Australia: Converting the form of liquidation – more bang for the liquidator's buck

Converting the form of Liquidation – More bang for the Liquidator's buck

Introduction

Early in his or her appointment a liquidator in a creditors' voluntary liquidation (CVL) should consider applying to the Court to convert the CVL to a Court ordered winding up in insolvency. Conversion may benefit the unsecured creditors, in whose interests the liquidator acts, by enabling the liquidator to pursue claims and make recoveries not available in a CVL.

The reasons liquidators have applied for conversion include:

• Obtaining the benefit of a directors' and officers' liability insurance (D&O) policy;
• Accessing recovery provisions of the Corporations Act 2001 (Cth) (Act) not available in a voluntary winding up.

The application

The Court may order that a company be wound up in insolvency pursuant to section 459A of the Act. Section 459P of the Act gives a liquidator (among others) standing to make the application. Factors relevant to conversion are considered below. As for any winding up application under section 459A, the liquidator as applicant must satisfy the Court that the company was/is insolvent at the date of filing the application and the date of the hearing¹.

Reasons to apply for conversion

Insurance proceeds under a D&O policy

In Carter v New Tel Ltd² one of three grounds on which the liquidators sought a Court ordered winding up was to enhance the prospect of insurance recoveries under the company's D&O policy. The liquidators were concerned there was a possible interpretation of the policy to the effect that it would respond to insolvent trading claims by a liquidator against a director if brought by a liquidator in a Court ordered winding up, but not a CVL.

The Court did not decide whether or not claims under the D&O policy were more likely to succeed in a Court ordered winding up than a CVL. However, the Court considered the wording of the D&O policy gave a plausible reason for conversion.

Re Australian Resources Limited (In Liq)³ concerned two companies in CVL. The directors of the companies had a D&O policy, which responded to claims against the directors for insolvent trading, but arguably only if such claims were commenced by a Court appointed liquidator. The liquidator appointed in the CVLs applied for a Court ordered winding up of the two companies, to attempt to enliven the D&O policy in respect of claims for insolvent trading the liquidator intended to pursue against the directors.

The Court did not decide if the D&O policy applied only in a Court ordered winding up, and not in a CVL. However, the Court considered that the chances of recovery under the D&O policy were substantially enhanced if the insolvent trading claims were pursued by a Court appointed liquidator. Also, there were clear potential benefits to the creditors by way of potential proceeds under the D&O policy. The Court held that these were sufficient reasons to make the winding up order.

Access provisions of the Act not available in voluntary winding up

Section 588FJ

Section 588FJ of the Act provides that circulating security interests (floating charges) created within 6 months before the relation-back day⁴ are void against the liquidator. If a floating charge is void, the liquidator may seek to recover the proceeds of floating charge assets previously realised by the secured creditor under the charge. However, section 588FJ applies only if "a company is being wound up in insolvency". The phrase wound up in insolvency⁵ means wound up by Court order under section 459A or 459B of the Act⁶. Accordingly, a liquidator in a CVL needs to apply to the Court to wind up the company in insolvency in order to pursue claims potentially arising under section 588FJ.

In Carter the Court held that making an order under section 459A of the Act would enable the liquidators to attack the validity of two floating charges under section 588FJ, and there was a probability that if the attack was successful there would be substantial benefits to unsecured creditors.

Walker and Anor v CBA Corporate Services (NSW) Pty Limited and Ors⁷ concerned the failed childcare operator, the ABC Group of companies. The liquidators of the ABC Group intended to pursue claims against a syndicate of lenders to the ABC Group under section 588FJ of the Act. The liquidators had been appointed in CVLs, so in order to access section 588FJ they needed to apply to the Court for an order under section 459A to have the relevant ABC Group companies wound up in insolvency.

The conversion application was successful and subsequently the liquidators have commenced proceedings against the lenders relying on section 588FJ of the Act (and other causes of action), seeking to recover approximately $100 million. In deciding the conversion application in the liquidators' favour, the Court placed considerable weight on the potential advantage that successful proceedings under section 588FJ would give to unsecured creditors. Given the magnitude of the collapse of the ABC Group, unless the liquidators could recover a substantial amount from the lenders, the unsecured creditors were unlikely to receive anything out of the winding up.

Section 468

Section 468(1) of the Act provides that certain dispositions of property of a company made after the commencement of a winding up by the Court are void. Similarly to section 588FJ, there is no equivalent provision for a company in voluntary winding up.

In Carter the second ground on which the liquidators sought a Court ordered winding up was to attract operation of section 468 of the Act. The liquidators were concerned that the company was obliged contractually to provide Optus with customer details. This was a potential disposition of valuable property of the company – its mobile customer base. The Court made the winding up order and this enabled the liquidators to challenge the validity of the disposition, which would not otherwise have been possible.

Potential obstacles to conversion

Discretionary power

The Court has the discretion whether or not to convert a CVL – under section 459A of the Act the Court may order the winding up of an insolvent company.

In Deputy Commissioner of Taxation v Tull Reinforcing Pty Ltd⁸ the Court held it will not make an order winding up a company in insolvency where the company is already in CVL unless "there is good reason to do so", because (the Court reasoned) in the ordinary case there is little practical difference between CVL and Court ordered winding up. The Court in Carter had referred to "plausible reason".

Accessing insurance proceeds under a D&O policy and provisions of the Act not available in voluntary winding up are examples of "good reasons" for conversion (Carter and Re Australian Resources). In contrast, in Re Australian Resources the Court said a mere desire to replace a liquidator is unlikely to be a sufficient reason.

However, the Full Court in CBA Corporate Services (NSW) Pty Ltd and Others v Walker and Others⁹ held there was no positive requirement of "good reason" in section 459A of the Act, because to impose this explicit requirement would displace or distort the broad discretionary power under section 459A. Further, the order under section 459A can be made if there is a rational possibility, as opposed to certainty, that the liquidator ultimately will commence the foreshadowed proceedings that rely on the liquidation being a Court ordered winding up.¹⁰

In Carter the liquidators had not reached a final view on whether both floating charges could be attacked under section 588FJ of the Act, but the Court considered there was a plausible case. In Walker the liquidators had not decided if they would commence proceedings under section 588FJ. The Court (and the Full Court on appeal) queried why a liquidator should be compelled to extend considerable cost and resources establishing the prospects of a possible section 588FJ claim until it is clear "the door has been opened" to commence that action by the Court making a winding up order.

Delay

Delay in making a conversion application is a factor relevant to the exercise of the Court's discretion to order that a company be wound up in insolvency. In Walker the liquidators were appointed in the CVLs on 2 June 2010. The liquidators filed the application for a winding up order under section 459A of the Act on 5 September 2011. As discussed above, the purpose of the conversion application was so that the liquidators could pursue claims against the lenders under section 588FJ. The lenders, which were the anticipated defendants in the liquidators' proposed section 588FJ proceedings, opposed the conversion application. The lenders argued that there was delay by the liquidators in making the conversion application and this delay would prejudice the lenders in the anticipated section 588FJ proceedings – for example, due to potential witnesses having left the lenders' employment. The liquidators argued that the time taken to commence the conversion application was reasonable in the context of the liquidation of the ABC Group, which involved lengthy investigations into a very complex corporate structure and transactions.

In Walker the Court at first instance (and on appeal) did not regard the delay as significant in the overall assessment of whether or not to exercise the discretion to make a winding up order under section 459A of the Act. However, the case highlights that any delay in applying to convert a CVL to a Court ordered winding up may be relied on by the defendants, and considered by the Court, as a factor weighing against the conversion order being made.

Conclusion

An order by the Court to wind up a company in insolvency potentially is a powerful weapon in a liquidator's armoury. The order may give a liquidator who was initially appointed in a CVL potential rights of recovery that were not available in the CVL, ultimately to the benefit of the unsecured creditors. Delay in making an application to convert the liquidation from a CVL to a Court ordered winding up may count against the liquidator. As such, a liquidator should consider applying to the Court for conversion very early in the liquidation, even if at the time of making the application there is only the possibility of recoveries flowing from the conversion.

Footnotes

¹This topic was considered in Addisons' Focus Paper "Easy as ABC – Insolvency and the Relation-Back Day", published 15 July 2013.
²[2003] NSWSC 128
³[2004] NSWSC 1095.
⁴Defined in section 9 of the Act and generally meaning the earlier of the date a voluntary administrator is appointed to the company, the date the company resolves to be wound up voluntarily or the date a winding up order is made by the Court.
⁵Section 588FJ(1)(a) of the Act
⁶Carter and Hadfield v ACN 092 328 400 Pty Ltd [2011] NSWSC 114.
⁷[2012] FCA 328; upheld on appeal in CBA Corporate Services (NSW) Pty Ltd and Others v Walker and Others [2013] FCAFC 74. For a detailed discussion of the appeal see Addisons' Focus Paper "Easy as ABC – Insolvency and the Relation-Back Day", published 15 July 2013
⁸[2006] FCA 810 citing Carter and Re Australian Resources
⁹[2013] FCAFC 74, on appeal from Walker and Anor v CBA Corporate Services (NSW) Pty Limited and Ors.
¹⁰CBA Corporate Services (NSW) Pty Ltd and Others v Walker and Others.

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