In 2014 the liquidators of Walton Constructions were removed by the Federal Court due to a perceived lack of independence arising from a referral relationship.
ASIC v Franklin1 (Walton) was commented on by the media, ASIC and ARITA and brought about changes to the ARITA Code of Professional Practice to expand the scope of disclosure required in relation to referral relationships.
Even after the discussion and changes following the Walton decision, concerns about practitioners’ independence arising from professional relationships remain, particularly with the increased prevalence of ‘pre-insolvency advisors’.2
- ASIC considers that there ‘can be a tension between the registered liquidator’s duty to creditors and a desire to maintain referral relationships’3
- AFSA has said that it will be examining arrangements between trustees and solicitors that create actual or perceived conflicts of interest4
- AFSA’s 2015-2016 Insolvency Practitioner Compliance Program focused on, amongst other things, independence and pre-insolvency advisors ‘to ensure practitioners remain at arms-length in relation topre-insolvency dealings’, and
- the Senate Economic References Committee also heard concerns about the relationships between pre-insolvency advisors and practitioners helping to facilitate illegal phoenix activity.5
Practitioners will recall that the liquidators of Walton Constructions were removed because a referral relationship with a party to transactions that the liquidators were obliged to investigate gave rise to a perceived lack of independence.
Importantly, the court considered that the reasonable fair-minded observer would perceive a conflict between their duties as liquidator and the interests of the liquidators in not jeopardising further referrals. The Walton Decision has been subsequently considered by courts not only in the context of similar professional relationships, but also as part of broader attacks on practitioners’ independence. Have any lessons emerged?
Referral relationships may cost more than you think
Most recently, in Bank of Queensland Ltd v Ross Auto Auctions Pty Ltd6 (Ross Auto) a liquidator who unsuccessfully opposed his removal was ordered to pay both the applicants’ costs and his costs of the application seeking to remove him.
Although not as extensive as the history of referral relationships found in Walton, there was clearly a history of frequent referrals from the ‘insolvency advisor’ to the liquidator. That relationship was disclosed in the Declaration of Independence Relevant Relationships and Indemnities (DIRRI). The secured creditor unsuccessfully attempted to remove the liquidator at an ‘acrimonious’ creditors’ meeting but subsequently persuaded the court that the liquidator should be removed.
The court accepted that the liquidator’s relationship with the insolvency advisor gave him a personal interest in maintaining that business relationship and that this interest could conflict with his duties as liquidator. While not finding any actual bias, the court considered that there was a reasonable apprehension of bias, and removed the liquidator.
The court considered that the liquidator should not have resisted the application for his removal, but did not act unreasonably in doing so. The court acknowledged that the liquidator acted with self-interest, but also said that liquidators should not readily concede their replacement because of the associated costs of a new liquidator being appointed.
The court ordered that the liquidator pay the applicant’s costs and his own costs of the proceedings. The case was not one where the liquidator acted so unreasonably or improperly that the liquidator was denied the right of indemnity from the company’s assets for those costs. Importantly however, the liquidator’s liability was not limited to the amount of the company’s assets available to him.
While the liquidator escaped bearing sole personal liability for the costs of the proceedings, the value of the indemnity from the company’s assets was likely to be limited as the Report as to Affairs stated that the company had assets of $1.6 million and secured creditors of $2.1 million. Beyond this, the liquidator would only be entitled to payment of those costs after other priority costs were paid.
On any view of it, the outcome in Ross Auto was not favourable for the liquidator. What could the liquidator have done differently?
To resign or not to resign
The expanded disclosure requirements for the DIRRI and guidance in the ARITA Code are of great assistance, but mere disclosure of potentially relevant relationships is not sufficient to discharge practitioners’ ethical duties or to protect them from allegations that they are not independent. How should practitioners respond to such allegations? The decision in Ross Auto highlights the dilemma faced by practitioners when confronted with allegations that they are not independent or may be perceived to not be independent. On one hand, practitioners should not readily concede their replacement, but on the other hand, they may be exposed to personal liability for adverse costs orders if they oppose being removed.
In Re Sutton Ford Pty Ltd (in liquidation)7 (Sutton Ford) a liquidator who agreed to resign (without any admission) after an application seeking his removal was filed was entitled to his costs in the liquidation. In that case, the liquidator was appointed after a referral from an accounting firm who regularly referred him work.
The directors and shareholders of the company alleged that the liquidator had failed to investigate a potential claim against the accountancy firm. In allowing the liquidator his costs, the court noted that the liquidator ‘has taken a responsible position in theapplication, so far as he recognised that the circumstances are such that it is in the interests of the liquidation that he resign’.
On the other hand, practitioners are not obliged to capitulate on any suggestion that they are not perceived to be independent. The ARITA Code specifically acknowledges that such allegations may be made by ‘selfinterested parties wishing to improve their position’.8 Beyond this, the mere possibility of a conflict does not prevent a practitioner from taking an appointment.9
The Sutton Ford decision demonstrates that practitioners must objectively assess allegations that they are not independent and respond reasonably. The ARITA Code confirms that practitioners must be proactive in uncovering circumstances that may give rise to a conflict of interest, and not to simply address the issue when the conflict arises. Practitioners’ focus should be on whether a reasonable and informed third party could have formed the view that a conflict was likely to arise based on the information reasonably available at the time.10
Practitioners should also consider the broader implications of their appointment for the liquidation. For example, in Ross Auto the case for the removal of the liquidator was strengthened by an offer by the applicants to fund their nominated liquidator to investigate the company’s affairs and prosecute any claims, but of itself this would not have been sufficient to justify the liquidator’s removal. The court also noted that costs savings from having a local (as opposed to an interstate) liquidator assisted, but were not determinative.
If a practitioner decides not to resign in the face of allegations they are not independent they should consider approaching the court to manage the issue.
Special purpose appointments – A possible middle ground
One possible way out for insolvency practitioners is to consider seeking the appointment of another practitioner to manage any conflict or potential independence issues.
For example, in Banksia Securities Limited11 special purpose receivers were appointed by the court to prosecute certain claims against the trustee for Banksia debenture holders. The basis of that appointment was the inability of the receivers and managers appointed by the trustee to prosecute claims against their appointor. The court also made orders ensuring that the special purpose receivers had funding to prosecute those claims.12
Additional appointments will not work for all administrations.
Practitioners need to bear in mind the potential costs consequences of an additional appointment. Where, as in Banksia, the proposed special purpose receivers were also the liquidators of Banksia, their familiarity with the administration will mean that any unnecessary costs will be minimised.
It is also appropriate that the existing and new appointees cooperate so as to minimise any additional costs. However, the potential costs to the administration of an additional appointment may not be justified in all cases.
Alternatively, practitioners should also consider seeking directions from the court, although the costs of doing so may also be an issue. Before approaching the court practitioners need to ensure that they take all reasonable steps to identify and manage any issue and keep the court and creditors informed.13
Other relationships impacting on independence
Courts have also considered other relationships that impact on practitioners’ independence after the Walton decision and some helpful guidance has emerged.
First, practitioners need to carefully consider their choice of solicitors, particularly where those solicitors also act for a creditor or have an interest in the administration.
Cases prior to Walton expressed reservations about the retainer of common solicitors by an insolvency practitioner and a creditor. In some cases, courts even went so far to say that an insolvency practitioner should not only avoid appointing common solicitors with a secured creditor, but should not retain solicitors who are on the secured creditor’s panel of solicitors.14
Importantly for practitioners, in IND Energy Inc15 the court confirmed that there is no absolute prohibition in retaining a solicitor who acts for a creditor. However, an insolvency practitioner cannot retain such a solicitor where doing so would give rise to a conflict with their duty to be independent between the competing interests of creditors and their duty to remain impartial in relation to all interests. Allegations of impartiality must be determined case by case, which creates a potentially dangerous grey area.
In some cases, a careful analysis may mean that no such conflict will arise. For example, in Anglican Development Fund Diocese of Bathurst Board16 the retainer by court-appointed receivers of solicitors who continued to act for a secured creditor through a ‘Chinese wall’ did not create an immediate issue and was left unresolved until after a potential inquiry under s 423 of the Corporations Act 2001 (Cth).
The court considered that the matters raised could give rise to a reasonable apprehension that the receivers could not get impartial advice in relation to any claims of the secured creditor. The court noted that it may be questionable whether a Chinese wall arrangement was appropriate, but ultimately did not have to consider the matter further as there was no evidence that advice about the secured creditor’s position was required.
In a far clearer example, in Leroy v Mogilevsky17 a trustee in bankruptcy was restrained from continuing to retain solicitors who had previously acted for the major creditor of the bankrupt estate. The solicitor’s position of conflict was compounded by taking an assignment of the creditor’s debt, and becoming a creditor of the estate. The court had no difficulty in concluding that the solicitor’s conflict of interest and duty impacted on the appearance of independence, if not the actual independence, of the trustee. The court was not prepared to remove the trustee, but their choice of solicitor exposed them to allegations of lack of independence.
Second, courts will generally be reluctant to remove practitioners simply because they have pre appointment meetings with interested parties. Clause 6.8 of the ARITA Code recognises the need for such meetings and confirms that, while those meetings do not usually impact on independence, practitioners should limit their advice to:
- the financial situation of the insolvent
- the solvency of the insolvent
- consequences of insolvency, and
- alternative courses of action available to the insolvent in the case of insolvency.
The increased involvement of pre-insolvency advisors has the potential to muddy the waters. Can discussions go beyond this?
In Recycling Holdings Pty Limited18 the court found that pre-appointment discussions could reasonably include the terms of a potential deed of company arrangement (DOCA). Beyond this, the court considered that it is to be expected that potential administrators would form some preliminary views on the DOCA and that a predisposition towards a DOCA may not give rise to questions about the administrator’s independence. Nonetheless, pre-insolvency advisors and phoenix activity are clearly on the regulators’ radar and pose potential threats to practitioners’ independence. Practitioners would be best advised keeping discussion at pre-appointment meetings to the more general matters outlined in the ARITA Code.
Third, it appears that so long as appropriate safeguards are put in place, large firms do not immediately face independence issues simply because they may act in many capacities and in different offices. For example:
- In Queensland Mining Corporation Ltd v Butmall Pty Ltd19 the Federal Court dismissed an application seeking to remove liquidators based on allegations of potential bias arising from the liquidators’ firm’s position as auditor of a creditor of the company, notwithstanding potential claims the company had against the creditor.
- In BC39 Pty Ltd v Rambaldi20 the court considered that the independence of a trustee in bankruptcy in a national firm’s Melbourne office was not affected by tax advice given by the Brisbane office to a company that had been served with a summons issued at the request of the Melbourne trustee to attend at a public examination.
- In Icicek Holdings Pty Limited21 the court, on the application of a trustee in bankruptcy, appointed liquidators to a company in circumstances where the liquidators and trustee were from the same firm. The court urged the liquidators to be vigilant and return to court if any circumstances arose which might call into question the appropriateness of that appointment.
Practitioner independence will clearly be an ongoing focus for the regulators, particularly in view of the increasing prevalence of preinsolvency advisors and concerns about practitioners’ relationships.
Allegations of impartiality must be carefully considered case by case, and practitioners should consider taking steps to protect their position as resigning or seeking directions or other orders from the court.
It is not possible to exhaustively list the relationships that a practitioner may have that could impact on their independence. Practitioners need to be vigilant and proactively consider all potentially relevant relationships for any threats to their independence and address them before allegations are raised.
This article originally appeared in Australian Restructuring Insolvency & Turnaround Association Journal | September 2016.