Will a Court order security for costs against a liquidator with litigation funding? Not always, as a recent decision of the NSW Supreme Court made clear.
The defendant was the director of a company (Commercial Indemnity Pty Ltd or 'Commercial Indemnity') which provided agency services for commercial and industrial rental and petroleum bonds.
In 2008, the defendant sold a half interest in Commercial Indemnity but never transferred the purchased shares. Following the sale, the defendant and co-owner worked full time in the business until 2013 when a serious dispute arose.
In May 2015, proceedings were commenced in the Supreme Court of New South Wales by the co-owner which sought a declaration that the defendant held half of the shares of Commercial Indemnity on trust and an order that a share transfer be executed. One month after this claim began, the defendant placed Commercial Indemnity into voluntary liquidation.
That same day, prior to the liquidator's appointment, the defendant caused a sale of the business of Commercial Indemnity to a company in which he and his wife held 100% of the shares. The business was later sold, a year later, to an unrelated third party for over $500,000 (which exceeded the original sale price by almost $480,000).
The co-owner was ultimately successful in the 2015 Supreme Court proceedings and, in June 2016, obtained the order for an execution of the share transfer. Shortly thereafter, the co-owner caused a special purpose liquidator (SPL) to be appointed and provided funding for investigations into the conduct of the defendant to be carried out.
In October 2018, the SPL commenced proceedings against the defendant, alleging breaches of duty as a director of Commercial Indemnity, and his wife, for accessorial liability, and the application for security then followed.
The issues for determination
Her Honour accepted the jurisdiction to order security was enlivened by reason of the insolvency of Commercial Indemnity. As such, the question for determination was whether the discretion should be exercised.
The SPL opposed security on the following grounds:
- the company's impecuniosity was attributable to the defendants;
- the claim was strong and the defendants' conduct should be 'strongly condemned'; and
- the delay in making the application (4 months after proceedings were commenced and following completion of the plaintiffs' evidence).
The defendants contended, principally, that security should be ordered given Commercial Indemnity was insolvent, a funding agreement was in place and there was no evidence such an order would stultify pursuit of the claim.
Notwithstanding the submissions of the defendants, her Honour refused to order security. What appeared to weigh heavily against the order was the discretionary considerations of prospects in the case and the public importance that directors be held to account for the consequences of their breach.
On merits, the SPL argued this was a matter in which the corporate plaintiff had been "put out of business". This was countered by the defendants who submitted the security application was an inappropriate forum for a mini-trial and that a preliminary view on strength or weaknesses should not be drawn.
Notwithstanding this, her Honour observed the defendants' position was somewhat undermined by their failure to serve any evidence (in breach of a timetable to which they consented) and noted the court could, in fact, have regard to prospects – in the appropriate case – and it was wrong to suggest that a constrained approach to the "merits factor" (usually applied on security applications before pleadings closed) precluded such an assessment where warranted.
In this case, her Honour, having reviewed the plaintiffs' evidence and the earlier judgments concerning Commercial Indemnity, concluded there was sufficient evidence the claims had merit which militated against an order for security.
On funding, it was noted that, where litigation funding is in place, the court will be readier to order security against a liquidator. The defendants cited the arrangement which enabled the proceedings to be brought and sought to emphasise the claim was, in fact, a private dispute between shareholders (as opposed to litigation of public interest) and suggested it had been constituted in such a way so as to avoid the co-owner being exposed to personal liability for a costs order.
Whilst her Honour acknowledged the existence of funding, and the inference that a commercial profit stood to be made by the funder, this was held to simply be one of several factors which would guide the exercise of the discretion and was not determinative of the application itself. Similarly, the fact that there was no compelling evidence of stultification was accepted and acknowledged as but one relevant factor.
The application was dismissed with costs.
This case serves as a reminder that a funded liquidator and insolvent plaintiff will not automatically justify an order for security. The discretion of the court, if the jurisdiction is enlivened, depends on a range of factors each of which will be balanced to determine an application.
As part of this assessment process, neither the "merits factor" nor the "public importance factor" should be discounted. This is particularly so when evidence has been served and the claim concerns allegations of breach of directors' duties and/or creditors being deprived of payment for goods and services. Such factors will tend against an order for security being made.
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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