In ASIC v Franklin (liquidator) & Ors, in the matter of Walton Constructions Pty Ltd  FCAFC 85, the Full Court of the Federal Court of Australia has put voluntary administrators (administrators) and liquidators on notice that referral relationships must be considered carefully in the context of independence issues.
Some of the key considerations arising in relation to this issue are as follows:
- The test of an administrator's or a liquidator's perceived independence is whether a fair-minded observer might reasonably apprehend that the administrator or liquidator might not discharge their responsibilities with independence and impartiality.
- Referrals to administrators or liquidators where there is a need for them to investigate their referrer's actions may be of concern.
- Expressions of concern about administrator or liquidator independence by creditors may be relied on by the Court as evidence that the fair-minded observer may apprehend bias.
- The Court has provided a further indication as to what use it will make of the Code of Professional Practice for Insolvency Practitioners published by ARITA (Code).
- There are new provisions in the Code in relation to the disclosure of referral relationships in Declarations of Independence, Relevant Relationships and Indemnities (DIRRI) with mandatory effect from 18 August 2014.
On 20 May 2014, we presented client briefings on ASIC v Franklin (liquidator) & Ors, in the matter of Walton Constructions Pty Ltd  FCA 68 (Davies J), a decision in respect of an ASIC prosecution of insolvency practitioners.
Davies J decided the case in favour of the insolvency practitioners.
In July 2014, the Full Court of the Federal Court of Australia delivered its judgment in relation to an appeal by ASIC from Davies J's decision.
In one respect, ASIC's appeal was successful. The Full Court found that the respondents did not give the necessary perception of independence and must be removed as liquidators of the subject companies.
However, the Full Court confirmed that the respondents did not contravene s 436DA Corporations Act 2001 (Cth) (Corporations Act) by failing to make adequate disclosures in their DIRRI upon initially being appointed administrators of the subject companies.
The respondents to the appeal were appointed administrators and then liquidators of Walton Construction Pty Ltd and Walton Construction (Qld) Pty Ltd (Walton companies).
The respondents were appointed as administrators of the Walton companies on the referral of corporate advisers, the "Mawson Group".
The Mawson Group provided advice about insolvency issues to the Walton companies prior to their collapse.
In addition to providing advice to the Walton companies, prior to the appointment of the respondents as administrators, related entities of the Mawson Group entered into transactions with the Walton companies. Such transactions included asset transfers and debt assignments.
In addition to this, the respondents' firm had been referred six other administrations by the Mawson Group.
The Mawson Group's referrals resulted in fee income for the respondents' firm in the order of $500,000 in the 2012 financial year and $250,000 in the 2013 financial year.
In three of these other referred matters, there were pre-appointment transactions between the Mawson Group's related entities and the relevant companies.
The Issue of Apprehended Independence
The Full Court found that the respondents were not in a position to be apprehended as independent in the circumstances described above and required their removal as liquidators of the Walton companies.
The Full Court confirmed that the test for apprehended bias in relation to administrators and liquidators is whether a fair-minded observer might reasonably apprehend that the administrator or liquidator might not discharge their responsibilities with independence and impartiality.
The Full Court also explained what knowledge could appropriately be imputed to the hypothetical fair-minded observer in applying the relevant test in this case, namely:
- that it is common for insolvency practitioners to receive referrals of work from other entities, including those who advise the relevant companies about issues of insolvency;
- that it is not uncommon for insolvency practitioners to investigate transactions involving referrers; and
- that insolvency practitioners may, from time to time, seek third party advice as to whether transactions are bona fide (although knowledge of an actual intention to do so in this case could not be imputed to the fair-minded observer).
Applying the above-mentioned test, the Court upheld ASIC's appeal and made the following findings.
- annual referrals to the value of $250,000.00 or $500,000.00 would be regarded as significant by a fair-minded observer who would apprehend that an insolvency practitioner may not wish to put future referrals in jeopardy;
- creditors are "a good proxy for the reasonable bystander" and expressions of concern by creditors will be taken into account by the Court where apprehended bias is in issue; and
- a fair-minded observer might apprehend that, because of the respondents' interest in not jeopardizing future referral income from the Mawson Group, the respondents might not discharge their duties with independence and impartiality.
ASIC alleged that the respondents failed to comply with their obligations under ss 60 and 436DA of the Corporations Act in relation to the disclosure of relevant relationships by failing to disclose that they would need to investigate transactions between the Walton companies and the Mawson Group in their DIRRI.
The respondents' DIRRI, that was given at the time of their appointment as administrators of the Walton companies, had noted their relationship with the Mawson Group as an "other relevant relationship" and indicated that the relationship did not cause any issue in relation to the acceptance of the appointment.
In summary, ss 60 and 436DA of the Corporations Act provide that as soon as practicable after their appointment, administrators must:
- disclose to creditors relevant relationships between themselves or their firm with the subject company or its associates in the two-year period preceding the appointment; and
- explain why any relevant relationships would not disqualify them from being appointed.
At first instance, Davies J held that the need to investigate transactions between the Mawson Group and the Walton Companies was not a required to be disclosed pursuant to ss 60 and 436DA of the Corporations Act, rather, it was a matter pertaining to the performance of respondents' duties, which is beyond what is required to be disclosed in a DIRRI.
The Full Court upheld Davies J in relation to this aspect of the appeal, stating:
- "the requirement to state a relationship does not cover the entire field of conflict of interest or duty";
- "it is not permissible, in construing the provision, to reason that because an investigation or proposed investigation into a transaction may result in an administrator having a conflict of interest or duty that, therefore, there is a (relevant) relationship between the entities"; and
- "the focus of that provision is on the administrator's belief"... and the "provision then proceeds by reference to the reasons for that belief".
This case gives interesting insight into what use the Court may make of the Code.
Neither Davies J nor the Full Court regarded the Code as extrinsic material that could be regarded by the Court in relation to ASIC's allegations about whether DIRRI disclosures were adequate for the purposes of the Corporations Act.
The relevant parts of the Code (or its predecessors) were not reproduced or referred to in the explanatory memorandum or amending legislation that preceded and introduced s 60 of the Corporations Act. As such, the Code falls outside the extrinsic material the Court is permitted to consider under the Acts Interpretation Act 1901 (Cth).
However, this finding should be contextualised by earlier judgments on the relevance of the Code and its predecessors, such as Re Monarch Gold Mining Co Ltd; Ex parte Hughes (2008) WASC 201, where the Court stated:
- A code of conduct such as this has no legal status. That is to say, a failure to comply with the terms of the code would not render a practitioner liable for prosecution under the Corporations Act or any other statute. It may lead to disciplinary proceedings by the Insolvency Practitioners Assn but that is a different issue...
- It is also important that the administrators paid close attention to their obligations under the code of practice. It shows that the code is something more than a public relations exercise designed to assuage the concerns of those involved with insolvency practitioners.
Notwithstanding the position of the Court, compliance with the Code remains mandatory for ARITA members. Further, it provides comprehensive and conservative guidance about best practice on the issue of independence and DIRRI disclosures.
In response to this case and amendments to the Privacy Act 1988 (Cth), ARITA has amended the Code, with the introduction of a new section 6.6.1 which requires Practitioners to disclose in their DIRRI:
- the Referring Entity (firm/organisation name); and
- the Practitioner's reasons for believing that the relationship with the Referring Entity does not result in the Practitioner having a conflict of interest or duty
where a Declaration of Relevant Relationships (or similar) is required under law; or where not required under law but consent is obtained from the Referring Entity.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.