What makes a contract an unprofitable contract which can be disclaimed by a trustee in bankruptcy without the leave of the Court under section 133(5A) of the Bankruptcy Act 1966 (Cth) (Bankruptcy Act)? Can a litigation funding agreement be considered an unprofitable contract when the agreement provides for a significant funder's premium or charge of 80% (85% in the case of an appeal)? The recent Federal Court case of Cooper (Trustee) v GT Capital Partners Pty Ltd, in the matter of Tonner [2019] FCA 2174 has provided further clarification on these issues.

Background

On 21 December 2017, Mr and Mrs Tonner and the Andrew Tonner Family Trust (collectively the Litigants) entered into a litigation funding agreement with GT Capital as 'Funder' (Funding Agreement). The Funding Agreement contained a number of  provisions which, on the face of it, were very onerous ones including:

  • The Funder's premium was 80% of any amount ordered to be paid to the Litigants rather than the amount actually recovered by the Litigants. This premium would rise to 85% if the Funder funded an appeal.
  • The Funder had the power to appoint its own solicitors to take over the conduct of the litigation.
  • The Funder could terminate the Funding Agreement at any time at its sole discretion on 7 days' notice.
  • The Litigants could not discontinue the proceedings without the consent of the Funder.
  • If the settlement sum included a non-monetary component (e.g. shares) the Litigants were required to pay the Funder an amount equal to the market value of that component within 10 days of the Litigants becoming entitled to the same.
  • The Funder may require the Litigants to lodge an appeal.

The litigation the subject of the Funding Agreement was commenced by Mr and Mrs Tonner on 1 March 2018 in the Supreme Court of Western Australia against Jaytona Pty Ltd, Jaysen Taylor and Tonia Taylor (Proceedings). The Proceedings concerned the ownership of Jaytona Pty Ltd, a civil engineering and construction business.

Nineteen days after the Proceedings were commenced, a sequestration order was made against the estate of Mr Tonner.

On 2 August 2019, Mr Tonner's trustee in bankruptcy, Mr Cooper, issued a notice of disclaimer on the Funder alleging that the Funding Agreement was an unprofitable contract for the purposes of section 133(5A) of the Bankruptcy Act. Section 133(5A) of the Bankruptcy Act provides:

A trustee is not entitled to disclaim a contract (other than an unprofitable contract) without the leave of the Court.

Justice Besanko relevantly identified two issues in dispute:

  1. Whether the Funding Agreement was properly characterised as an unprofitable contract. If it was, the trustee in bankruptcy would be entitled to disclaim the Funding Agreement without needing to seek leave.
  2. In the alternative, if the Funding Agreement was not an unprofitable contract, should the trustee in bankruptcy be given leave to disclaim it.

What is an Unprofitable Contract?

The Bankruptcy Act does not define the term 'unprofitable contract'. Accordingly, Besanko J considered some of the case law concerning section 568(1A) of the Corporations Act 2001 (Cth) (Corporations Act), which to a large extent reflects the provisions of s 133(5A) for liquidators. The case law elucidated a number of common elements which would render a contract unprofitable, and liable to be disclaimed by a liquidator including:

  • Any unprofitable contract must be one which gives rise to prospective liabilities;
  • Contracts which delay the winding-up of a company because they require performance over an extended period of time and involve expenditure which may not be recovered; and
  • Contracts under which a company has obligations, the burden of which is not commensurate with the benefits the company receives.

Interestingly, the case law concerning s 568(1A) of the Corporations Act highlighted that a contract will not be unprofitable solely because it is financially disadvantageous.

In applying the above principles to the case of a disclaimer of an unprofitable contract by a trustee in bankruptcy under s 133(5A) Besanko J held:

"the most important consideration in determining whether a contract is….unprofitable…is whether the continued performance of the contract is consistent with the prompt, orderly and beneficial administration of the bankrupt estate or, put another way, can be satisfactorily carried out by the trustee consistent with his or her duties and obligations" (at [40]).

Considerations relating to the financial advantages or disadvantages of the contract were considered to form an aspect of the assessment of whether a contract was unprofitable.

In this case, Besanko J observed that there was a lack of objective evidence as to the strength and value of the cause of action in the Proceedings. This, together with the fact that the amount of the Funder's premium was so high, led Besanko J to conclude that the Funding Agreement was of doubtful profitability for the bankrupt estate. However, this fell short of a finding that the Funding Agreement was unprofitable.

Leave to Disclaim

Accordingly, Besanko J was required to consider the second question of whether the Court should grant leave to the trustee in bankruptcy to disclaim a contract which was not an unprofitable contract. In this regard, His Honour determined to grant the trustee in bankruptcy leave to disclaim for three key reasons.

Firstly, the terms of the Funding Agreement, in restricting the trustee in bankruptcy's control of the Proceedings, had the potential to impede upon his ability to administer the bankrupt estate. Namely, it restricted the trustee's ability to "maximise the assets of the estate, having regard to sound commercial judgement to balance returns against reasonable costs."

Secondly, the terms of the Funder's premium unfairly advantaged the Funder to the detriment of the trustee. This was notwithstanding that the Funder had sought for the Court to impose, as a condition of any grant of leave to disclaim, that the trustee enter into an equivalent Funding Agreement with a reduced Funder's premium of 40%. The Court dismissed this submission, noting that the issues with the Funding Agreement were not limited to the high funder's premium and the Funder was not able to point to any authority in which the Court has ordered a trustee in bankruptcy or liquidator to enter into a new contract.

Thirdly, Besanko J held that any prejudice suffered by the Funder in having the Funding Agreement disclaimed, was mitigated by certain factors including that the Funder would not lose the entire commercial benefit of the Funding Agreement as it would not be affected as far as the other litigants are concerned (and the Funder had indicated that it would pursue the Proceedings as far as Mrs Tonner's claim was concerned).

Takeaway

A litigation funding agreement can be disclaimed by a trustee in bankruptcy if it is considered to be an unprofitable contract. Otherwise, the trustee in bankruptcy must seek leave of the Court to disclaim such an agreement.

This case represents a precedent for the application of s 133(5A) to litigation funding agreements. The case indicates that such agreements will be unprofitable contracts if the continued performance of the contract is inconsistent with the proper administration of the bankrupt estate, in that it prevents the trustee from performing his/her duties and obligations. Notably, the case demonstrates that there is a high bar to proving that an onerous litigation funding agreement is necessarily an unprofitable contract. A merely financially disadvantageous agreement (even one with a Funder Premium or charge of 80%, or 85% in the case of an appeal) or an agreement which is of doubtful profitability will be insufficient to meet this definition.

Accordingly, trustees in bankruptcy would be minded to seek leave from the Court to disclaim any onerous litigation funding agreements under s 133(5B), in circumstances where it cannot be proven with sufficient certainty that the agreement will impede the trustee from performing his/her duties and obligations.