Funding litigation for the company in liquidation

02 September 2020

A liquidator is not obliged to litigate where there are no funds available to meet expenses under s545(1) of the Corporations Act 2001 (Cth). Yet there are many occasions where the liquidator will want to increase the pool of assets available for general distribution among unsecured creditors from successful litigation against directors for breaches of duties,[1] or a range of voidable transactions.[2] However, the lack of funds in an insolvent company could potentially restrict the ability of the insolvency practitioner to take such actions. The liquidator could seek funding from creditors[3] and more recently, the commercial litigation funding has played a role.[4]

 

Since Re Movitor Pty Ltd[5] in 1996 commercial litigation funding has been available in the insolvency context as a result of the court’s interpretation of the liquidator’s statutory power of sale or disposition of company property under s 477(2)(c) of the Corporations Act 2001 (Cth). The involvement of a litigation funder can enhance the funds available for distribution among the pool of unsecured creditors by removing the cost bar that could have hindered a liquidator to institute proceedings against directors or beneficiaries of voidable transactions.

 

A number of issues have arisen since 1996 in the use of commercial litigation funders in the insolvency context. These issues relate to the size of the premium negotiated with the litigation funder; the control over the litigation; conflicts of interest; and the availability of litigation funding leading to a proliferation of vexatious proceedings. Despite this, there has been rapid growth in commercial litigation funding involving insolvency administrations.

 

Under s477(2B) of the Corporations Act  2001 (Cth) any agreements made by a liquidator require Court approval, where the term of the agreement is more than three months, and so this has created an opportunity for the Court to become involved in ‘approving’ commercial litigation-funding agreements. This is often accompanied by relief sought by Sections 90-15 and 90-20 of the Insolvency Practice Schedule (Corporations) and is usually heard on an ex parte basis. As a result, a system of ‘judicial oversight’ in respect of insolvent litigation funding agreements has developed. Courts do not merely ‘rubber-stamp’ whatever is presented by the liquidator and they carefully scrutinise the proposed agreement.[6] Courts have developed certain principles when considering sanctioning a funding agreement and these relate to matters such as the prospects of success of the proposed litigation; possible oppression; 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; consultations with creditors; the public interest and the risks involved in the claim.[7]

 

The Court is clear that the standard required for approval under s 477(2B) of the Corporations Act 2001 (Cth) does not involve exercise of a commercial judgment in respect of the terms of the agreement, but it does require an assessment of whether there are ‘good and solid reasons’[8] for the  entry into the commercial litigation funding agreement so that it is a proper exercise of the liquidator’s power and not one that is ill-advised or improper.[9]

The level of control the liquidators retain in conducting the proceedings

Case law gives some guidance as to the factors that the court will take into account when assessing the validity of any funding agreement particularly the extent to which the litigation funder wishes to control the litigation. Problems of control can extend to excessive control by the litigation funders that might include influencing strategy, seeking to interfere with the client-lawyer relationship; or controlling or meddling in settlement negotiations. A funding agreement could be placed in jeopardy if the litigation funder attempted to exercise too much control over the litigation.[10]

Control is exercised by the liquidator usually as a term of the agreement where the liquidator will be solely responsible for providing all instructions to the lawyers in relation to the action, although the agreement would also require the liquidator to provide to the litigation funder, or - by instruction to the liquidator’s lawyer - to provide such reports and updates on the conduct of the action as may be reasonably required or reasonably requested. The litigation funder is permitted some control[11] and they usually hold a right to terminate their funding of the action.[12]

The amounts that commercial litigation funders benefit from funding liquidator actions

The level of the litigation funder’s premium has been discussed in some cases as one of the relevant factors with Courts being concerned that there may be recovery of disproportionate sums.  Of course, it will be a commercial arrangement and potentially confidential but it is an issue that goes directly to whether the litigation funding agreement would ultimately lead to a benefit to the creditors. [13] In Leigh re King Bros[14] Austin J observed that the litigation agreement provided for a funder’s premium was 25% of the Final Amount (essentially, the proceeds of recovery) if recovery occurred within 6 months, and this rose to 30% if recovery was within 12 months, and 37% if recovery was more than 12 months after the date of the agreement. The fee was limited to 15% if the proceedings were concluded before any drawdown. Austin J observed that this was consistent with the level of funding fees charged in other cases. His honour noted that in Buiscex Ltd v Panfida Foods Ltd (in liq)[15] (1998) 28 ACSR 357 it was suggested that a premium as high as 75% may be justifiable in certain cases. In other cases the court has commented on the funder’s premium noting a range from zero[16] to substantial.[17]

The current state of litigation funding in insolvency

In 2020 the Federal Government is conducting an inquiry into litigation funding and class actions although there is little focus in the reference on insolvency actions. Currently the insolvency industry is using commercial litigation funding and this is working well without specific express treatment in the Corporations Act. Its very presence provides opportunities to institute proceedings against malignant directors or beneficiaries of voidable transactions. To forego the present healthy state could leave the liquidator with few options such as selling their claim under s100-5 Insolvency Practice Schedule (Corporations).

 


[1] Such actions against directors include breaches of general law fiduciary type duties or duty of care, skill and diligence, as well as statutory directors’ duties to act in good faith in the best interests of the company (Corporations Act 2001 (Cth), s 181(1)), to act with care and diligence (Corporations Act 2001 (Cth), s 180(2)), to avoid insolvent trading (Corporations Act 2001 (Cth), s 588G), etc.

[2] For example, unfair preferences (Corporations Act 2001 (Cth), s 588FA), uncommercial transactions (Corporations Act 2001 (Cth), s 588FB), unreasonable director-related transactions (Corporations Act 2001 (Cth), s 588FD), etc.

[3] A possibility that has existed for over 100 years see Re Manson; Ex parte the Official Assignee (1897) 18 LR (NSW) (B & P) 45. See s564 of the Corporations Act 2001 (Cth) which provides for the court to make orders in favour of creditors where they indemnify liquidators. The object of this provision is the encouragement of pursuit of claims by liquidators, namely to benefit creditors and shareholders generally and to recover property from wrong-doers and thus discourage misconduct in relation to corporations; State Bank of New South Wales v Brown (2001) 38 ACSR 715, 728.

[4] There are other options: the contributories may wish to fund see In the matter of 77738930144 Pty Limited (in liq) (formerly Commercial Indemnity Pty Ltd) [2017] NSWSC 452 or the liquidator could bring the proceedings on a speculative basis and then receive recompense in the event of a successful outcome or he or she could seek government funding.

[5] (1996) 14 ACLC 587.

[6] Stewart re Newtronics Pty Ltd [2007] FCA 1375, at [26]. McDermott and Potts as liquidators of Lonnex Pty Ltd (in liquidation) [2019] VSCA 23.

[7] See eg Re ACN 076 673 875 Ltd (rec’r & mgr apptd) (in liq) [2002] NSWSC 578, at [17]-[34];  Leigh, re AP & PJ King Pty (in liq) [2006] NSWSC 315, at [25], (per Austin J), and endorsed by the Full Court in Fortress Credit Corporation (Australia) II Pty Ltd v Fletcher [2011] FCAFC 89; Carter, re Australian Vocational Learning Institute Pty Ltd (in liq) [2019] FCA 1638.

[8] Hughes, in the matter of Sales Express Pty Ltd (in Liq) [2016] FCA 423, at [20].

[9] Re Gerard Gassegrain & Co Pty Ltd (in liq) [2013] NSWSC 257, at [11].

[10] Ascot Vale Self Storage Pty Ltd (in Liq) v Nom de Plume Pty Ltd [2019] VSC 794.

[11] Buiscex Ltd v Panfida Foods Ltd (in liq) (1998) 28 ACSR 357, 363.

[12] Re Australian Institute of Professional Education Pty Limited (in liq) Re Australian Institute of Professional Education Pty Limited (in liq) [2018] FCA 642.

[13] Jones, Saker, Weaver and Stewart (Liquidators), in the matter of Great Southern Limited (in liquidation) (receivers and managers appointed) [2012] FCA 807.

[14] Leigh re King Bros [2006] NSWSC 315.

[15] Buiscex Ltd v Panfida Foods Ltd (in liq) (1998) 28 ACSR 357.

[16] Carter, in the matter of Australian Vocational Learning Institute Pty Ltd (in liq) [2019] FCA 1638.

[17] Jones, Saker, Weaver and Stewart (Liquidators), in the matter of Great Southern Limited (in liquidation) (receivers and managers appointed) [2012] FCA 807.

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