Stand Down: Court Approves Compromise Of Preference Claim When Validity Of Appointment Challenged - Insolvency/Bankruptcy

This week's TGIF examines a decision of the Supreme Court of Victoria in which an unfair preference claim was defended on the basis that the liquidators had been invalidly appointed and lacked standing to continue the proceeding.

Key takeaways

Challenges to the date of insolvency and reliance on the good faith defence are some of the more common arguments raised in response to a preference claim. A challenge to the validity of the liquidators' appointment is unusual.
If an appointment is successfully impugned, s 90-15 of the IPS confers a power on the Court to determine substantive rights and provide guidance on matters of law.
When a resolution to place a company into liquidation is declared invalid, unpaid remuneration will mean former liquidators are creditors with standing to seek a range of orders and may be entitled to payment on either a quantum meruit or restitutionary basis.

What happened?

In October 2014, Polat Enterprises (the Company) was incorporated for the development of two properties on the Princes Highway.

Following two years of losses, zero profit and a six-figure debt to the ATO, the Company was placed into liquidation by, ostensibly, a resolution passed by the sole shareholder.

The appointed liquidators undertook an investigation into the Company's affairs and later commenced proceedings to recover unfair preferences alleged to have been paid to the former director and shareholder (the Defendant). In her defence, filed five months after proceedings were commenced, the Defendant asserted:

she was the sole shareholder on the date the resolution to wind the Company up was, purportedly, passed; and
she did not receive notice of, attend or vote in favour of any resolution to place the Company into liquidation.

On that basis, it was contended the resolutions were invalid and the liquidators had no standing to maintain the proceedings.

The evidence

Documents served revealed the Defendant had loaned monies to the co-founder of the Company and had become sole director and shareholder as a form of 'security' for her investment.

With her loan balance standing at more than half-a-million dollars, the ASIC record was – without the Defendant's knowledge – updated to remove and replace her as director, with the share register updated to reflect a relative of the co-founder as sole shareholder. The shareholders' meeting to effect the liquidation occurred within a fortnight.

An alternative – then a compromise

Once this was revealed, the liquidators filed a motion seeking orders that the resolutions were valid or, in the alternative, that:

they be granted leave to apply for orders that the Company be wound-up in insolvency;
they be appointed liquidators for the purposes of the winding-up; and
the 'relation-back day' remain the date of the purported passage of the resolution.

Four weeks later, a further motion was filed that annexed a deed reflecting a compromise reached between the parties and seeking the Court's approval under both s 477(2B) of the Act and related orders under ss 90-15 and 90-20 of the Insolvency Practice Schedule (IPS).

The decision

The Court observed that the Defendant's direct evidence that she did not know about, or agree to, her resignation, share transfer and consent to the winding up created a degree of uncertainty with respect to the validity of the resolutions. As such, and given the challenges the plaintiffs would face to prove the counterfactual, it was considered appropriate to, in accordance with the compromise, make orders pursuant to s 90-15 that the resolutions were invalid.

In making this declaration, the Court noted the section had wide import and directions which might be given pursuant to it extend to matters of law and questions of legal procedure.

By virtue of being creditors of the Company (by reason of unpaid remuneration), the former liquidators were then deemed to have standing to apply to wind the Company up under s 459P(1)(b) of the Act and the Court:

concluded the Company had been insolvent from at least August 2015 and remained so; and
granted leave for the plaintiffs to be re-appointed liquidators.

The remaining questions for determination concerned approval of the proposed deed by which the Defendant would settle the proceeding and pay the sum of $90,000 over three months (thus enlivening the requirement under s 477(2B) of the Act) in exchange for a release and, relatedly, a further order under s 90-15 that the plaintiffs were justified in entering the deed.

On these issues, the Court firstly accepted approval under s 477(2B) was appropriate and, secondly, that its jurisdiction under s 90-15 was engaged given the deed was, to some extent, contentious. In terms of a declaration that the liquidators were justified entering into the deed, the fact that the settlement had been negotiated by parties represented by solicitors and counsel, in circumstances where maintenance of the preference claim carried inherent risk, proved persuasive.

Comment

The facts of this case draw out the wide utility of s 90-15, which has proved to be one of the more common provisions relied on during the COVID-19 pandemic. Whilst most recently called upon for matters going to power, propriety or reasonableness, it is important to remember the section can also be used to determine substantive legal rights.

This case also provides comfort to invalidly appointed insolvency practitioners (who find themselves with unpaid fees in an unfunded liquidation) that they may still be entitled to remuneration, on either a quantum meruit or restitutionary basis, and their standing as creditors entitles them to seek a grant of leave for re-appointment.

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.