Creditors scuttle proposed compromise of proceedings by the liquidator - Insolvency/Bankruptcy

This week’s TGIF considers a recent decision of the Victorian Court of Appeal where a company’s creditors successfully opposed an application by the company’s liquidators to compromise proceedings commenced on the company’s behalf.

Lonnex Pty Ltd (Lonnex) and Millennium Management Pty Ltd (Millennium) were related companies which had sold medical practices to a company known as Lonnex & Millennium Management Holdings Pty Ltd (LMMH) for $22 million. The full amount of the purchase price was funded by way of loan granted to LMMH by Lonnex and Millennium. That same day, the loans were forgiven by Lonnex and Millennium by entry into a deed of forgiveness and release. The effect of this was that Lonnex and Millenniums assets were acquired by LMMH, while other liabilities (mostly owed to the major creditors) were left with Lonnex and Millennium.

A liquidator was subsequently appointed to Lonnex, and a different liquidator was appointed to Millennium. Both liquidators filed proceedings against LMMH claiming that the forgiveness of debt referred to above was an uncommercial transaction/unreasonable director related transaction.

Following a mediation, the liquidators of Lonnex applied to the Court under sections 477(2B) and 511 of the Corporations Act 2001 (Cth) (the Act) for orders directing that they were justified in compromising the proceeding, and approving entry into terms of settlement accordingly.

Lonnex and Millennium’s major creditors (the ATO and Commissioner of State Revenue) opposed the application, as did Millennium’s liquidator. The ATO wanted to pursue the litigation by appointing Millennium’s liquidator to Lonnex.

Competing arguments

The liquidators of Lonnex submitted that the Court should approve the compromise for several reasons, including that:

they no longer had funding from the ATO to pursue the action;
they were personally at risk of adverse cost orders if the proceeding was discontinued due to a lack of funding, or if it failed;
they had advice from Counsel which identified risks associated with pursuing the action; and
they considered the proposed settlement to represent a reasonable commercial return for Lonnex’s creditors.

The ATO, the Commissioner for State Revenue, and the liquidator of Millennium all disagreed that the settlement represented an acceptable commercial outcome. The ATO indicated that it would fund Millennium’s liquidator to continue the Lonnex proceedings. It also argued that the Counsel’s advice obtained by the liquidators of Lonnex was deficient because it did not properly evaluate whether the proposed compromise was reasonable.

The Court’s decision

The Court was not prepared to sanction the proposed compromise of the proceeding.

With respect to the funding issue, the Court did not consider the liquidators of Lonnex not being in funds to be a decisive factor. Rather, it was one of many factors that the Court needed to consider. The Court noted that the liquidators of Lonnex did have the option of resigning so that Millennium’s liquidator could be appointed in their place.

The Court was not bound to act in accordance with the wishes of major creditors, but it was necessary for the Court to take the creditors’ views into account. The liquidators of Lonnex submitted that the settlement represented an acceptable commercial outcome for the creditors, however, the Court found it compelling that the Lonnex creditors disagreed. The Court referred to established authority to the effect that creditors are generally better placed than a Court to assess what is and what is not commercially acceptable.

The Court agreed with the ATO’s criticisms of the advice from Counsel, and there was also a concern that settlement of the proceedings by Lonnex could have an adverse impact upon the related proceedings by Millennium.

Key principles and takeaway

The role of the Court in deciding whether to give approval to a proposed compromise of litigation under s 477(2B) of the Act is different to the Court’s role when a liquidator seeks directions under s 511 in relation to such a compromise.

With respect to s 477(2B), the Court’s role is more limited; it must be satisfied that there is no error of law, or grounds for suspecting bad faith or impropriety, and that there is otherwise no reason to intervene.

Where directions are sought under s 511 of the Act, the Court must be positively persuaded that the liquidator’s decision to enter into the compromise is, in all the circumstances, a proper one. This involves a broad consideration of all the relevant circumstances including, the attitude of creditors and any legal advice.

This case highlights that, where there is creditor opposition, it will be incumbent upon a liquidator to demonstrate clear and cogent grounds in support of the proposed compromise, supported by properly reasoned legal advice.

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.