12 February 2015
In this issue:
- Discussion of cases that illustrate winding up on the just and equitable ground.
- Winding up on the just and equitable ground as it relates to companies experiencing management deadlock.
- Incidental issues that may arise in a management deadlock case identified and discussed.
Under section 461(1)(k) of the Corporations Act 2001 (Cth) a court may make a winding up order and appoint a liquidator to a company where it is of the opinion that it is just and equitable that the company be wound up.
The “just and equitable” circumstances in which such an order may be made are not closed. For example, recently the just and equitable ground featured in China v James Smith (No 4) (2014) WASC 140, 17/4/2014, where Mr. John Carrello, BRI Ferrier, Perth was appointed liquidator by the court over a single purpose company in circumstances where that company’s sole purpose had failed. Similarly, the just and equitable ground arose for consideration in In the matter of DJG Securities Pty Ltd (2013) NSWSC 588, 14/5/2013. Here Messrs, Resnick and Silvia, BRI Ferrier, Sydney were appointed by the court as joint and several liquidators over a company in circumstances where the court formed the view that there was a lack of confidence in the conduct of the affairs of the company, and a risk to the public interest that warranted protection.
Although the court has discretion as to when the just and equitable ground may be invoked, the most common instance of winding up on this ground involves cases where irretrievable breakdown of the relationship between persons in control of a company has occurred.
Cases of this kind most often concern a company formed on the basis of a personal relationship of mutual confidence and trust between the incorporators. When that confidence and trust has broken down, just and equitable obligations similar to those arising in partnership relations become relevant. These cases are commonly referred to as “quasi-partnership cases” in view of the quasi-partnership relations found to be underlying the corporate structure.
Reviewing quasi-partnership cases
In cases of this kind it is common for the parties involved to have carried on business in partnership prior to the incorporation of their company. From the time of incorporation the partnership ceases and thereafter the relationship of the partners becomes one of co-directors and co-shareholders of the company. However, while the parties may have joined forces as shareholders and directors in a company, their previous personal relationship continues to be integral in the management of the affairs of the company.
These issues arose for consideration in In the Matter of Amazon Pest Control Pty Ltd (2012) NSWSC 1568, 14/12/2012. In that case, prior to March 2000, Mr. Lakis and Mr. Lardis had carried on business in partnership. In March 2000 they ceased trading as a partnership and commenced trading their business through a company in which they became the company’s two directors and shareholders. In 2012 a breakdown of relations between the two parties occurred resulting in Mr. Lakis seeking an order to wind up the company on just and equitable grounds pursuant to section 461(1)(k), Corporations Act.
The court was particularly concerned with the extent of personal expenses drawn by Mr. Lardis, and the misdescription of those expenses in the company’s accounts as business expenses, with the consequence that the company’s profitability had been understated by reason of the disguised personal expenditure. The court stated:
“….. the extent of payment of personal expenses from the company and the misdescription of those expenses in the company’s financial records are matters that frustrate the commercially sensible operations of the company and would also warrant a lack of confidence in the conduct and management of its affairs.” (para 21).
In concluding that Mr. Lakis had understandably lost confidence in the management of the company the court was satisfied that an order for winding up on the just and equitable ground was appropriate.
Is a previous partnership relationship necessary?
Importantly, quasi-partnership cases do not necessarily require the parties involved to have been in a partnership relationship prior to the incorporation of their company. For example, in Nassar v Innovative Precasters Group Pty Ltd (2009) NSWSC 342, 1 May 2009, the court found that the three parties involved in that case had no relevant relationship before they joined together as co-directors and co-shareholders under a corporate structure.
Notwithstanding, the court accepted that on the incorporation of their company the three participants had an expectation and an entitlement to participate in the day-to-day management of the company. As the court stated:
“…..they were in a situation which, of its very nature and because of the informality that attended the day-to-day relationships, warranted mutual co-operation and a level of trust. The submission that the three individuals were partners in the Partnership Act sense cannot be accepted. But I do accept that their relationship entailed mutual co-operation and a level of trust and that they came to be associated together in a form of quasi-partnership.” (para’s 78-79).
When as a result of irreconcilable differences participation in management by all the parties came to an end, the court made a winding up order on the just and equitable ground accepting that “winding up is the characteristic remedy in circumstances where a working relationship predicated on mutual co-operation, trust and confidence has broken down.” (para 132).
There are a number of incidental matters that may arise in cases involving irretrievable breakdown of corporate management.
For instance, where the winding up applicant has contributed to the breakdown, questions may arise as to whether it is appropriate to accede to the application. Although the respective contributions to the breakdown should be assessed in determining what is just and equitable, a degree of fault on the part of the applicant has not been allowed to operate as an absolute bar to obtaining a winding up order so as to address the deadlock in the company’s affairs: see In the matter of Amazon Pest Control Pty Ltd (2012) NSWSC 1568, (para. 22).
Importantly, regard must be had to section 467(4), Corporations Act which requires the court to determine whether the winding up applicant is acting reasonably in seeking an order on just and equitable grounds instead of pursuing some other available remedy.
In view of the terms of section 467(4), in some cases a compulsory purchase of the applicant’s shares by co-shareholders or by the company may be considered the more reasonable remedy, as opposed to winding up: see Tomanovic v Global Mortgage Equity Corporation Pty Ltd (2011) NSWSC 104, para 237. In other cases, however, a compulsory purchase of the applicant’s shares would be futile in view of the financial circumstances of the co-shareholders or the company, such that a winding up order is the only appropriate remedy to bring the deadlock to an end: see Nassar v Innovative Precasters Group Pty Ltd (2009) NSWSC 342, (para’s 123-124).
Finally a court may be reluctant to make a winding up order in circumstances where the company is solvent and profitable. However, as emphasized by the Full Court in Hillam v Ample Source International Ltd (No. 2) (2012) FCAFC 73, there is no principle or assumption that a winding up of a solvent company is inappropriate in the event that the court determines that a winding up order is the appropriate remedy.
We are accustomed to seeing liquidators being appointed over companies undergoing winding up on grounds of insolvency. Winding up of a company on the just and equitable ground, however, is an essential remedy provided by the Corporations Act enabling the court to exercise discretionary power to deal with, inter alia, the breakdown of corporate relations. The remedy is particularly appropriate with respect to a breakdown in relations in a small company under majority control, where material co-operation and a level of trust and confidence between those in control is an essential aspect of the company’s management structure.
Finally, the important role of the liquidator in such cases should not be underestimated. As expressed by one court, the essential task of the liquidator is to overcome the paralysis being experienced by the company, and in the role of a competent functionary address the question of where the best interests of the company lie. In undertaking that role the liquidator will have the usual range of statutory rights, obligations and powers at his or her disposal, while also being subject to the usual practical constraints of cost and funding.