A good reason for a Special Purpose (Liquidator): suspected illegal phoenix activity - Insolvency/Bankruptcy

This week’s TGIF considers a recent decision of the Federal Court where a special purpose liquidator was appointed to investigate suspected illegal phoenix activity.

WHAT HAPPENED?

The company formerly known as Intelara Pty Ltd (Intelara) was wholly owned by and had common directors with Intelara Holdings Pty Ltd (Holdings). The directors of both companies were also the shareholders of Holdings.

When Intelara experienced financial difficulties in the latter part of 2015, it engaged the services of a “restructuring” consultant.

The restructuring consultant advised on the options available to Intelara, describing the most suitable course as ‘a legal phoenix’ and suggesting that a particular insolvency practitioner be appointed (with whom contact has already been made). Additional “restructuring” advice was again sought by Intelara in late 2015.

In December 2015, four days after receiving that advice, Intelara went into voluntary liquidation.

Immediately prior, Intelara had entered into an asset sale agreement with Intelara Engineering Consultants Pty Ltd (Engineering). Engineering had been created five days earlier and had the same directors. Companies controlled by the directors were the shareholders of Engineering.

By the asset sale agreement, Intelara transferred to Engineering all of its assets and 24 of its employees (including the directors) for consideration calculated by the Court, confusingly, as being either the sum of $1.00 or negative $412,574.00. Engineering had no substantial assets or working capital.

In January 2016, Engineering sold its assets to Holdings. Only the directors’ employment was transferred, while the other 22 employees remained. The day after that sale Engineering passed a special resolution that it be wound up. Engineering could not pay the employee entitlements which it had assumed under the initial asset sale agreement and which had accrued during the intervening 44 day period.

The Fair Entitlements Guarantee Recovery Unit (FEG), administered by the Department of Jobs and Small Business, advanced the sum of $676,777.31 to the liquidators of Engineering under the Fair Entitlements Guarantee Act 2012 (Cth) to meet the employees claims and entitlements. FEG was advised that no dividend was expected to be paid.

In addition, approximately $200,000.00 was paid by FEG in respect of other employees that had not been transferred to Engineering under the initial asset sale agreement.

The transfer of employees and their entitlements to Engineering meant that funds recovered by the liquidator of Intelara were used to repay its bank debt and discharge the security held, including the personal guarantees of the directors.

THE APPLICATION

First, the Commonwealth was granted ‘eligible applicant’ status by ASIC and undertook public examinations, through which it secured documents and information relating to these events.

The Commonwealth, on behalf of the department, then made this application in respect of Intelara pursuant to section 90-15 of Schedule 2 of the Corporations Act 2001 (Cth).

The liquidator of Intelara claimed in correspondence with FEG to have considered the transaction and determined that it was not an uncommercial transaction. There was evidence before the Court suggesting that prior to her appointment, the liquidator had advised Intelara and its directors in relation to the anticipated restructure which would be achieved by transferring assets of Intelara to a new entity. This was denied and no final determination of these issues was required in the present application.

There was concern that the liquidator was either unwilling or unable to pursue causes of action which would recover funds from which the FEG’s claim as a contingent creditor of Intelara might be met. There was also concern that the potential causes of action would soon be time barred.

The appointment was not opposed by the liquidator.

DECISION

The question addressed by the Court was whether it would be just in the administration of Intelara and beneficial to the outcome of the liquidation for the appointment to be made. Derrington J determined that it was, and identified as a “powerful consideration” in the exercise of the Court’s discretion that the appointment would avoid the liquidator’s difficulty in investigating a transaction in which she had allegedly been involved and the apparent conflict of interest.

If the initial asset sale agreement is set aside, FEG will be entitled to prove in the winding up of Intelara for the amounts paid in respect of those employees transferred to Engineering. The clear benefit to FEG ensured its support of the SPL and a form of funding agreement between FEG and the SPL alleviated the usual concerns that the appointment would impose an unreasonable costs burden on Intelara.

Ultimately, an SPL was appointed with narrowly defined powers to conduct investigations (including examinations of the liquidator and her staff, but only in relation to conduct prior to the liquidation) and pursue claims in relation to certain matters.

COMMENT

This decision reveals something of FEG’s attitude towards phoenix activity and its appetite for funding SPLs to pursue investigations and potential proceedings.

The proactive measures taken by the Commonwealth in undertaking public examinations and this application, against an experienced liquidator, were endorsed by the Court insofar as it was noted that the Commonwealth could not sit back and allow the limitation periods for taking action against directors and others to expire without further investigation.

Interestingly in the current environment of impending law reform relating to illegal phoenix activity, the Court comments that “the word ‘restructure’ is obscure and can cover a variety of sins. It has become now a common phenomena to see the word ‘restructure’ used as not referring to the restructure of a company’s business, but to the wholesale transfer of a company’s business to other entities.

In this way, the case also serves as a warning to insolvency practitioners engaged in pre-appointment work or giving restructuring advice.

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