In light of the modern trend towards “pre-pack” arrangements as a legitimate restructuring solution, a recent judgment handed down in the Federal Court provides a timely reminder for insolvency practitioners that independence is paramount and liquidators can be removed upon the application of a creditor in circumstances where there is a perception of conflict.
Haulotte Australia Pty Ltd v All Area Rentals Pty Ltd (in liq)  FCA 615 concerned the voluntary administration, and later liquidation, of an equipment hire company (“Company”). Prior to entering administration, the Company’s sole director asked its customers to start making payments to another company with a very similar name (“Related Company”). The Related Company’s secretary and sole director was the wife of the director of the Company (“Director”). The Company’s accountant (“Accountant)” recommended an administrator (“Administrator”) who was subsequently appointed to the Company. The Administrator had previously received referrals of this nature from the Accountant.
The Company’s largest creditor (“Plaintiff”) provided a proof of debt, attended the first meeting of creditors and joined the committee of creditors; however, it never received notice of the second meeting of creditors. The Plaintiff was therefore not represented at the second meeting, where creditors voted in favour of a DOCA. The Accountant held proxies for 19 of the 22 creditors represented at the meeting. The Plaintiff demanded that the Administrator properly convene a second meeting of creditors, and upon his failure to respond, the Plaintiff commenced proceedings to set aside the resolutions passed at the meeting and appoint an alternative liquidator to the Company.
The DOCA was not executed, and the Company subsequently transitioned into liquidation. The Administrator was appointed liquidator (“Liquidator”). The Plaintiff successfully applied to have the Liquidator removed and replaced as liquidator.
The case raises several important points for insolvency practitioners, namely that a liquidator may be removed for the better conduct of the liquidation, or for the general advantage of those interested in the assets of the company, even if there is no finding that the liquidator is unfit, acted improperly, or breached their duties.
There were two key limbs to the Court’s decision that removal would be for the better conduct of the liquidation, and to the advantage of creditors generally. The first was that, in the overall circumstances of the case, it would be better for the conduct of a vigorous and independent liquidation that another liquidator be appointed in light of a perception of conflict on the Liquidator’s part. Secondly, the Plaintiff agreed to provide funding to a replacement liquidator in circumstances where there were otherwise no funds to progress the liquidation. The Plaintiff was not prepared to fund the Liquidator and the Liquidator had no other source of funds.
Need to avoid perceived as well as actual conflict
Because of an apparent assignment of debtors and creditors from the Company to the Related Company that may have been facilitated by the Accountant, Jessup J considered that actions taken or endorsed by the Accountant or his firm were likely to be “subjects proper for investigation by the liquidator”. His Honour found there was no reason to suspect that the relationship between the Accountant and the Liquidator was anything other than professional. Nonetheless, the Accountant had been a source of work for the Liquidator in the past and His Honour considered it would therefore be preferable that the investigations be conducted by a liquidator with no prior connection to the Accountant, and having no expectation of work from him in the future.
Need to be vigilant about potential phoenix activity
Jessup J made no finding that anyone had engaged in phoenix activity. However, he described the apparent “project by [the Director] to transfer customers, and the associated receivables, to [the Related Company]” as “troubling”. His Honour said that such a situation calls for a “vigorous and independent approach on the part of the liquidator”.
In this case, the evidence established that the Plaintiff’s representative advised the Administrator at the first meeting of creditors that it had concerns that the Director was trading the Company’s business as the Related Company. Indeed, the evidence indicated that the Administrator signed an application form for the transfer of the Company’s telephone number to the Related Company after the first meeting of creditors.
Need to treat information and instructions from directors with scepticism
The Court emphasised the need for administrators to maintain a healthy degree of scepticism toward information provided by directors and their advisors, particularly regarding assets of the company. In this case, the Administrator reported to creditors that the Company had no debtors. This was in spite of the fact that the balance sheet had previously showed debtors in the sum of $699,959.44, and the Director had not complied with the Administrator’s requests for the MYOB file and an explanation for the level of debtors.
His Honour found that the Administrator knew of the Related Company, the relationship between the directors of both companies, and that some trade creditors had been transferred from the Company to the Related Company. Jessup J considered that there were enough signs of the transfer of business that the Administrator should have been sceptical of the Director’s statements that there were no debtors, and of his failure to provide the MYOB file.
Importance of engaging with creditors
It was the exclusion from the second meeting of creditors which formed a key component of the Plaintiff’s objections to the Liquidator’s conduct of the voluntary administration. Whilst Jessup J found that the notice was simply lost in the mail, there are still lessons for administrators in the situation which arose. The Plaintiff was the largest creditor, had joined the committee of creditors, and was clearly interested in the outcome of the external administration. To minimise the risk of an application such as that brought in this case, administrators should be cautious about relying strictly on the postal notification requirements in the regulations. It may be prudent to follow up via phone or email to confirm receipt of the notice with significant creditors; for example if it becomes apparent that such a creditor has not filed a proxy in advance of the meeting.
What do you need to do?
In this era of “pre-pack” DOCAs, administrators should be careful to maintain their independence – and their appearance of independence - at all times, and exercise healthy scepticism towards the information provided to them by directors and their advisers. Failure to do so, coupled with a failure to properly engage with creditors, can expose liquidators to applications for their removal. Insolvency practitioners should also remain vigilant towards possible phoenix activity upon their appointment as administrators.