Funding agreement and costs agreement
43 The statute law and principles relevant to an application under s 477(2B) of the Corporations Act were conveniently summarised by Gleeson J in Deputy Commissioner of Taxation, in the matter of ACN 154 520 199 Pty Ltd (in liq) v ACN 154 520 199 Pty Ltd (in liq) (No 2) [2017] FCA 755 (DCT and ACN 154 520 199 Pty Ltd) at [21]-[26] as follows:
21 Section 477(2B) of the Act provides:
Except with the approval of the Court, of the committee of inspection or of a resolution of the creditors, a liquidator of a company must not enter into … an agreement on the company's behalf (for example, but without limitation, a lease or an agreement under which a security interest arises or is created) if:
(a) without limiting paragraph (b), the term of the agreement may end; or
(b) obligations of a party to the agreement may, according to the terms of the agreement, be discharged by performance;
more than 3 months after the agreement is entered into, even if the term may end, or the obligations may be discharged, within those 3 months.
22 The Court's role in considering an application under s 477(2B) is to determine whether it is a proper or bona fide exercise of the liquidator's powers. In Re 7 Steel Distribution Pty Ltd (in liq) (recs and mgrs apptd) [2013] NSWSC 669; (2013) 31 ACLC 13-021 at [17], Black J said:
The Court is not concerned, in granting an approval under s 477(2B) of the Corporations Act, with matters of commercial judgment but is concerned to be satisfied that the entry into the agreement is a proper exercise of power and not ill-advised or improper on the part of the liquidator … In Pascoe; Re Matrix Group Ltd (in liq) [2011] FCA 1117 at [14], Jacobsen J [sic] noted that the question for the Court in such an application was whether the liquidator's judgment had been infected by a lack of good faith, or an error of law or principle, and whether there was a real or substantial ground for doubting the prudence of the Liquidator's conduct in seeking to enter into the funding arrangement. That question arises, in the context of s 477(2B), in the context of entry into a longer term agreement, the performance of which might otherwise delay the completion of the winding-up.
23 In Stewart, re Newtronics Pty Ltd [2007] FCA 1375 (Newtronics), Gordon J, at [26(4)], cited with approval Austin J's statement in Corporate Affairs Commission v ASC Timber Pty Ltd (1998) 29 ACSR 109 at 118 that, in reviewing the liquidator's proposal, the task of the Court is not "to reconsider all of the issues which have been weighed up by the liquidator in developing the proposal, and to substitute its determination for his in….a hearing de novo", but rather the task of the Court is:
… simply to review the liquidator's proposal, paying due regard to his or her commercial judgment and knowledge of all of the circumstances of the liquidation, satisfying itself there is no error of law or ground for suspecting bad faith or impropriety, and weighing up whether there is any good reason to intervene in terms of the "expeditious and beneficial administration" of the winding up …
24 The standard imposed under s 477(2B) concerns an assessment by the Court as to whether entry into the agreement is a proper exercise of power and not ill-advised or improper on the part of the liquidator, rather than involving the exercise of commercial judgment: Re Gerard Cassegrain & Co Pty Ltd (in liq) [2013] NSWSC 257 at [11] per Black J citing McGrath re HIH Insurance Ltd [2010] NSWSC 404; (2010) 266 ALR 642.
25 In Pascoe; Re Matrix Group Ltd (in liq) [2011] FCA 1117 at [7], Jacobson J cited with approval the following statement by Austin J of the relevant test in Leigh Re King Bros [2006] NSWSC 315 at [23]:
Although the court has the statutory task [under s 477(2B)] of giving "approval" to a liquidator's agreement that may end more than three months after it is entered into, the case law shows that the court undertakes something less than a complete "merits review". As Giles J said in Re Spedley Securities Ltd (in liq) (1992) 9 ACSR 83 at 85-6:
… 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.
26 In Fortress Credit Corporation (Australia) II Pty Ltd v Fletcher; (2011) 85 ACSR 38 at [24], the Full Court endorsed the following list of factors (identified by Austin J in Leigh Re King Bros at [25] and Re ACN 076 673 875 Ltd [2002] NSWSC 578; (2002) 42 ACSR 296 at [17]-[34]) relevant to the Court's assessment of a litigation funding agreement:
(1) the prospects of success of the proposed litigation;
(2) the interests of creditors other than the proposed defendant;
(3) possible oppression;
(4) the nature and complexity of the cause of action;
(5) the extent to which the liquidator has canvassed other funding options;
(6) the level of the funder's premium;
(7) consultations with creditors; and
(8) the risks involved in the claim.
44 Unsurprisingly, this case law proceeds on the basis that the liquidator is the proponent of the funding agreement. However, in this case, the proponent was initially a creditor of the company in liquidation which was also related to the proposed funder. Despite Ms Young's evidence in relation to the draft funding agreement and cost agreement, there are a number of features of the funding agreement as originally proposed which caused the Court concern about whether the special purpose liquidators would be free to act independently.
45 ERA Legal had drafted the funding agreement and acted for GDK, a creditor of the company in liquidation. It was a term of the funding agreement that ERA Legal must be appointed as the lawyers and their costs agreement could not be varied or terminated without the consent of the funder which, like GDK, is controlled by Mr Simic. It was not clear that the special purpose liquidators would have control of the legal costs which, once paid, the funder would be entitled to recoup out of the "fruits" of the potential claims. This was because it was not clear that the lawyers' invoices must first be approved by the special purpose liquidators as having been reasonably and properly incurred before they were paid by the funder. The lawyers would have significant power to control proceedings commenced in relation to the potential claims since the special purpose liquidators would be required to act on their reasonable legal advice and their position was entrenched by the requirement to get the funder's consent to vary the costs agreement or remove the lawyers. It was not clear whether the clause which required the special purpose liquidator to follow the lawyer's reasonable legal advice applied to the special purpose liquidators' decision whether or not to commence proceedings. While it was express that the funder acknowledged that the lawyers had no obligation to act in the funder's interest, there was no such express provision in relation to GDK for whom the lawyers have acted to date.
46 Put succinctly, the concern was that the lawyers would (for all practical purposes) be the decision maker and the primary beneficiary of the agreement with an entrenched position and Nevrast had an unacceptable degree of control in relation to the identity of the special purpose liquidators' legal advisors and the termination of proceedings commenced by the special purpose liquidators.
47 Further, the special purpose liquidators were not in a position to obtain legal advice from other lawyers of their choice concerning whether an offer to acquire the potential claims could be accepted or in relation to ruling on Life Investment's proof of debt, matters which might well concern the other creditors of the Company given that ERA Legal had acted for GDK on the public examinations.
48 Following the appointment of the special purpose liquidators and the filing of their interlocutory application, these concerns were raised with GDK and the special purpose liquidators in correspondence and at a further hearing. Ms Young was called to give evidence.
49 The concerns identified above are addressed in the draft funding agreement in exhibit "5". I am satisfied that the special purpose liquidators would be in a position to exercise their powers independently if they enter into a funding agreement in the form included in that exhibit. I have some concern that the issues were not identified by the special purpose liquidators themselves, but having regard to the stress placed on the importance of their capacity to act independently in this process and the imminent end of the limitation period, that issue should not prevent approval being given to the funding agreement and cost agreement if it is otherwise appropriate.
50 Ms Young's evidence addressed some particular features of the funding agreement which have not changed. One of those matters is that GDK's costs of the public examinations would be recoverable out of the fruits of the potential claims before the amount payable to the funder for its premium and the amount payable to the special purpose liquidators on account of all creditors is determined. Ms Young considered that it was appropriate that this should occur. Based on Ms Young's reading of Mr Iannuzzi's report to creditors and her understanding of the winding up to date, but for costs incurred by GDK in conducting the public examinations, it would be highly likely that the potential claims might not have been identified. Ms Young noted that she has been informed by ERA Legal of the amount of the costs incurred by GDK (including in communicating with Mr Iannuzzi since his appointment) which seem to her to be within the normal range. That amount has been disclosed to the Court and Ms Young's view appears to be reasonable. Accordingly, I do not consider that this feature would be a basis for refusing approval of the funding agreement.
51 Based on Ms Young's experience and enquiries, the proposed premium payable to Nevrast out of the fruits is at the higher end of the usual range of premiums paid to private litigation funders. She says, and I accept, that this is usually a reflection of the risks involved in the claims and the prospects of recovery. Ms Young's evidence is that there are risks involved in the claims and it is commercial and in the best interests of creditors in the circumstances of this case that the special purpose liquidators enter into the funding agreement with that premium. This is because there are otherwise limited (if any) prospects of a return to unsecured creditors if the claims are not pursued and no other creditor has come forward to fund the claims. In the circumstances, Ms Young has not attempted to approach other possible litigation funders. Further Mr Simic, the controlling mind of Nevrast and GDK, has information in respect of a number of the matters which are the subject of the potential claims, including the fit-out of the restaurant. His knowledge will in all likelihood assist the prosecution of the claims. In addition, Ms Young has weighed the risk of prejudicing the current funding offered by Nevrast and potential claims having regard to the impending end to the limitation period for the claims under s 588FF. In her experience, it often takes third-party funders months to consider a fresh matter and it might be that no funding offer was received either at all or which was more favourable than that proffered by Nevrast.
52 There is no evidence that the special purpose liquidators have consulted other creditors. The evidence before the court is that many of those creditors are the likely defendants of the potential claims, so that it might be expected that that consultation would not occur, especially given the timeframe.
53 Turning to the costs agreement, Ms Young considers that it is appropriate to engage ERA Legal to act on the potential claims. Mr Daren Anderson, the managing director of ERA Legal, conducted the public examinations and Mr O'Neill, a lawyer employed at ERA Legal assisted in reviewing the materials produced under orders in those proceedings. They therefore have an intimate knowledge of the available materials and employing those lawyers will almost certainly reduce the costs associated with conducting any further investigations and commencing proceedings as compared to the costs which would necessarily be incurred if another firm were to be engaged. It may also be that their knowledge of the material is critical to the capacity to bring any proceeding before the limitation period expires in May 2018. Ms Young and Mr Arnautovic have no reason to believe that ERA Legal will act in any way other than in their interests so the fact that GDK is a creditor of the Company should not be an impediment to retaining that law firm. Accordingly, Ms Young and Mr Arnautovic are of the view that entering into the costs agreement is in the best interests of the general body of creditors.
54 As noted by Gleeson JA in Commercial Indemnity at [68]-[72], there is no universal rule that a liquidator may not retain lawyers who previously acted for a substantial creditor but it is regarded as "generally undesirable" and the guiding principle is whether such an arrangement offends the requirement for independence of the liquidator having regard to the circumstances. Like Gleeson JA at [73], the Court emphasises that it expects the special purpose liquidators, as officers of the Court, to maintain continued alertness as to whether it is necessary to seek advice from another lawyer, either in relation to the potential claims generally or on any matter in particular.
55 Here, the circumstances are that:
(1) The Court has been provided with evidence of the nature and extent to which ERA Legal has acted for GDK in relation to the Company and on other matters. ERA Legal has not acted for GDK or its related entities to any great extent. I am satisfied that the relationship between GDK and ERA Legal would not provide any significant commercial incentive for ERA Legal to prefer (consciously or unconsciously) the interests of GDK or Nevrast.
(2) The Court's concerns in relation to the independence of the special purpose liquidators arising out of early drafts of the funding agreement have been addressed.
(3) There is a looming expiration of a limitation period and ERA Lawyers are well placed to provide advice concerning the potential claims arising out of their participation in the public examinations. It would now be difficult for other lawyers to be put in the same position within the time period and that would involve greater expense in what is quite a small liquidation.
56 Having regard to the special purpose liquidators' opinions, the terms of the draft funding agreement and costs agreement in exhibit "5" and the circumstances referred to above, I am satisfied that it would be a proper or bona fide exercise of the special purpose liquidators' powers to enter into those agreements. This is so even though not all of the factors listed by Austin J in In the matter of ACN 076 673 875 Ltd (2002) 42 ACSR 296; NSWSC 578 at [17]-[34] can be accurately assessed at this time in this case.