Settlement rejected by committee of inspection approved by the court?

Naidenov, in the matter of AJW Interiors and Constructions Pty Ltd (in liq) [2024] FCA 25
What is the test for approving a settlement rejected by the committee of inspection?

Overview

In this case, a liquidator applied for approval of a settlement of claims brought against the company’s director and an employee, as well as nunc pro tunc approval of the agreement entered into with the solicitors who acted on the matter. Even though the settlement was modest (only sufficient to cover the liquidator’s remuneration) and the committee of inspection had voted against it, the Court approved it on the basis that there was a real risk of an adverse costs order being made against the company if the proceeding were continued. The Court refused to approve the agreement with the company’s solicitors, finding that the liquidator should have sought approval of the agreement at the time it was entered into and had not presented any good reason for failing to do so.

Background

The liquidator of AJW Interiors and Constructions brought applications pursuant to s 477(2A) of the Corporations Act 2011 (Cth) to approve a settlement entered into on behalf of the company and s 477(2B) to approve, nunc pro tunc, a conditional costs agreement with a law firm entered into on behalf of the company.

The settlement was entered into with the director of the company (Mr Wilson) and his spouse, who was an employee (Ms Gordon). In July 2022, the liquidator had brought claims of approximately $5.4m against Mr Wilson in respect of alleged breaches of his duty under s 588G of the Act and unreasonable director-related transactions, and claims of approximately $360,000 against Ms Gordon in respect of unjust enrichment, uncommercial transactions and unreasonable director-related transactions. The essence of the claim against Mr Wilson was for insolvent trading and the essence of the claim against Ms Gordon was the payment of monies for no consideration.

The liquidator had retained a law firm to act as solicitor for the company in connection with the claims against Mr Wilson and Ms Gordon, and had entered into a costs agreement with the law firm on the company’s behalf in April 2022. The costs agreement is a conditional costs agreement premised on a successful outcome being obtained in the proceedings. Under its terms, the solicitors are not entitled to receive payment of “Legal Costs” (as defined) unless a successful outcome, which includes a settlement, is obtained, in which case a 25% uplift applies to all fees charged under the agreement, including those of paralegals and legal clerks. The agreement requires the solicitors to take various steps in the proceedings, and states that in relation to lengthy matters fee estimates will be regularly updated. The liquidator did not seek s 477(2B) approval at the time the conditional costs agreement was entered into.

In April 2023, the liquidator agreed to settle the claims against Mr Wilson and Ms Gordon. The settlement sum was modest - it was sufficient to cover the liquidator’s remuneration claims for the period, but not the legal costs incurred by the liquidator. The settlement did not provide any return to creditors. The liquidator stated that his entering into of the agreement was informed by his view that the prospect of recovery against Mr Wilson and Ms Gordon did not warrant prosecuting the proceeding, save to the limited extent to which an insurance policy held by the company will respond to the claim.

In May and September 2023, the liquidator called meetings of the committee of inspection to vote on the settlement. The resolution to approve the settlement was not passed at either meeting. The liquidator commenced this application to approve the settlement and the costs agreement in June 2023, more than one year after the agreement was entered into.

The Court’s Decision

Applications by liquidators for approval under ss 477(2A) and (2B) are commonplace. Sections 477(2A) and (2B) condition the powers otherwise vested in liquidators under s 477 of the Act in that liquidators are prohibited from entering certain agreements unless to do so is sanctioned by the court or the committee of inspection or by a resolution of the creditors. Section 477(2A) prohibits a liquidator from compromising a debt to the company if the amount claimed by the company is more than the prescribed amount (presently $100,000). Section 477(2B) prohibits a liquidator from entering into an agreement on behalf of a company under the liquidator’s control where the term of the agreement or the obligations of a party to the agreement may end or be discharged by performance more than three months after the agreement is entered into.

A consideration that is relevant to the court’s consideration of whether to approve an application under both ss 477(2A) and (2B) of the Act is whether the proposal is consistent with the expeditious and beneficial administration of the winding up, the general expectation being that the winding up of a company will proceed expeditiously. In the context of s 477(2B) in particular, consideration of the impact of the agreement on the duration of the liquidation, and whether that is, in all the circumstances, reasonable in the interests of the administration, is a controlling, or main, consideration.

Should approval under s 477(2A) be granted in respect of the settlement?

The essential purpose of the requirement for approval under s 477(2A) is to ensure that the interests and wishes of those affected by a compromise, chiefly the creditors, are a major consideration in making such a compromise. In reviewing the liquidator's proposal, the court pays due regard to the liquidator’s commercial judgment and knowledge of all of the circumstances of the liquidation, but satisfies itself that there is no error of law or ground for suspecting bad faith or impropriety, and evaluates whether the proposal is consistent with the expeditious and beneficial administration of the winding up.

Although the Court was mindful that the committee of inspection had twice refused to vote in favour of the settlement, it approved the settlement.

The Court’s task is not to assess the commercial judgment of the liquidator or the competence of those advising the liquidator. Rather, what falls to be considered is whether, at the time the application is determined, the approval sought is in the interests of the administration.

Although the settlement was modest (sufficient to cover only the liquidator’s remuneration), the evidence revealed that significant costs, including large legal costs, had already been incurred.

In addition, the prospect of any recovery on the claim against Mr Wilson (which represented the substantial part of the relief claimed in the proceeding) was poor given the nature of the claim, the terms of the relevant exclusion under the D&O policy and the dearth of information about Mr Wilson’s ability to satisfy a judgment.

Finally, if the proceeding were continued and the plaintiffs failed, there was a real risk that the plaintiffs would suffer an adverse costs order. In these circumstances, continuation of the proceeding was unlikely to result in a better outcome than the settlement that had been agreed.

Should approval under s 477(2B) be granted in respect of the conditional costs agreement?

Section 477(2B) is directed to protecting the general objective that the winding up of a company be completed expeditiously. The requirement of approval is concerned with ensuring that liquidators’ powers are not exercised in such a way as to be unconducive to an expeditious and beneficial administration. The assessment of whether entry into a long term agreement is conducive to an expeditious and beneficial administration is not confined to consideration of the monetary interests of creditors but extends to the proper administration of the winding up. Thus, a liquidator’s pursuit of assets of the company in liquidation may be a legitimate exercise of the liquidator’s powers under s 477 even if those assets can only go towards paying the liquidator’s expenses where it is in the interests of the administration.

The proper course is for a liquidator to seek approval in advance of entering into agreement to which s 477(2B) applies. Approval can be given nunc pro tunc, but the court will be cognisant of the explanation given by the liquidator as to why the approval was not sought prior to entering into the agreement. The court will be hesitant to grant approval nunc pro tunc, or at all, where there is some substantial delay in seeking approval which is not adequately explained.

The main or controlling consideration is the impact that the performance of the agreement will have on the duration of the administration, and whether that is, in all the circumstances, reasonable in the interests of the administration, not the exercise of disciplinary functions over liquidators.

The court’s task is not to second guess the liquidator’s commercial judgment; it is rather to determine whether there are grounds for suspecting a lack of good faith, or some error of law or principle, or some other good reasons to intervene. Here, the Court made no finding of lack of bad faith or dishonesty, but concluded that there were other good reasons to refuse to grant approval nunc pro tunc.

Having regard to the nature of the obligations created by, and the scope of the work contemplated under, the costs agreement, it was clear that the term of the agreement would likely exceed the period prescribed by s 477(2B) of the Act and that liquidator’s power to enter into the agreement on behalf of the company was subject to obtaining approval under s 477(2B) of the Act.

If the liquidator had taken steps to obtain s 477(2B) approval, as he was required to do, he would have had to take steps to justify to either the creditor stakeholders or the court, why it was in the interests of the administration to prolong the administration by entering the costs agreement. He executed the costs agreement without obtaining such approval. In doing so, the liquidator exceeded the power conferred on him by s 477 of the Act.

The result was that the administration was prolonged without the liquidator ever seeking to justify that it was in the interests of the administration to enter the agreement. The expeditious and beneficial conduct of the administration was impacted by the liquidator incurring, on behalf of the company, significant and substantial obligations to the law firm under the costs agreement over a period of approximately 14 months.

The liquidator had not presented in his evidence any basis upon which he could reasonably have held an opinion that it was in the interests of the administration to cause the proceeding against Mr Wilson and Ms Gordon to be commenced and for liabilities to be incurred under the costs agreement in actively progressing that proceeding. While the Court’s task is not to second guess the liquidator’s commercial judgement, that does not mean that the Court is bound to accept a bald assertion by the liquidator, as to the liquidator’s commercial judgement, in circumstances where that opinion cannot be reconciled with the evidence.

Conclusion

Accordingly, the Court approved the settlement but not the conditional costs agreement.

Judge: Cheeseman J

Counsel for the plaintiffs: Mr G McDonald

Solicitors for the plaintiffs: Gavin Parsons and Associates