Liquidators settling court proceedings: the importance of creditors’ wishes

As is illustrated by the recent Supreme Court of Victoria Court of Appeal decision in McDermott and Potts as liquidators of Lonnex Pty Ltd (in liquidation), creditors’ wishes are important when a liquidator is looking to settle court proceedings. Though liquidators should not act at the dictation of creditors, it is important to bear in mind that informed creditors are in the best position to evaluate what is in their own interests, and as such their wishes ought be regarded as a highly material consideration in any settlement agreement. Consequently, when creditors do not support a proposed settlement agreement, a liquidator can expect the agreement to be closely scrutinised.

Liquidators who have commenced court proceedings oftentimes face resistance from a company’s creditors when looking to settle the proceedings. This can be problematic for liquidators because if the parties’ obligations under a proposed settlement agreement are not to be discharged within three months of the agreement and the agreement is not approved by the committee of inspection or a resolution of creditors, a liquidator must obtain court approval before entering into the settlement agreement pursuant to section 477(2B) of the Corporations Act 2001 (Cth) (the Corporations Act).

Traditionally liquidators who have found themselves seeking court approval under section 477(2B) have also sought relief under section 511 of the Corporations Act, which allows liquidators to apply to the court to determine any question arising in the winding up of a company. As this section was recently replaced by sections 90-15 and 90-20 of the Insolvency Practice Schedule (Corporations) to the Insolvency Law Reform Act, liquidators will no doubt be seeking relief under those replacement provisions moving forward.

Often times obtaining court approval under the above mentioned sections can be a straightforward process. However, that is not to say that court approval is a forgone outcome; as is illustrated by the recent Supreme Court of Victoria Court of Appeal decision in McDermott and Potts as liquidators of Lonnex Pty Ltd (in liquidation) courts will carefully scrutinise such applications having regard to the interests and wishes of creditors, particularly when there is opposition from creditors.

Background

The material facts are as follows:

1. Lonnex Pty Ltd (Lonnex) and a related party, Millennium Management Pty Ltd (Millennium), each operated two medical clinics.
2. On 3 February 2011, Lonnex and Millennium sold their respective medical clinics to Lonnex & Millennium Management Holdings Pty Ltd (LMMH) for $22 million and $18 million, payable at LMMH’s option by way of intercompany loan. The loans were then forgiven by Lonnex and Millennium.
3. Lonnex was wound up on 10 October 2012 and Millennium was wound up on 29 May 2013. Ross McDermott and John Potts were appointed liquidators of Lonnex and Andrew Yeo was appointed liquidator of Millennium.
4. On 8 October 2015, the liquidator of Lonnex,[1] funded by the Commissioner of Taxation, commenced proceedings against LMMH seeking declarations that the release Lonnex provided to LMMH was an uncommercial transaction and an unreasonable director-related transaction, and sought judgment for $22 million.
5. Around this time, Millennium’s liquidator, Mr Yeo, also commenced similar proceedings against LMMH in respect of the Millennium transaction.
6. LMMH defended the Lonnex proceedings.
7. On 16 June 2017, following mediation, LMMH offered to settle the Lonnex proceedings for a sum of money which could not be disclosed (as the proceedings were still on foot). Lonnex’ liquidators were willing to accept the offer, but the Commissioner and the company’s other creditors were not.
8. The Commissioner was no longer willing to fund Lonnex’ liquidators to run the litigation after the mediation. However, he was willing to fund Millennium’s liquidator to run the Lonnex litigation if Lonnex’ liquidators were removed.
9. In the circumstances, Lonnex’ liquidators applied under sections 477(2B) and 511 of the Corporations Act for orders directing they were justified in compromising the proceeding and approving their entry into the settlement agreement.

First instance decision[2]

At first instance, Associate Justice Efthim focused on the fact that none of Lonnex’ creditors supported the liquidators’ application. His Honour noted that the creditors’ views were an extremely important factor to take into consideration, especially since they opposed the application. Relevantly, the creditors were of the view that the returns from the settlement sum (which were described as “not major returns“) were not in their interests.

The fact that the Commissioner would not fund Lonnex’ liquidators to continue with the litigation was not a determinative factor, as there was an alternative course available – namely, the litigation could continue with funding if Lonnex’ liquidators were replaced by Millennium’s liquidator. Though his Honour considered the liquidators’ self-interest to be understandable, he did not think it should override the views of the creditors.

Accordingly, the liquidators’ application was refused.

Appeal decision[3]

In the appeal decision, Justices Whelan, McLeish and Hargrave emphasised that courts are “generally unqualified and ill-equipped to make or approve of business and commercial decisions” and “are loath to interfere with the commercial judgment of liquidators on matters within their powers“. However, they also explained that courts need to balance a liquidator’s commercial judgment with the attitudes of creditors. They summarised the importance of these competing considerations as follows:

“The liquidator is ordinarily best placed to determine what course the liquidation should take, in the interests of creditors, any contributories and the proper recovery of the costs and expenses of the liquidation. The court will generally not enter into the merits of that determination, confining itself to the question whether the proposed course is a proper one for the liquidator to take. At the same time, the interests and wishes of creditors are highly influential and the creditors are, if properly informed, in the best position to evaluate what is in their own interests. As such, the views of the creditors as to the merits of the present proposal are a highly material consideration.”

Accordingly, they held that Associate Justice Efthim was correct to regard the wishes of creditors as a very important consideration. Indeed, they went even further to say that he would have erred not to have done so.

Their Honours also agreed that the absence of funding to conduct the litigation was itself not an overriding factor, as it was possible for Millennium’s liquidator to be placed in funds to conduct the Lonnex proceeding (i.e. Lonnex’ liquidators were not stuck with having to continue with the proceedings in the absence of funds).

As such, the appeal was dismissed and the liquidators were denied approval to enter into proposed settlement agreement.

Key message

Lonnex illustrates how important creditors’ wishes are when a liquidator is looking to settle court proceedings, and highlights the value and importance of a good working relationship between liquidator and creditor. Though liquidators should not act at the dictation of creditors, it is important to bear in mind that informed creditors are, as the Court of Appeal noted, in the best position to evaluate what is in their own interests, and as such their wishes ought be regarded as a highly material consideration in any settlement agreement. Ergo, when creditors do not support a proposed settlement agreement, a liquidator can expect the agreement to be subject to close scrutiny.

[1] NB: Just McDermott at that time. Potts was later appointed as joint liquidator of Lonnex in 2016.

[2] Re Lonnex Pty Ltd (in liq) [2017] VSC 734.

[3] McDermott and Potts as liquidators of Lonnex Pty Ltd (in liquidation) [2019] VSCA 23.