Liquidators face a number of complex and challenging issues when bringing litigation to recover funds for the benefit of creditors. A recent decision of the New South Wales Supreme Court emphasises the importance for liquidators of obtaining proper advice before commencing proceedings.
The case also emphasises that in certain circumstances, a liquidator can be personally responsible for paying a defendant's costs, without a right of indemnification out of the assets of the company - an outcome that no liquidator wants to face.
Key takeaways from this case
- Liquidators must carefully consider all litigation in which they become involved. They must be confident that proceedings have a sufficient prospect of success to justify the expenditure of creditors' money - not just a case that is "fairly arguable".
- It is very important for liquidators to ensure they receive the best possible legal advice and are competently represented.
- Insolvency can be a costly and complicated issue to prove, but it needs to be addressed properly and analysed before proceedings are commenced.
- Liquidators need to ensure that their evidence (particularly on crucial issues such as insolvency) is in order well before going to Court.
Arena Management v Campbell Street Theatre
In Arena Management Pty Ltd (Administrator Appointed) (Receivers and Managers Appointed) v Campbell Street Theatre Pty Ltd (No. 2), the first plaintiff, Arena, was the tenant of the Sydney Entertainment Centre until its lease was terminated by the landlord. The defendant, CST, appointed receivers and managers to Arena pursuant to a Deed of Charge. The second plaintiff, Arena's liquidator, sought declarations that there was no money owing by Arena to CST or, alternatively, a declaration that the charge was unenforceable on various grounds. His Honour Justice Palmer dismissed the plaintiffs' application.
His Honour then considered the question of costs. As the plaintiffs had been wholly unsuccessful in their claims, His Honour felt that there was no basis for an order that each party should bear its own costs. Unsurprisingly, CST agreed, and further submitted that costs should not only follow the event, but that the liquidator should be ordered to pay CST's costs on the indemnity basis, without indemnification from the assets of Arena. Also unsurprisingly, the liquidator sought to resist those orders.
His Honour concluded that the liquidator did not act prudently and reasonably in commencing and prosecuting the proceedings, and therefore ordered the liquidator to pay CST's costs of the proceeding on the indemnity basis, without a right of indemnification out of the assets of Arena. His Honour's reasons for doing so were as follows:
- It appeared that the liquidator's Counsel sought to advance a positive case of fraud in cross- examination, without those allegations being pleaded or having evidence to support those allegations (as a party must have). His Honour was critical of the plaintiff's Counsel about this argument, and also in relation to his conduct of the matter generally.
- His Honour also considered that the liquidator failed to lead positive evidence, which could have improved the plaintiffs' case. In particular, His Honour noted that the liquidator seemed to rely entirely on the absence of relevant entries in Arena's general ledger in asserting that no debt was secured by the charge, even though there were bank statements and other documents of associated companies that supported the making of the loans. His Honour was critical of this strategy, and noted that in interpreting the effect of the financial evidence, the liquidator was required to be pragmatic and exercise commercial commonsense.
- His Honour noted that material available to the liquidator indicated that as a matter of commercial reality, the alleged loans had in fact been made. His Honour concluded that the liquidator's position was unreasonable and that he "blinkered himself" in deciding there was no evidence to support the debt to CST.
- His Honour was also critical of the evidence led by the liquidator in support of the assertion that Arena was insolvent (which was crucial to the success of this claim). In particular, His Honour: -
- described the evidence of insolvency, from which the liquidator suggested that the Court should draw inferences, as "piecemeal and fragmentary";
- found that some of the evidence tendered by the liquidator was of no assistance at all, and that the liquidator had conducted no meaningful analysis of some documents;
- concluded that the evidence relied on by the liquidator in support of Arena's insolvency was so weak that he was not acting reasonably and prudently in allowing the case to go to trial; and
- stated that, if better evidence was available (such as if the liquidator had been able to show insolvency through a comprehensive analysis of Arena's financial position), then the liquidator did not acting reasonably and prudently in failing to prepare that evidence before the trial.
- His Honour stated that in determining whether the liquidator acted properly and responsibly in bringing and prosecuting the proceedings, the question was whether a prudent liquidator, with the benefit of commercial commonsense and experience, and with the benefit of competent legal advice, could reasonably have concluded that these proceedings had a sufficient prospect of success to justify spending a considerable amount of creditors' money on legal costs, not to mention the risk of an adverse costs order if the case failed.
- Interestingly, His Honour noted that a "sufficient prospect" does not mean only "fairly arguable", and that the latter is a low threshold related more to summary dismissal of proceedings. His Honour stated that a liquidator is similar to a trustee, in that he or she is dealing with other parties' money, and must look at the ultimate result of the proceedings, not merely whether it will survive an application for summary dismissal.
Implications of this case
The decision in Arena emphasises the fact that liquidators must carefully consider all litigation in which they become involved. Although Arena involves what could be described as exceptional circumstances, His Honour's comments about "sufficient prospects" make it clear that liquidators must not only be confident that proceedings are arguable, but that there must be reasonable prospects of success.
It also appears from His Honour's criticisms that the liquidator in Arena may not have received the best possible legal advice. Again, it is very important for a liquidator to ensure that he or she is competently represented. Often, obtaining the best legal representation is not possible for economic reasons,
particularly when a company is without funds. In those circumstances, liquidators need to consider other options, such as litigation funders and creditor funding, if legal action is appropriate.
His Honour's comments about the liquidator's evidence on insolvency are also important. Insolvency can be a costly and complicated issue to prove, but it needs to be addressed properly and analysed before proceedings commence. With the rise of caseflow management in the Queensland Supreme Court, problems can arise for liquidators when issues such as evidence of solvency are not properly resolved, as in the case of Multi Service Group Pty Ltd (see this Alert). Litigation often needs to be made ready for trial at great speed, and preparation must be carried out quickly and thoroughly.
Beyond caseflow management issues, the Queensland Supreme Court has recently published Practice Direction No. 9 of 2010, which deals with setting trial dates. That practice direction contains a readiness checklist that practitioners are encouraged to review before a matter proceeds to trial. Interestingly, that checklist provides "Counsel who are to conduct the Trial have advised on evidence; or if it is not intended to engage Counsel, solicitors have prepared memoranda on evidence". The checklist seems to suggest that the Court places great importance on Counsel's advice on evidence, which is an often overlooked step when funds are tight. It appears unlikely that this took place in Arena. Courts have little patience for disorganised litigants, and liquidators need to ensure that their evidence (particularly on crucial issues such as insolvency) is in order well before going to Court.
For more information about this case, please contact HopgoodGanim's Insolvency practice.
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