to the solicitors if it was out of the ordinary.

No inquiry was ever made of the solicitors querying any of their bills on the matter.

The Court noted that s 447E does not require the Court to enter into the field of commercial decision-making undertaken by an administrator however, by reason of their failure to undertake appropriate review of their solicitor's invoices, and thereby to supervise the work undertaken by those solicitors, the Deed Administrators managed the affairs of the Company in a way that was prejudicial to its creditors or members.

The Court did not accept that the Elias Shareholders claim that the Deed Administrators had paid their solicitors "without caring" whether the amounts were properly and reasonably claimed. The Court said that the lack of scrutiny was due to a "failure of process", rather than indifference.

Ultimately, the Deed Administrators were allowed a further opportunity to provide evidence justifying their legal costs and, in the event they were unable to do so, they would be required to repay such costs to the Company (leaving the Deed Administrators to pursue any rights they may have against their solicitors).

COMMENT

The decision outlines what is expected of insolvency practitioners in respect of incurring and payment of third parties (such as legal professionals) acting on their behalf.

In particular, such practitioners have a responsibility to exercise care and closely monitor fees as they are incurred. These obligations are likely met if an appropriate process exists for the review of invoices and the supervision of work undertaken by legal professionals.

A failure to do so can be costly as the Court may order that the insolvency practitioner repay the company for any unjustifiable legal fees.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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