Liquidators´ Duties Clarified

Article by David Goldman and Michael Rose

Relief has arrived for insolvency practitioners keen to learn the extent of the court's discretion to order enquiries into their conduct, following the NSW Court of Appeal's decision in Hall v Poolman [2009] NSWCA 64, which overturned the trial judge's order.

While the Court of Appeal held that there was jurisdiction for the trial judge to order an enquiry, the trial judge's discretion miscarried because he:

• failed to take into account the public interest in bringing insolvent trading proceedings; and

• incorrectly found that the liquidators were required to seek judicial directions before accepting litigation funding.

This article sets out the issues raised by this decision that can affect the conduct of liquidations. We also list a series of tips for liquidators to be aware of.

Complaint need not be formal

According to the majority, in order to enliven the court's jurisdiction to order an enquiry, all that is needed is a criticism expressed to the court about the conduct of a liquidator connected to the performance of the liquidator's duties.

A submission made by senior counsel at trial for one of the defendants - that the proceedings were a moneymaking exercise for the funder, the liquidators and their lawyers - was upheld to be a complaint for the purposes of section 536(1)(b) of the Corporations Act 2001 (Cth) ("the Act").

The Court of Appeal considered that section 536 of the Act gives the court an important supervisory jurisdiction over the affairs of a corporation, in situations where normal market forces and a shareholder's rights are curtailed.

It is not necessary that a prima facie case be made out to support the enquiry. It may be enough that there is a sufficient basis for ordering an enquiry, so long as that basis relates to the faithful performance of a liquidator's duties or observance of the requirements set out in section 536(1)(a) of the Act.

Factors capable of supporting an enquiry

The Court of Appeal agreed with the trial judge that the following matters were capable of supporting an order for enquiry:

• the extent and costs of the litigation;

• the lack of proportionality between the liquidators' costs and the possible recoveries;

• the fact that at best creditors would receive only a token benefit from the proceedings and the possibility that the proceedings were commenced only for the benefit of the liquidators and the funder; and

• the fact that one of the liquidators gave evidence expressing discomfort about the level of costs incurred.

Quantum and relative recovery not determinative

The Court of Appeal held that liquidators may act in accordance with their duties and pursue litigation under a funding arrangement even if there is little or no likelihood of recovery beyond the liquidator and funder recovering their own costs and expenses.

Liquidators are entitled to bring proceedings even if the only prospect of recovery is reimbursement of the
liquidators' own fees and expenses, so long as such proceedings are commenced in a bona fide exercise of statutory powers.

No obligation on liquidators to apply for directions

Contrary to the trial judge's view, the Court of Appeal held that there was no obligation upon liquidators to apply for directions as a matter of course prior to entering into a litigation funding agreement. Rather, liquidators should be informed by exercising their own duties of skill, care and diligence. In the present case, the liquidators had already obtained the approval of creditors.

Utility of proceedings

The Court of Appeal also took into account the fact that the proceedings the subject of the enquiry had settled, and having regard to the trial judge's stated purpose of the enquiry, being to assist in making a costs limiting order, the need for an enquiry no longer existed.

Need to consider public interest

The Court of Appeal held that the trial judge's failure to give weight to the question of public interest as a discretionary factor in ordering an enquiry justified setting aside the trial judge's order for an enquiry.

It also held that, in not considering the public interest in the liquidators pursuing proceedings against the directors, the trial judge's exercise of his discretion in ordering an enquiry miscarried.

Tips for liquidators

1. It is not mandatory to seek approval of the court prior to entering into a funding agreement, however such a decision should be informed by the liquidator's duties of skill, care and diligence properly exercised. The approval of creditors or the committee of inspection will be helpful but not determinative (note this will be mandatory under section 477(2B) of the Act).
2. Liquidators should be mindful of the costs to be incurred in a proceeding, as excessive costs, or costs disproportionate to any potential return may found the basis for an enquiry under section 536 of the Act. The actual return to creditors, not the percentage dividend or pro-rata return, will be most relevant.
3. In appropriate cases it may be in the public interest for a liquidator to commence proceedings to recover fees previously incurred by the liquidator, even if those proceedings will not produce a return for creditors.
4. The powers of the Court to order an enquiry under section 536 are broad, and extend beyond the power to order an enquiry based on complaints about failure to perform duties faithfully, and may include complaints about competence or lack of diligence.
5. Section 536 should not be utilised against liquidators by third parties in lieu of another, more appropriate remedy.
6. Liquidators should consider settling proceedings as soon as possible if the actual return to creditors is likely to be minimal.

For an overview of the trial judgment, see D Goldman, " Negligible justice from third party funded litigation"

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.