Duties of voluntary administrators

The case of Macks v Viscariello [2017] SASCFC 172 considers a number of important issues relating to duties of voluntary administrators. The Full Court’s decision finalises a long-running saga involving several sets of parallel proceedings across multiple courts and several parties relating back to facts more than 17 years ago. This note will highlight important legal issues discussed in the Full Court’s decision.

Factual background

The case involved claims for breach of duty and misleading conduct against an insolvency practitioner, who had been voluntary administrator and then liquidator of two companies (Bernstein and Newmore) operating retail linen stores. The companies were insolvent and needed further capital and so the director negotiated with a potential purchaser to buy the businesses, however this buy-out did not proceed due to the refusal of the companies’ senior secured creditor refusing to compromise their debt.

The claims were brought by the sole director of the companies (also a creditor) who felt aggrieved at the fact that the companies entered voluntary liquidation rather than proceeding into a deed of company arrangement to implement the buy out. The director sought the practitioner’s assistance when negotiating the buyout proposal for the companies prior to the administration, and then appointed him as administrator, with the expectation that the buyout proposal would be implemented through a DOCA. However, given the senior secured lender had refused to consent to the buyout (which was conditional on it consenting to a significant haircut on its debt), the proposal could not be completed. With no DOCA proposal in a form that could be implemented (given the impossibility of satisfying an essential condition), the administrator recommended liquidation and then became the voluntary liquidator of the companies following a vote of the creditors.

The liquidator had sold some of the companies’ stock to the partner of the director, and commenced recovery proceedings against her when she defaulted on the obligation to pay $28,000. This brought on a war of attrition where the defendant (Ms H) challenged every step in the recovery across multiple courts. The liquidator was then advised by his lawyers to assist in funding a separate action to bankrupt Ms H, which he agreed to do, initially agreeing to provide a small sum but eventually giving an open-ended indemnity to the creditor seeking to bankrupt Ms H, using the companies’ funds to support this action. The director also brought multiple proceedings against the liquidator. In total, the multiple court actions lasted 11 years and generated over $500,000 in legal costs. The director argued that the liquidator had breached his duties in his conduct of the litigation and in his conduct of the administration and liquidation.

There were two main areas of focus in the case:

  1. The duties that administrators owe when reporting to creditors;
  2. The duties and responsibilities that administrators have when engaging in litigation.

The case has been bitterly contested on multiple fronts over more than a decade and so there are many aspects of the appeal dealing with court procedure and the powers of the court that I won’t be covering here. I’ll focus on the duties of insolvency practitioners.

Duties when reporting to creditors

The end goal of voluntary administration is for the creditors to vote on the future of the company. The creditors’ voting choices are limited under s 439C to:

  1. the company executing a DOCA;
  2. the administration ending; or
  3. the company being wound up.

Voluntary administrators have a legal obligation to give an opinion to creditors as to how they should vote at the second creditors’ meeting. The administrator must prepare a report for the creditors which is sent with the notice of meeting prior to the second meeting. The report is commonly called the s439A report, although following the Insolvency Law Reform Act 2016 (Cth) the report is now required under Insolvency Practice Schedule (Corporations) 2016 (Cth) (IPS) s 75-225.

The Full Court found (at [250]) that as there was no concrete DOCA proposal that could be put to the creditors, the administrator was not under a duty to explain or indeed to recommend the buyout proposal as it was incapable of being implemented without the secured creditor’s consent (which it had made clear it opposed). See also Ten Network Holdings Ltd (admin apptd) (rec and man appt) [2017[ NSWSC 1247 (where the court held that there was no obligation on the administrator to report on a buyout proposal that had lapsed prior to the meeting). I published an article on the Ten Network case recently in the Journal of Banking and Finance Law and Practice (‘Unpacking the Ten Network Administration’ (2017) 28(4) JBFLP 343).

Administrators as fiduciaries

The director claimed that the administrator’s failure to recommend the DOCA proposal was a breach of fiduciary duty owed to creditors, and enforceable by him as a creditor. The Full Court held (at [188]) that “It is now well-established that an administrator is a fiduciary.” Of course, there is nothing novel about this statement, but the explanation of the scope of that fiduciary role is significant for insolvency practitioners.

The Full Court confirmed that fiduciary duties owed by administrators are owed to the company (at [192]), and there is no duty generally owed by an officer to creditors (at [193], and applying the High Court’s decision in Spies v The Queen [2000] HCA 43).

The Court held (from [210]-[212]) that there was no fiduciary duty to disclose particular matters to creditors, because this would represent prescriptive rules, and fiduciary duties in Australia are only proscriptive, applying Breen v Williams [1996] HCA 57. The Full Court explained (at [213]):

“An administrator is required to perform the statutory duties (requirements) that are prescribed by Pt 5.3A of the CA. Those duties or requirements are not fiduciary in nature. The CA confers various powers on administrators to enable his or her duties or requirements to be performed. The administrator’s fiduciary duties, as an officer of the company under administration, operate as a constraint in exercising those powers and performing his or her statutory function.”

The Full Court also considered whether officers owe a duty of care to creditors, including a detailed examination of the recent case of Perpetual Nominees Ltd v McGoldrick (No 3) [2017] VSC 78, and the earlier decision in Mills v Sheahan [2007] SASC 365. The Court drew a distinction between duties arising when selling assets and duties arising when exercising powers in winding up the affairs of the company (at [200]), and confirming the trial judge’s decision that no duty of care was owed to individual creditors when conducting their statutory obligations because this would be inconsistent with the statutory scheme in Pt 5.3A: at [203].

Misleading conduct

The Full Court rejected the director’s argument that the conduct of the administrator in reporting to creditors was ‘in trade or commerce’ and was misleading under state and federal consumer laws. The Court held (at [226]) that communication by the administrator in reporting to creditors was not in trade or commerce because it was ‘antecedent to any decision to be made by the creditors at the second creditors meeting – statements that were provided to facilitate discussion and ultimately, to make a decision regarding the Companies’ future.’ The relationship between the administrator and the company’s stakeholders is not a commercial exchange, but a statutory construct. The administrator’s conduct in carrying out his statutory responsibilities is not challengeable as misleading or deceptive conduct under consumer law, but rather by statutory review mechanisms in the Corporations Act (such as the former s 1321, which is replaced by IPS s 90-15): at [233].

Duties when engaging in litigation

The trial judge found that the liquidator had breached his statutory duties as an officer under ss 180-182 by continuing with the litigation after June 2005 (after a low settlement offer had been made by Ms H) and by continuing to support the bankruptcy proceedings. The trial judge had found that the liquidator’s conduct was so unreasonable that it must have been motivated by collateral and improper purposes due to animosity with the director, but this finding was overturned on appeal. The Full Court allowed the appeal against the findings of breach of duty relating to the litigation in 2005, but held that the continuation of litigation in 2006 when it was clear that the litigation strategy had not worked was a breach of the duty of care. The Full Court also held that the liquidator’s open ended indemnity of the bankruptcy proceedings against Ms H was in breach of s 180.

The Full Court overturned the trial decision and held that continuing the litigation in 2005 and supporting the bankruptcy proceedings were not objectively unreasonable (at that time) given that both courses of action were based on legal advice and could result in a favourable settlement. However, by mid-2006, it was clear the strategy would not result in acceptable recovery for the companies, particularly as the legal costs were now more than 10 times the initial amount sought. The Full Court held (at [509]):

There is a public interest in liquidators bringing recovery actions. The public interest in the proper investigation and administration of the affairs of an insolvent company may include pursuing a matter where the amount recovered in proceedings would be absorbed by costs and expenses and would not benefit the creditors. Further a liquidator is entitled to bring proceedings where the only prospect of recovery is reimbursement of the liquidators’ own fees and expenses. However a liquidator should not pursue litigation simply in order to generate fees without any view to the interests of creditors or the public interest. Each case must be determined on the applicable facts. A question may arise whether the pursuit of the litigation represents a bona fide exercise of the liquidator’s powers.

The settlement in 2005 was less than the amount sought, and was much less than the amount outstanding, including costs orders for prior proceedings. ‘There was no basis for concluding that Macks ought to have ‘second guessed’, and rejected, the advice given by’ his lawyers: at [546]. However, by April 2006 the legal advice had changed and it now contended that there was unlikely to be any benefit in continuing with the proceedings. Furthermore, the initial estimates on the cost of supporting the bankruptcy proceedings had now been significantly exceeded. The court held that the liquidator had ‘effectively lost control of the proceedings’. The Full Court stated (at [561]):

We consider that [the liquidator] failed to rationally review his position at this time. Rather than attempt to negotiate a settlement of all matters (which may or may not have come to fruition), he decided to continue vigorously pursuing the Bernsteen action and the Proceedings. However, [the liquidator] needed by this time to take steps to finalise those matters. In not taking steps to finalise the proceedings he failed to exercise his power and discharge his duty with the degree of care and diligence that a reasonable liquidator would do in the company’s circumstances. His continued pursuit of the proceedings in those circumstances was unreasonable.

The Court held (at [615]) that there were not sufficient findings of fact to support determinations that the liquidator breaches ss 181-182.

Conclusion

The Full Court’s decision largely vindicates the liquidator on issues relating to the voluntary administration and to the bulk of their conduct in the early stages of the litigation, although there were still breaches of s 180 relating to the continuation of legal proceedings from 2006 when the complexity and cost of the proceedings outweighed any potential public interest or benefit to creditors.

The case provides important guidance on the scope and nature of the duties of administrators and liquidators, particularly the need for a more nuanced approach to shaping those duties to the statutory obligations that insolvency practitioners have. The case also clarifies that while insolvency practitioners are fiduciaries and need to consider the interests of creditors, not all of their duties are fiduciary in nature and they do not owe those duties to individual creditors.

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