Australia: Recent Insolvency Cases - Are You up to Date?

We have noticed a gradual increase in the level of insolvency activity over the first quarter of 2006. This is not surprising given that retail and construction have reportedly slowed since December 2005, the Tax Office has publicly declared war on slow tax payers and most recently, the Reserve Bank raised interest rates for the first time in over 12 months and the cost of petrol increased to levels never before seen nor imagined.

With this in mind, we thought it an opportune time to bring you up to date on some recent insolvency related decisions and, in particular, how the Courts are dealing with discretionary applications filed during an external administration. In this, our fourth Insolvency Update for 2006, we review three such decisions by first looking briefly at the facts in each case, followed by an identification of the legal issues at hand and finally, a consideration of the Court’s findings and the practical implications arising from each decision.

This decision demonstrates the Court’s attitude to the use of the voluntary administration regime to avoid liquidation where a company is clearly insolvent.

Bechara applied to the Court to wind up Sotrip. Prior to the hearing of Bechara’s application, Sotrip’s directors resolved to place the company in voluntary administration.

Sotrip owned one parcel of land in Mudgeeraba, Queensland, which was valued at between $620,000 and $800,000. Prior to being placed in administration, Sotrip contracted to sell the land for $660,000 to McInnes Perpetual Pty Ltd, a company wholly owned and controlled by a Mr Cassaniti.

The administrators’ second report to creditors stated that the land was encumbered to the extent of $2,763,000. The report also cited the potential for a liquidator to investigate preferences, insolvent trading and the circumstances surrounding the sale of the land. However, the report recommended the acceptance of a $300,000 Deed of Company Arrangement (DOCA) proposal.

The $300,000 proposal was withdrawn shortly before the second creditors’ meeting and was replaced by a proposal for the establishment of a $50,000 fund that purported to be in addition to the sale proceeds of $660,000.

Sotrip and Mr Cassaniti applied for an adjournment of the winding-up hearing to provide Sotrip’s creditors with time to consider the proposed deed of company arrangement.

The main issue for consideration was whether Sotrip had advanced sufficient evidence under s.440A of the Corporations Act 2001 (the Act) to the extent that a greater dividend would be available to creditors under DOCA compared with a winding up.

Justice Barrett held that the promise of the sale proceeds and the $50,000 fund was ‘illusory and misleading’. When cross examined, Mr Cassaniti could not identify the source of the funds or the time when the funds would become available. Furthermore, the sale proceeds of $660,000 would not be available to creditors as the property was secured for a sum of nearly four times that amount. His Honour was satisfied that the support of creditors for the $50,000 proposal was given on the basis of a wholly misleading description and that their supposed support could be safely ignored.¹

Additionally, Barrett J expressed concern that the possibility of a liquidator investigating matters raised in the administrators’ report would be lost if a DOCA was executed. Accordingly, Sotrip failed to establish the requirements of s.440A and the application to adjourn the winding up of Sotrip was dismissed.

This case demonstrates the Court’s attitude to attempts to delay the winding up of hopelessly insolvent companies where the proposed DOCA lacks substance. This case also highlights the general importance of leading sufficient evidence to establish an entitlement to the relief sought in highly contested applications of this nature.

This was an ex-parte application under s.447A of the Act by the administrators of Priceright to extend the time for an adjournment of a second meeting of creditors beyond the 60 day limit contained in s.439B of the Act and Corporations Regulation 5.6.18(2).

The second meeting of creditors had already been adjourned to 1 May 2006, which reflected the extent of the statutory maximum of 60 days.

The administrators claimed that a further adjournment was warranted because a DOCA was at an advanced stage of formulation and that it had a realistic prospect of offering the company’s creditors 51 cents in the dollar as against a likely range of 8 to 19 cents in the dollar on liquidation (excluding any potential recovery actions).

The issue in this case was whether s.447A could be used to extend the convening period time for a second meeting of creditors beyond the statutory 60 day limit.

Justice Barrett was satisfied that the Court’s power under s.447A was sufficiently wide to allow such relief.²

Barrett J was mindful that the extension sought by the administrators had not been sanctioned by creditors because it had not been foreshadowed at the second meeting of creditors. However, his Honour held that an order under s.447A was ‘still one about how Part 5.3A is to operate in relation to the particular company’.³

Barrett J made the order proposed by the administrators that the second meeting of creditors be adjourned to a date not later than 31 May 2006, reserving leave for any interested person to apply ‘to vary the substantive order upon 24 hours’ notice’.

Although decided on discrete facts, this decision reinforces the ‘magic wand’ effect of s.447A of the Act and in particular, that it can be utilised to obtain an extension of a convening period in excess of the 60 day maximum prescribed by s.439B of the Act.

This case involved an application by a liquidator for Court approval of a litigation funding agreement under s.447(2B) of the Act.

Mr Leigh was the liquidator of 17 entities of the King Brothers group of companies. The companies were subject to various fixed and floating charges held by both the National Australia Bank Ltd (NAB) and entities within the financing division of Toyota.

On 8 April 2003, the directors of the companies resolved to appoint an administrator. NAB and Toyota both appointed receivers and managers to the assets covered by their respective charges. At the second meeting of creditors held on 4 July 2003, it was resolved that the companies be wound up. On 10 September 2003, Mr Leigh reported as liquidator that potential recovery actions were available and that he intended to seek funding from creditors or from a litigation funder if no creditor was prepared to fund. This action was supported by legal advice which was tendered to the Court confidentially at the application.

Mr Leigh attempted to raise funding from two interested creditors, neither of which was ultimately prepared to provide funding.

At a meeting of creditors held in late September 2005, the liquidator identified the ATO and Toyota as potential recovery targets. By January 2006, the liquidator was in possession of a litigation funding proposal from Litigation Lending Services.

The liquidator applied to the Court under s.477(2B) of the Act for approval of entry into the litigation funding agreement.

The issue in this case was in what situations will the Court grant approval for a liquidator to enter into a litigation funding agreement?

Justice Austin approved the litigation funding agreement, being mindful of the need to avoid undue scrutiny or a complete merits review ‘unless there can be seen to be some lack of good faith, some error of law or principle, or real and substantial grounds for doubting the prudence of the liquidator’s conduct’.⁴

Austin J summarised the relevant factors for consideration as :⁵

• The liquidator's prospects of success in the litigation.

• The interests of creditors other than the proposed defendant.

• Possible oppression in commencing the proceedings.

• The nature and complexity of the cause of action.

• The extent to which the liquidator has canvassed other funding options.

• The level of the funder's premium.

• The liquidator's consultations with creditors.

• The risks involved in the claim (including the amount of costs likely be incurred in the proposed litigation, the extent to which the funder is to contribute to those costs, and the extent to which the funder is to contribute to the costs of the defendant in the event that the action is not successful, or towards any order for security for costs).

In this case, the fact that the liquidator had sought legal advice on the prospects of recovery, the increased potential for returns to creditors, the liquidator’s attempts to negotiate other financing options and the terms of the funding agreement (including a capped recovery for the funder) persuaded Austin J to approve the agreement.

The principles in this case are helpful in determining what the Court will consider when determining whether to approve a litigation funding arrangement under s.447(2B) of the Act.

The principles considered by Austin J in this matter are equally applicable to liquidators determining whether it is viable to pursue litigation using the available funds in the liquidation. Addressing each of the issues identified by the Court, including obtaining independent legal advice, seeking creditor approval and recording consideration given to these issues will help a liquidator deflect any subsequent scrutiny levelled in respect of a decision to pursue particular litigation.

This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.