Brownton Ltd v Edward Moore Inbucon Ltd [2002] NSWSC 578 | Case summary

2575/02 IN THE MATTER OF ACN 076 673 875 LTD JUDGMENT 1 HIS HONOUR: The plaintiff is the liquidator of a company formerly known as Nomad Telecommunications Ltd, and now named by its ACN Number. The proceeding, No 2575 of 2002, is for examination summonses to a number of examinees including William Cowan, David Greatorex and Mark Hodge, who were directors of the company. There is a similar proceeding involving a related company called Nomad Services, the liquidator of which is a different person, numbered 2432 of 2001. 2 By an interlocutory process filed on 28 May 2002 in proceeding No 2575 of 2002, the liquidator sought an order under s 477 (2B) of the Corporations Act 2001 (Cth), approving the entry by him and the company into a litigation funding agreement. Messrs Cowan, Greatorex and Hodge appeared by counsel to oppose the application. There is no similar application in proceeding No 2432 of 2001 because the creditors of Nomad Services have approved a litigation funding agreement with the same financier. The present application arose because a motion to approve a litigation funding agreement for Nomad Telecommunications was defeated, by (according to the plaintiff) votes of interests associated with the proposed examinees. 3 I heard the liquidator's application on 5 June 2002, in circumstances of some urgency. The urgency arose principally out of the fact that some examinations had been set down to take place on 12, 13 and 14 June 2002. 4 The hearing was also to deal with applications in both proceedings for summary dismissal of certain examination summonses, adjournment of certain examinations, access to the liquidator's affidavits, and revision of the categories of production in certain examination summonses. In the course of the day those matters were settled, and I made orders by consent. One of my orders in both proceedings was for vacation of the hearing dates of 12, 13 and 14 June for the examinations, and adjournment of the examination summonses to 25, 26 and 27 September 2002 before the Registrar. That left only the application in No 2575 of 2002 for approval of the litigation funding agreement to be dealt with. 5 At the conclusion of the hearing of that application and without objection from the parties, I announced my decision and made an order approving the litigation funding agreement under s 477 (2B), while reserving my reasons for judgment. These are my reasons for judgment. 6 The plaintiff was appointed liquidator of Nomad Telecommunications on 22 January 2001 by order of the Supreme Court of Queensland. Andrew Heers, a partner of the plaintiff in the same accountancy firm, has the day-to-day carriage of the liquidation. Mr Heers has provided affidavit evidence in support of the application, as the plaintiff is overseas. 7 In his affidavit made on 28 May 2002 Mr Heers said: "6. From my investigations into the affairs of the Company I believe that the Company may have incurred debts whilst it was insolvent in contravention of Section 588G of the Corporations Act, given that:- 6.1 many creditors' debts were unpaid for up to approximately six to seven months prior to the Company ceasing its activities; 6.2 many creditors were agitating to be paid and had issued letters of demand and summonses in respect of their unpaid debts; and 6.3 the Company continued to make losses whilst incurring significant cash outflows during this period." 8 Examination summonses under s 596A were issued, on the plaintiff's application, by order of the Deputy Registrar on 7 May 2002, the examinees being directors or former directors of the company. According to Mr Heers, there are presently no funds available to enable the company to conduct the examinations and thereafter pursue any litigation (such as proceedings against directors for insolvent trading) unless litigation funding is obtained. Hence the plaintiff has negotiated the litigation funding agreement which is the subject of the present application. 9 The litigation funding agreement is called an "initial funding and option agreement". Under the agreement a company called Insolvency Management Fund Ltd ("IMF") agrees to fund the conduct of public examinations in respect of the affairs of the company, up to $30,000 for legal costs and disbursements and up to $30,000 for the liquidator's costs, and to be responsible for any adverse costs order. In return, IMF receives an option to fund any cause of action that may be pursued after the public examination process has ended, and is entitled to receive 15% of any amount recovered if there is a settlement before expiry of the option period, and 40% of any amount recovered in respect of proceedings thereafter. 10 The agreement requires the liquidator to engage Walker Insolvency Lawyers with respect to the examinations and, if the option is exercised, any subsequent proceedings. There is evidence that Walker Insolvency Lawyers are associated with IMF. Mr John Walker is a director of IMF. I was informed by counsel for the liquidator, although evidence was not adduced on these matters, that Mr Walker was formerly a partner in Walker Insolvency Lawyers and is now non-executive chairman of the firm, and that the firm and IMF share premises and a receptionist/telephonist; but that no present partners of the firm have any financial interest in IMF. 11 The plaintiff convened a meeting of creditors which was held on 20 May 2002, issuing a report to creditors dated 1 May 2002. The purpose of the meeting was to obtain the approval of the creditors to the plaintiff entering into the litigation funding agreement on the company's behalf, given that the obligations of the parties to the agreement might be discharged by performance more than three months after the agreement would be entered into. However, a motion to approve the agreement was defeated on the voices and on a poll. During the course of the debate Mr Heers, who was chairman of the meeting, said that the liquidator had conducted preliminary investigations into potential insolvent trading actions. This evidence corroborates the statement in paragraph 6 of his affidavit, quoted above. 12 The evidence of Mr Heers, not challenged at the hearing of the application, was that the creditors who voted against the resolution were Mr Greatorex (representing 3.7% of the total admitted claims), Mr Cowan (representing 0.3%), a company associated with Mr Greatorex called Heathid Pty Ltd (representing 2.2%), a company associated with Mr Cowan called Stradis Pty Ltd (representing 0.2%), a company associated with another examinee, Mr Hodge, called Oceania & Eastern Group Funds Ltd (representing 32.1%), a company called Halfa Facility Services NV (representing 14.5%), and a Mr Michael Magnus (representing 2.2%). Oceania and Halfa jointly lodged a proof of debt and appointed the same proxy. Mr Magnus was represented at the meeting by the solicitors for the proposed examinees. 13 The creditors who voted against the litigation funding agreement all appear to have been associated with the proposed examinees, whose examinations would not take place unless funding was obtained. Their votes represented 55.5% of the total admitted claims (the total value of the debts of creditors voting against the motion being $8,399,425.22). Three creditors voted in favour of the resolution, namely Vodafone Billing Services Pty Ltd representing a debt of $5,008,395.30, Vodafone Pty Ltd representing a debt of $1, and Tyco Capital (Aust) Limited representing a debt of $1,817,256.93 (the total value of the debts of creditors voting in favour of the motion being $6,825,653.23). Vodafone and Tyco have subsequently provided letters to the plaintiff expressing their support for the proposed funding arrangements and the application to the Court. 14 A letter has also been provided by ANZ Banking Group Ltd. The bank now wishes to be treated as an unsecured creditor, but its claim had not been admitted at the meeting and it did not vote. It claims to be owed $10.042 million. The letter says that the bank supports the plaintiff's application to have the funding agreement approved. 15 On 24 May 2002 the solicitors for the proposed examinees wrote to the plaintiff and Mr Heers setting out a number of issues raised by the solicitors at the meeting. Those issues included the amount of work done by the plaintiff and Mr Heers on the proposed claims for insolvent trading, and on possible defences to such claims. According to the letter, the replies by Mr Heers at the meeting amounted to a concession that not much work had been done. The letter inquired as to who would meet the costs of the application to the Court for approval, foreshadowed after the motion for creditor approval had been defeated. The plaintiff did not apply to this letter, but in my view no inference can be drawn from his failure to respond, given his evidence that there were no funds available in the liquidation 16 The principles governing the exercise of the Court's discretion under s 477 (2B) to approve a liquidator entering into an agreement have been developed and applied in several cases dealing with litigation funding agreements. In formulating his or her attitude to the proposed agreement, the liquidator must act in good faith and for proper purposes, but provided he or she does so the Court gives the liquidator considerable latitude in exercising commercial judgment. In Re Spedley Securities Ltd (1992) 9 ACSR 83, 85-6 Giles J remarked (in a different context): "… the Court is necessarily confined in attempting to second guess the liquidator in the exercise of his powers, and generally will not interfere unless there can be seen to be some lack of good faith, some error of law or principle, or real and substantial grounds for doubting the prudence of the liquidator's conduct." 17 These remarks were applied to the discretion to approve entry into a litigation funding agreement in Re Imobridge Pty Ltd (1999) 18 ACLC 29. In that case Fryberg J rejected the proposition that the Court should exercise its discretion under s 477 (2B) to approve an agreement unless it be shown that the applicant is not acting in good faith in proposing to enter into it. He held (at 38) that while the Court should give due weight to the liquidator's commercial judgment, and should not attempt to try the proposed proceedings, the Court should nevertheless form some opinion as to the merits of the proposed action. He identified a number of factors that would affect the exercise of the discretion in the litigation funding context. Three of these factors are pertinent here. 18 The first relates to the liquidator's prospects of success in litigation. Fryberg J observed (at 38) that while good prospects of success would favour granting approval of the agreement, poor prospects, although not necessarily fatal to the application, would militate against approval. 19 Where the litigation funding is for the purpose of commencing and prosecuting proceedings, this issue is likely to assume particular importance. The presence of absence of legal advice as to prospects of success may be a matter of some significance to the Court. However, in the present case this factor is not of any great significance, in my view. It is too early to identify particular proceedings, let alone to make any firm assessment of the prospects of success in any proceeding, and therefore inappropriate to expect the liquidator to have legal advice concerning prospects of success. The litigation funding agreement will in the first instance provide funds for the examination of directors and former directors, and a better assessment of prospects for success can be made after the examinations and related production of documents have taken place. 20 Nevertheless, in the present case the evidence of Mr Heers in paragraph 6 of his affidavit, quoted above, is of significance. It is to the effect that, although there are now no funds available to pursue further investigations, some investigations into the affairs of the company have taken place, on the basis of which Mr Heers has formed the belief that there may have been contravention of s 588G. The grounds for his belief are set out, and so far as they go, they appear to be plausible. The existence of this evidence is important, because it rebuts the contention by the examinees that the litigation funding agreement is a purely speculative exercise for which there is no proper foundation. 21 The letter written by the examinees' solicitor and dated 24 May 2002 provides some evidence that "not much work" has been done on the merits or availability of any insolvent trading claim, and little or perhaps no work has been done on quantifying any claim for insolvent trading. In my view, however, that does not mean that the plaintiff's claim must be described as speculation. The affidavit of Mr Heers is evidence that some investigations were carried out, sufficient for him to form the belief that the company may have incurred debts while insolvent in contravention of s 588G, given the various circumstances referred to in that paragraph. His evidence, while hardly overwhelming, is sufficient to satisfy me that there is a good enough prospect of a viable claim to justify litigation funding arrangements of the kind proposed, in which the funding extends only to the conduct of examinations at a relatively modest cost, with an option to the financier to take proceedings. 22 The second factor relates to the interests of creditors other than the respondent to the application. Fryberg J said (at 41): "… the fact that the most likely outcome of the litigation will benefit only the professionals involved in the winding up is not necessarily a reason to stifle the litigation. … That there is also some chance of benefit for the unsecured creditors without any detriment to them to some degree reinforces the case for bringing the proceedings." 23 In the present case the litigation funding agreement will produce benefits to the lawyers who act on the liquidator's behalf, in the form of fees for conducting the examinations, and also in the form of fees for any ensuing litigation. The agreement will also produce benefits for the financier in the event that proceedings are successfully taken and a verdict is recovered. However, there is also a prospect of benefits for the unsecured creditors of the company, in the form of a dividend on winding up, out of any such recovery. 24 Such evidence as there is suggests that the prospect of benefits for the creditors is sufficiently substantial to warrant the liquidator making the litigation funding arrangements that are before the Court for approval. Apart from paragraph 6 of Mr Heers' affidavit, there is the commercial reality that IMF would not, acting rationally, prosecute litigation at its expense unless there were a reasonable prospect of a verdict or settlement, and under the agreement the liquidator is to receive 60% of that recovery. That argument might have been undermined if there was evidence that the partners of Walker Insolvency Lawyers control IMF, because in that case they would arguably have a motive for pursuing litigation to generate costs, but there is no such evidence. 25 Fryberg J's third factor is possible oppression. His Honour had in mind the fact that if proceedings are funded by a litigation funding agreement, there may be oppression to another party in the proceedings, or to the respondent to the application in third party proceedings. For example, prejudice and possible oppression may arise if there has been delay by the liquidator; or the liquidator has not paid the costs of another party in a previous application; or the proceeding to be funded will lead the defendant in that proceeding to sue the respondent to the application, who is in financial difficulty. There is no evidence that any of those specific kinds of prejudice are present here. 26 However, the examinees complain that in the present case a form of oppression arises out of the relationship between the financier and Walker Insolvency Lawyers. Obviously a litigation funding agreement that requires the engagement of a particular lawyer must be scrutinised for conflicts of interests. However, there is no evidence that Walker Insolvency Lawyers stand to benefit from the gains made by the financier IMF, their benefits apparently being confined to their professional fees. There is no reason for thinking that the solicitors will conduct the litigation unduly aggressively, in order to obtain collateral advantage, or that they will act otherwise than in a proper manner. Therefore there is no evidence of relevant oppression here. 27 The examinees also complain that they will be prejudiced because the same litigation financier is proposed for examinations in the liquidation of Nomad Telecommunications and in the liquidation of Nomad Services. It may well be that some conflicts of interest will arise for the lawyers during that process, since it is possible that pursuit of a line of inquiry for the benefit of one liquidation might be to the prejudice of the other liquidation. An obvious example would be if a question arises as to whether a director of Nomad Telecommunications is a shadow director of Nomad Services. It seems to me, however, that conflicts of interest of these kinds are not so inevitable as to require separate solicitors and even separate financiers to be used, especially when one takes into account the advantages of cost and efficiency which are likely to flow from the current arrangements. Additionally, I was informed from the bar table that the lawyers concerned were very conscious of the risk of conflict of interest and were planning the examinations in a manner which took that risk into account. 28 In Re Addstone Pty Ltd (1998) 16 ACLC 1320 Mansfield J explored the legal principles which permit a liquidator to enter into a litigation funding agreement notwithstanding the law of maintenance and champerty. He observed (at 1328) that the power to dispose of property of the company conferred by s 477 (2) (c) of the Corporations Act creates a statutory exception to the law of maintenance and champerty. He then considered whether the liquidator in the case before him was acting bona fide under s 477 (2) (c) in selling or disposing of property of the company, namely causes of action or the proceeds of conducting litigation, in entering into the proposed litigation funding agreement. He identified the following as a non-exclusive list of considerations relevant to that issue: (i) the nature and complexity of the cause of action; (ii) the amount of costs likely to be incurred in the conduct of the action and the extent to which the financier is to contribute to those costs; (iii) the extent to which the financier is to contribute towards the costs of the defendant in the event that the action is not successful, or towards any order for security for costs by the Court before which the action is to be heard; (iv) the extent to which the liquidator has canvassed other funding options; (v) the level of the financier's "premium"; (vi) the risks involved in the claim; and (vii) the liquidator's consultations with the creditors of the company. 29 Although the issue under s 477 (2) (c) is different in important ways from the issue of approval under s 477 (2B) (see Imobridge at 37), in my opinion these considerations are also applicable to an application for approval under s 477 (2B). However, they are not fully applicable in the present circumstances, because here the litigation funding agreement is only for the purpose of the conduct of the examinations, subject to the financier's option to fund any ensuing litigation. However, to the extent that they are relevant, it seems to me that items (i), (ii) (iii) and (vi) generally favour the granting of approval by the Court. The process of conducting examinations is not excessively complex, and any litigation that may flow from it is likely to raise fairly well established categories of directors' liability. There is nothing about the level of costs likely to be incurred which, at this stage, would provide a disincentive to proceeding, at least to completion of the examinations. Essentially the liquidator and the company in liquidation will be protected from financial risk by the financier in respect of the examination process, and they will have a right of termination of the agreement in the event of various specified events of insolvency on the part of the financier. That being so, there are no undue risks to the liquidator, the company or its creditors through conducting the examinations, even on a basis that gives the financier an option to proceed to litigation. 30 Items (iv) (investigation of alternative funding), (v) (level of premium) and (vii) (consultation with creditors) require further comment. 31 As to investigation of alternative funding and the level of the premium allocated to the financier, Mr Heers' evidence is that he has not made any application to other litigation financiers, but that he is aware from his experience that the terms of the proposed agreement are reasonable. His relevant experience appears, however, to be limited. He has been a chartered accountant for "more than a year", and he has acted in "all manner of personal and corporate insolvency administrations for eight years". His evidence includes a list of matters of which he presently has the carriage, none of which is stated to have (though many of them may have) any connection with litigation funding, and there is no list of his completed matters. He has not had direct experience with litigation lending products, save that he has been involved in reviewing them for the purpose of obtaining funding for one other administration. It seems to me that if he had greater experience, he would have realised the desirability of obtaining more than one funding tender before making an application to the Court for approval. My view is that he has not shown that he has sufficient experience in litigation funding to justify my giving his opinion as to the reasonableness of the proposed agreement any weight at all. 32 However, absence of alternative quotations for litigation funding is not fatal. The cases show that the Court is able to make its own assessment of the reasonableness of the premium. In Re Movitor Pty Ltd (1996)136 ALR 643 at 655, Drummond J noted (referring to the observations of Megaw LJ in Brownton Ltd v Edward Moore Inbucon Ltd [1985] 3 All ER 499, 506) that if the financier "might make 'an excessive profit', that 'might properly be a factor in deciding whether the commercial interest relied on by the assignee was genuine'". These observations suggest that the Court is prepared to exercise its own judgment as to what is an excessive level of premium. 33 Here the premium is 15% in the first phase, rising to 40% if proceedings are taken. In my opinion the premium is not excessive in the circumstances of this case. It appears from Buiscex Ltd v Panfida Foods Ltd (1998) 28 ACSR 357 that a premium as high as 75% may be justifiable in certain cases. In that case Hodgson CJ in Eq held that a premium of 75% of the recoveries was not unreasonable in light of the facts that the chances of substantial recovery were not very high, there was no risk of loss to the creditors or shareholders if the litigation was pursued, and the liquidator indicated that he had negotiated and believed the deal was reasonable. There was no evidence of any significant chance that a better deal could be done, or that the opposition to the proposed agreement by creditors was based on any judgment by them that a better deal could be found. In his Honour's view, there was a public interest that proceedings be brought, if possible, given that the proposed proceedings alleged breaches of fiduciary duty by the directors of the company. Although creditors opposed the funding agreement, the interests of the minority shareholders, who might benefit from the proposed investigations and litigation, were also to be taken into account. 34 As to consultation with creditors, the evidence shows that the creditors other than those related to the examinees have been given the opportunity to express their views, both at the meeting of creditors on 20 May 2002 and in correspondence tendered in evidence. Now that the view of the ANZ Bank is available, it is clear that the creditors representing the vast majority in value of the debts of the company support entry into the litigation funding agreement. 35 Weighing up all of these considerations as best I could, I reached the view on 5 June 2002 that I should approve the plaintiff as liquidator entering into the proposed litigation funding agreement. In my view it could not be said that the plaintiff acted in bad faith or for improper purposes. The examinees submitted that accounts lodged by the liquidator revealed that he has fees totalling $107,514.50 outstanding in respect of Nomad Services and an undisclosed amount in Nomad Telecommunications. He will need to recover more than $107,514.50 purely to meet his accrued fees to date. The examinees submitted that in these circumstances it is open to the Court to infer that the plaintiff is motivated by a desire to recoup his fees to date rather than by the welfare of creditors generally. But the only evidence is that the plaintiff is owed a substantial amount of money. It is not permissible to leap from that fact to an inference of improper motive, especially when, viewed objectively, the evidence suggests that there is a prospect that implementation of the arrangements may lead to recoveries which will benefit the creditors. 36 I infer from the fact that the application is before the Court that the liquidator believes that entering into the litigation funding agreement will be for the benefit of the company and its creditors. In my view there are no substantial grounds for doubting the prudence of his conduct and approach. Fundamentally this is a case where, in the absence of a litigation funding agreement, there is every likelihood that the creditors of the company will receive no dividend. There is no evidence that any creditor is prepared to provide funding, and there is before the Court a proposal which does not appear on its face to be unreasonable, especially given that it is confined to the process of examination with an option for the financier to take proceedings. It would have been better if the liquidator had been able to show that he has explored other alternatives, but it is not essential to do so and in this case I was prepared to make an order without such evidence, after weighing up other considerations. 37 The examinees criticised the proposed arrangements on the ground that they should have been confined to preliminary investigations not extending to the conduct of examinations, so that work could be done to establish whether there was any foundation before the examination process began. In my view, however, there was a sufficient basis, given Mr Heers' belief based on some investigations, to proceed to conduct examinations at the next stage. 38 Although the majority of the creditors who voted at the meeting on 20 May 2002 opposed the litigation funding agreement, those creditors represented interests associated with the proposed examinees, persons who may become defendants in any litigation. There are at least grounds for concern that the creditors who voted against the proposal may have done so for the purpose of stultifying the examination process in which the conduct of the examinees is likely to be placed in question. Moreover, if the ANZ Bank, a creditor for a very large amount, had voted, it would have supported the proposed agreement and the motion would have been carried. 39 In this case an important consideration relates to the interests of creditors unrelated to the proposed examinees, and their interests point to approval of the proposed agreement. They stand to benefit if the examinations take place and lead to litigation in which there are recoveries, and their own view is that the agreement should be approved. There is also a public interest at stake here of the kind referred to by Hodgson CJ in Eq. Although in the present case the precise nature of the cause or causes of action is not clear, the public interest in bringing directors to account for allowing their company to trade while insolvent is sufficiently indicated by paragraph 6 of Mr Heers' affidavit. 40 For these reasons, I made an order approving the plaintiff entering into the proposed litigation funding agreement, at the conclusion of the hearing on 5 June 2002. In doing so, I made it clear that this case was not one where a liquidator, having made no investigations, engages a litigation financier in order to conduct a fishing expedition to find out whether there is any case against any of the directors, through the process of examinations. Here there was evidence that the liquidator had conducted investigations, although obviously seriously constrained by absence of funds. If I had thought that the litigation funding arrangements were proposed without any foundation for belief in the existence of the cause of action, and in a purely speculative manner, my decision may well have been different. **********

Brownton Ltd v Edward Moore Inbucon Ltd

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