Australia: Litigation funding to commence proceedings – will recovery of costs and expenses be enough?

Marsden v Screenmasters Australia provides guidance to liquidators who commence and continue proceedings, pursuant to funding arrangements, when met with arguments that the proceedings will not confer a benefit to creditors.

WHAT HAPPENED?

On 12 December 2014, the liquidators of the Cardinal Group Pty Limited (Cardinal Group) (Liquidators) commenced proceedings against Screenmasters Australia Pty Limited (Screenmasters) for declarations that certain payments made to Screenmasters were either unfair preferences or uncommercial transactions and for the recovery of $49,600.00 plus interest.

This was one of 20 sets of proceedings brought by the Liquidators for the recovery of unfair preference payments in the order of $8 million. Screenmasters filed a defence in the proceedings and then, in an attempt to sidestep the claim, brought an interlocutory application under s 536 of the Corporations Act 2001 (Cth) (the Act) seeking that the court order an inquiry into the course of action pursued by the Liquidators.

The application was brought on two bases, being that:

  1. the Liquidators were pursuing the proceedings without any reasonable prospect that any amount recovered would benefit the Cardinal Group creditors or otherwise serve to benefit the liquidation; and
  2. the Liquidators approach to settlement of the claim was impermissibly influenced by entry into a litigation funding agreement, as a result of which, the costs to be incurred in the proceedings was not a material concern.

SECTION 536 AND THE COURT'S DISCRETION

This section of the Act relates to the supervision of liquidators. It allows the Court or ASIC to inquire into the conduct of a liquidator where it appears that the liquidator has not faithfully performed his duties or when complaints have been made about incompetence or lack of diligence.

For the Court to order such an inquiry, it needs to be satisfied that there is a "sufficient basis" to do so and its discretion will depend on factors such as the nature and strength of the allegations, any answers offered by the liquidators, the likely benefit to be derived from it and the 'interest' of the applicant in the outcome.

When asked to inquire into a liquidator's decision to commence recovery proceedings, the following matters will be relevant:

  • size of anticipated return to creditors;
  • the position of creditors;
  • proportionality between costs and recovery;
  • failure to apply for directions before commencement of the proceeding; and
  • litigation funding.

WAS THERE A SUFFICIENT BASIS FOR INQUIRY?

While Markovic J accepted that the quantum of the claim was low, and that the costs were likely to exceed the maximum recoverable amount, her Honour was not persuaded that the threshold to order an inquiry had been met.

Markovic J found that the Liquidators had acted in accordance with their duties when their actions were viewed in the broader context of the liquidation. Specifically, Markovic J noted the Liquidators:

  • conducted extensive investigations into the affairs of Cardinal Group for the purposes of realising funds for creditors;
  • provided regular and full disclosure of the risks and benefits of the proceedings to the creditors;
  • prior to commencing proceedings, had sought legal advice and issued letters of demand to prospective defendants;
  • sought to insulate the estate from the costs of pursuing the claims by procuring litigation funding and adopting a litigation strategy to achieve efficiencies and minimise costs; and
  • were justified in continuing the proceedings as the total recovery was the relevant consideration and this claim, while small, would add to the pool of funds available to unsecured creditors.

ENTRY INTO THE FUNDING AGREEMENT

Screenmasters raised the litigation funding agreement as an issue, suggesting it formed the only basis for the proceedings being continued and that the pursuit of the litigation was essentially a "make work scheme" for the liquidator and the lawyers.

Markovic J emphasised that there is no per se objection to liquidators entering into litigation funding agreements and in fact, as was identified by the NSW Court of Appeal in Hall v Poolman, they may do so in circumstances where there is little or no prospect of recovery beyond their own costs and the expenses of the funder.

Pursuit of a claim in such circumstances will be considered legitimate where:

  • costs are reasonably incurred by the liquidators in preliminary investigations;
  • there are no assets, in the absence of funding, to pay the costs already incurred;
  • litigation costs are reasonably incurred and proportionate to prospective benefits (to both creditors and the payment of liquidators fees); and
  • the litigation funding agreement is not agreed in manifestly unreasonable terms.

Further, in the same vein as the decision of Hall v Poolman, Markovic J emphasised that there was a general public interest in the investigation and recovery of unfair preferences and the fact that any recovery from such proceedings may not add to the pool of funds available to unsecured creditors was not of itself a sufficient reason to order an inquiry.

COMMENT

This decision provides guidance to liquidators with respect to the commencement and continuation of recovery proceedings.

It will be necessary to consider whether the recovery actions, when considered as a whole, will add to the pool of assets available for creditors. The fact that some of the claims are for smaller amounts is not, of itself, a reason to abandon the claims.

Additionally, it is not necessarily the case that liquidators cannot bring proceedings in respect of unfair preferences where the only prospect is recovery of their own fees – in such circumstances, the pursuit will still be proper provided the guidance in Hall v Poolman is followed.

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.

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