Adjudicating on proofs of debt: A quasi-judicial function with protection for aggrieved creditors

27 February 2014

In this issue:

The role of the liquidator when adjudicating on proofs of debt for dividend purposes
The statutory remedy available to a creditor aggrieved by liquidator’s decision to reject or modify a proof of debt
Onus on creditor to satisfy the court that liquidator’s decision is wrong
Useful insights into the adjudication process from Capocchiano v Young

Introduction

The adjudication of proofs of debt by the liquidator (or trustee in bankruptcy) has been described by the High Court as a fundamental aspect of the liquidator’s “duty to distribute the assets in his hands or under his control among the persons truly entitled.”

The legal and practical issues associated with this important task has recently been the subject of a case from the Supreme Court of New South Wales, Capocchiano v Young (2013) NSWSC 879 (2 July 2013).

Before reviewing the decision it will be useful to briefly canvass the legal principles associated with adjudication of proofs of debts.

Background

In determining whether to admit or reject a proof of debt for dividend purposes the liquidator has been described as acting in a “quasi-judicial capacity according to standards no less than the standards of a court or judge.”

Although emphasising the “quasi-judicial capacity” of the liquidator the courts have consistently acknowledged that the liquidator is not expected to replicate the judicial process in its full extent and rigour. But the adjudication must still be carried out with the impartiality that is required of a judge, and by reference to legal principle. As one Court has observed:

“….the expression ‘quasi-judicial’ is to be understood not as imposing the full panoply of judicial function. Rather it operates by analogy in requiring the liquidator to do more than merely acting prudently or in good faith.”

In the event that the liquidator decides to reject a proof of debt, the ordinary remedy available to the person aggrieved by the decision is an application to the court under section 1321, Corporations Act to have the liquidator’s decision reversed or modified.

Although the proceedings referred to in section 1321 are described as an “appeal” from the liquidator’s decision the proceedings are in fact originating proceedings which the court hears de novo. This essentially means that, unlike a genuine appeal process, the court in approaching the matter de novo will review all the relevant facts and apply legal principles to those facts afresh.

Notwithstanding the de novo nature of the proceedings, in ways more comparable to a genuine appeal process, the primary onus rests on the party challenging the liquidator’s decision to satisfy the court that the decision should be reversed or modified. If that onus is not satisfied, or the court is unable to conclude either way as to whether the proof should be admitted or not, then the liquidator’s decision will stand.

Significantly, in proceedings under section 1321 a liquidator in defending the decision to reject a proof of debt no longer acts in a quasi-judicial capacity. The liquidator is now cast in the role of an adversary, defending the assets available for distribution against a liability, which, according to the view he or she has formed, is not legally enforceable. The liquidator will be in a position to argue against the creditor’s claim on any ground that would be available to the company to raise on being sued by the creditor.

The decision in Capocchiano v Young

The recent decision in Capocchiano v Young (2013) NSWSC 879, 2/7/2013 provides useful insights into:

The decision of the liquidator to reject a proof of debt
The material before the liquidator justifying his decision
Proceedings instituted by the claimant under section 1321, Corporations Act seeking to have the decision reversed or modified
The role of the court in reviewing all relevant evidence relating to the claim
The failure of the claimant to satisfy the court that the liquidator was wrong in rejecting the proof

Facts

The facts may be briefly stated. The plaintiffs (“the Capocchianos”) are husband and wife. Great Wall Resources Pty Ltd (“the company”) carried on the business of property development. Mr. Capocchiano was the company’s sole shareholder and its sole director. The company’s record keeping during the course of its trading was found to be, in the words of the court, “at best, haphazard and incomplete.” On 7/12/2010 the company was wound up in insolvency on the application of the deputy commissioner of taxation.

In the course of 2012 the Capocchianos lodged a proof of debt in the sum of $4,303,290. The particulars included a claim for director’s loans to the company over the period 2002-2010, and for the same period, “unpaid wages to director and wife.”

In August 2012 the liquidator issued a formal notice of rejection of proof of debt stating that in his attempts to reconstruct and reconcile the accounts between the company and the Capocchianos the liquidator had come to the view that the Capocchianos were not creditors of the company, and, in fact, were indebted to the company.

Findings of the court

With respect to the claim for wages the court found that the Capocchianos had failed to adduce any evidence, such as company minutes or employment contracts, of an agreement between them and the company for employment remunerated by wages. The court also found that the director had signed financial accounts acknowledging that no wages were paid or due, and group tax and superannuation had not been paid by the company which suggested that there were no wage entitlements.

With respect to loans advanced to the company the court found that the Capocchianos had failed to demonstrate the true state of their loan account with the company. The primary reason for this was that the accounts made no allowance for monies drawn from the company to pay personal expenses. The court stated:

“There is abundant evidence that many personal expenses were paid for by the company, consistent with Mr. Capocchiano’s complete self-identification with the company. The Capocchianos’ inability or failure to grapple with this aspect of the correct reconciliation of their claim means that the court cannot be satisfied, on their evidence, of the true state of the account between them and the company on the balance of probabilities……that uncertainty in and of itself means that the liquidator’s decision to reject the July 2012 proof must be upheld.”

Finally, in upholding the liquidator’s decision with costs, the court stated:

“No persuasive reasons have been advanced by the Capocchianos as to why costs should not follow the event in relation to their originating process.”

Concluding comments

The liquidator’s adjudication of proofs of debt for dividend purposes often generates conflict between the liquidator and a creditor as to the existence or amount of the creditor’s claim.

To ensure that this often difficult undertaking is discharged in an orderly and appropriate manner clear guidelines characterizing the quasi-judicial role of the liquidator have been developed by the courts. Most importantly the impartiality that adjudication of proofs of debt entails ensures that the liquidator will not simply adopt the contentions of the company or its directors as to the existence or amount of a creditor’s claim without independent reflection on the merits of their assertions.

Where the liquidator has rejected a proof of debt the claimant has been provided with a statutory right of access to the courts to have the liquidator’s decision reviewed. At this stage the courts will consider all available evidence relating to the claim.

In view of an orderly adjudication process regulated by well established principles and guidelines, conflicts relating to adjudication of proofs of debt can, in most cases, be quickly and conveniently resolved by the courts in the event that the parties have not been able to achieve a negotiated outcome.