JURISDICTION : SUPREME COURT OF WESTERN AUSTRALIA

CITATION : RAVENSWOOD RESORT PTY LTD (In Liq) -v- KAMMAL [2006] WASCA 217

Jurisdiction : SUPREME COURT OF WESTERN AUSTRALIA

Citation : KAMMAL -v- MARTIN BRUCE JONES AS LIQUIDATOR AND CHAIRMAN OF A MEETING OF CREDITORS OF RAVENSWOOD RESORT PTY LTD (IN LIQ) [2005] WASC 275

Corporations law - Appeal against setting aside company's approval of litigation funding agreement - Unusual circumstances - Director of company also director of litigation funder - Qualitative assessment of unreasonable prejudice to company - Whether assessment of nature, extent and significance of prejudice - Whether evidence of director in conflict of interests - Whether evidence of liquidator's investigation at risk - Whether absence of funding agreement inhibits company initiating or defending proceedings

Corporations Act 2001 (Cth), s 600A

Corporations Regulations 2001 (Cth), reg 5.6.26

BGC Contracting Pty Ltd v Kimberly Gold Pty Ltd (2000) 18 ACLC 894

Bovis Lend Lease Pty Ltd v Wily [2003] NSWSC 467; (2003) 45 ACSR 612

Deputy Commission of Taxation v Pontinex Pty Ltd [2000] NSWSC 99; (2000) 34 ACSR 391

Fleet Broadband Holdings Pty Ltd v Paradox Digital Pty Ltd [2005] WASC 261

Kantfield v Plastamatic (Aust) Pty Ltd (1994) 14 ACSR 687

Khoury v Zambena Pty Ltd [1999] NSWCA 402

Konica Australia v Aprolab Flashpoint (1999) 17 ACLC 1651

Natrajan v ACIB Accumulas Pty Ltd [2006] VSC 22; (2006) 56 ACSR 356

Network Exchange v MIG International Communications (1994) 12 ACLC 594

QPSX Ltd v Ericcson (Australia) Pty Ltd (No 3) [2005] FCA 933; (2005) 219 ALR 1

Sydney Land Corporation v Kalon Pty Ltd (1997) 16 ACLC 95

Wood v Laser Holdings Ltd (1996) 14 ACLC 801

Allesch v Maunz [2000] HCA 40; (2000) 203 CLR 172

Brownton Ltd v Edward Moore Inbucon Ltd [1985] 3 All ER 499

Clairs Keeley (A Firm) v Treacy & Ors [2004] WASCA 277; (2004) 29 WAR 479

Coal & Allied Operations Pty Ltd v Australian Industrial Relations Commission [2000] HCA 47; (2000) 203 CLR 194

Edwards v Noble [1971] HCA 54; (1971) 125 CLR 296

Mount Lawley Pty Ltd v The Western Australian Planning Commission [2004] WASCA 149; (2004) 29 WAR 273

University of Wollongong v Metwally (No 2) [1984] HCA 74; (1984) 158 CLR 447; (1985) 59 ALJR 481

1 This is an appeal from a decision setting aside a resolution carried at a meeting of the creditors of Ravenswood Resort Pty Ltd (In Liq) ("the company") held on 30 August 2005 whereby a litigation funding agreement put forward by Megacity Holdings Pty Ltd ("Megacity") was approved, pursuant to the powers conferred upon the Court by s 600A of the Corporations Act 2001 (Cth) ("the Act"). The application to set aside the resolution was brought on the basis that it had caused, or would be likely to cause, unreasonable prejudice to the applicant creditor, who is the respondent to the appeal. Three matters were relied upon to sustain the assertion of unreasonable prejudice:

1. The fact that the proposed funding agreement would include a covenant by the liquidator not to sue Ms Sim who is a person associated with the funder;

2. The prospect of a conflict of interest and/or compromise to the integrity of the Court's function arising from the association between the funder and the directors of the company, who may be witnesses in the funded proceedings; and

3. The prospect of the funding agreement inhibiting the proper investigation of the company's affairs or the prosecution of proceedings arising from such investigations.

2 For the reasons which follow, in my opinion the evidence did not sustain the assertion that the second or third matters would be likely to occur if the funding agreement proceeded, and did not sustain a conclusion that any prejudice flowing from the covenant not to sue Ms Sim would be unreasonable.

3 The application for an order pursuant to s 600A of the Act was made by Ahmad Khalif Bin Mustapha Kammal who is the respondent to these proceedings. At the same time, Mr Kammal had brought an appeal pursuant to reg 5.6.26 of the Corporations Regulations 2001 (Cth) against the rejection by the chairperson of the relevant meeting of the proof of debt which he had lodged for the purpose of being permitted to vote at the meeting. That appeal and the application pursuant to s 600A of the Act were heard together. The appeal against the chairperson's rejection of Mr Kammal's proof of debt was upheld by the trial Judge. No appeal has been brought from that part of his Honour's decision.

4 Section 600A of the Act empowers the Court to make, inter alia, an order setting aside the resolution of a meeting of creditors held in connection with winding up the company. Before doing so, the Court must be satisfied that if the vote or votes that a particular related creditor or creditors cast on the proposed resolution had been disregarded for the purposes of determining whether or not the proposed resolution was passed, the proposed resolution would not have been passed and that the passing of the proposed resolution:

"(i) is contrary to the interests of the creditors as a whole or of that class of creditors as a whole, as the case may be; or

(ii) has prejudiced, or is reasonably likely to prejudice, the interests of the creditors who voted against the proposed resolution, or for it, as the case may be, to an extent that is unreasonable having regard to:

(A) the benefits resulting to the related creditor, or to some or all of the related creditors, from the resolution, or from the failure to pass the proposed resolution, as the case may be;

(B) the nature of the relationship between the related creditor and the company or body, or of the respective relationships between the related creditors and the company or body; and

(C) any other relevant matter."

5 The circumstances leading up to the relevant meeting of creditors can be identified from the findings of fact made by the trial Judge, which findings are not contested. On 23 June 2003, the Supreme Court of WA ordered that the company be wound up and appointed Martin Bruce Jones as liquidator. On 4 August 2005, the liquidator gave notice of a meeting of creditors of the company to be held on 22 August 2005 to consider, amongst other things, litigation funding to prosecute a claim against Rustic Haven SDN BHD ("Rustic Haven") under s 588FE of the Act and to defend a claim by Rustic Haven that it was a secured creditor of the company as a result of being entitled to a purchaser's lien over certain property.

6 Accompanying the notice of meeting was a report from the liquidator dated 4 August 2005. The liquidator reported to creditors that on 30 September 2003, Rustic Haven had commenced proceedings against the company seeking a declaration that it was entitled to a purchaser's lien in respect of certain land owned by the company. That land had been sold and on 15 October 2003, the Court had ordered that the surplus proceeds from the sale of the land be held by the liquidator until such time as the claim by Rustic Haven had been determined.

7 The liquidator further reported that at the heart of Rustic Haven's claim was the argument that it had made an agreement with a joint venture formed to develop the land in question whereby it was entitled to purchase the land at a discount of 40 per cent against the usual sale price.

8 The liquidator provided further detail of the litigation in his report to creditors.

9 He also reported to creditors that his investigations had identified a number of potential breaches of the Act including insolvent trading, the making of voidable transactions, breaches of directors' duties and the making of unfair loans.

10 Although not the subject of specific findings by the trial Judge, the liquidator's report to creditors records that on 3 March 2005, he wrote to six litigation funders seeking expressions of interest to fund the defence of the Rustic Haven claim and to pursue the uncommercial/voidable transaction claims he had identified. As a result, he had received two draft Litigation Funding Agreements proposing joint funding by Australian Litigation Fund and Ms Peggy Sim ("Sim").

11 The liquidator reported to the creditors on the proposed terms of funding, which included an acknowledgement that there may come a time wherein the prosecution of the litigation might be hindered by the fact that Sim is one of the funders - she being a director of the company, in which case it was proposed that arrangements be made to replace Sim as a funder.

12 The meeting of creditors held on 22 August 2005 was adjourned because the joint funding proposal had been withdrawn. However, by circular to creditors dated 23 August 2005, the liquidator reported that an offer of litigation funding had been received from Megacity. In that circular the liquidator further reported that Sim was a shareholder and director of Megacity. Another director of Megacity, Dr Teo, was also a director of the company at the time of the events the subject of the existing and prospective litigation. The terms of the funding proposal were also reported. They included a term whereby Megacity would be entitled to a success fee of 35 per cent of any amounts recovered over and above funding costs, plus repayment of all costs funded by it. It was a further term of the funding proposal that the company and the liquidator must covenant not to sue Sim in respect of her role as a director of the company and/or another company, RRCM Pty Ltd (In Liquidation). In his report to creditors of 23 August 2005, the liquidator reported his view that such a covenant would not materially affect the return to creditors because:

(a) it would not reduce the amount of the claim against the other directors or the ultimate holding company (Rustic Haven) in an insolvent trading claim; and

(b) he had formed the view that the other potential defendants had the capacity to meet in full any claim or compensation order.

13 The adjourned creditors' meeting was reconvened on 30 August 2005. The liquidator, acting as chairman, rejected the proof of debt which had been lodged by Mr Kammal in an amount of $3,630,000. That is the proof of debt which the trial Judge found had been wrongly rejected.

14 The resolution approving the litigation funding agreement proposed by Megacity was put and carried unanimously, with five creditors to the value of $5.4 million voting in favour of the resolution, no creditors voting against it, and two creditors, including Rustic Haven, being a creditor to the value of $1.9 million, abstaining.

15 The trial Judge held that all creditors voting for the resolution other than Richard Yeap & Associates, being a creditor having a debt to the value of $4735.50, were related creditors as defined by s 600A of the Act. He further found that if Mr Kammal had been permitted to vote on the resolution, he would have voted against it. Thus, if the votes of related creditors had been disregarded, and if Mr Kammal had been permitted to vote, as the trial Judge found he should, the resolution approving the litigation funding agreement would not have been passed. Rather, there would have been votes equal in number for and against the resolution with the creditor voting against the resolution vastly exceeding the creditor voting for the resolution in value. Although this might raise some nice questions about the ultimate outcome of the vote had those events transpired, before us it was accepted by all parties that the statutory pre-condition to the effect that the outcome would have been different if the votes of related parties had been excluded from consideration was satisfied.

16 It will also be noticed that these particular circumstances do not exactly meet the statutory conditions specified for the exercise of the power conferred by s 600A, in which no reference is made to the bringing to account of votes which had been wrongly excluded from consideration. If a strictly literal approach is taken to the section, and only the votes of related creditors disregarded, it would be concluded that the resolution would still have passed, in that the only vote cast would have been that cast by the disinterested creditor, Richard Yeap & Associates, unless, of course, account is taken of the votes which would have been cast by Mr Kammal had he been permitted to do so.

17 However, before us the appellant expressly eschewed any reliance upon such a narrow construction of the section. This was an appropriate course to take, having regard to his position as an officer of the Court and the finding that had been made by the Court in respect of his wrongful rejection of the respondent's proof of debt. However, it did mean that the Court was deprived of any argument in respect of the precise scope of operation of the section in these somewhat unusual circumstances. I will therefore proceed upon the basis of an assumption that the statutory preconditions to the exercise of the power conferred by the section, insofar as they relate to voting, were met in the circumstances I have described, without being taken to have made a determination as to the validity of that assumption, essentially because that has been the approach taken by both parties to the appeal.

18 In his reasons for decision, the trial Judge summarised the arguments that had been advanced to sustain the assertion that the Court should exercise the powers conferred by s 600A. Those arguments were:

(a) the litigation, if successful, would reward Sim who is both a shareholder and director of the funding company;

(b) to succeed in part of the litigation, it would be necessary for the liquidator to prove that the company was trading whilst insolvent, or that the transaction led to insolvency at a time when Sim was a director of the company;

(c) the litigation funding is, however, conditional upon Sim not being sued - even if it be found that the company was trading whilst insolvent during the time she was a director - which covenant not to sue is prejudicial to or reasonably likely to prejudice the interests of Dr Kammal as a creditor;

(d) Megacity will receive a benefit in the form of a percentage of the fruits of the litigation in circumstances in which liability might otherwise have attached to Sim.

19 The trial Judge also made reference to the decision of Justice Austin in Bovis Lend Lease Pty Ltd v Wily [2003] NSWSC 467; (2003) 45 ACSR 612, in which the significant factor which caused the Court to set aside the resolution was that its effect would be to deprive the creditors of the benefit of further investigations into the prospect of recoveries for insolvent trading, unfair preferences and uncommercial transactions, and to deprive them of the prospect of recovery under such claims.

20 Having regard to the reasoning in that case, the trial Judge formed the conclusion that the passage of the litigation funding resolution had prejudiced, or was reasonably likely to prejudice the interests of Mr Kammal as a creditor who was minded to vote against the proposed resolution, to an extent that was unreasonable having regard to the benefits resulting to some or all of the related creditors from the resolution and the nature of the respective relationships between the related creditors and the company.

21 Save to the extent that an inference as to the process of reasoning can be drawn from his Honour's reference to Bovis (supra), and from his summary of the arguments advanced in support of the application, the process of reasoning by which his Honour arrived at his conclusion is to be found exclusively in the following paragraph of his reasons for decision:

"This conclusion is reinforced by the fact that the litigation funding comes from a company whose directors were directors of Ravenswood Resort when Rustic Haven paid moneys which led to transfers of land being held in escrow and those lands being subject of the caveat proceedings for which the litigation funding is sought. The integrity of the Court's function is arguably compromised as the funding agreement is not at arms length in that the liquidator relies upon the testimony of the directors of Ravenswood Resort in the caveat proceedings based on s 588FE of the Corporations Act: QPSX Ltd v Ericcson (Australia) Pty Ltd [2005] FCA 933 at par 51."

22 I should also note that no finding was made by the trial Judge on the question of whether the passing of the resolution was contrary to the interests of the creditors as a whole because reliance upon that aspect of s 600A was expressly eschewed in the proceedings before him.

23 There are a number of grounds of appeal. Apart from raising an issue in respect of the adequacy of the reasons provided by the trial Judge, in essence they all challenge his conclusion that the passage of the relevant resolution had prejudiced, or was reasonably likely to prejudice the interests of Mr Kammal as a creditor to an extent that was unreasonable. The correctness of that conclusion, drawn by the trial Judge from facts which were not in controversy, lies at the heart of the appeal. For the purpose of expressing my conclusion on the appeal, and the reasons for that conclusion, it is, I think, preferable to directly address the matters identified by the trial Judge, and by the respondent in argument on the appeal, which are said to support that conclusion, rather than to be unduly distracted by the detailed grounds of appeal.

24 Applying a broad approach to the reasons for decision at first instance, and taking into account in particular his Honour's summary of the arguments advanced in support of the application and his reliance upon the decision in Bovis (supra), and further taking account of the matters raised in argument by the respondent on the hearing of the appeal, the unreasonable prejudice which it is said the respondent has or will be likely to suffer derives from three matters which are said to flow from the approval of the litigation funding agreement, namely:

(a) the disadvantage and prejudice which is said to flow from the covenant by each of the company and the liquidator not to sue Sim;

(b) the prejudice arising from the compromise to the integrity of the Court's function and the potential conflicts of interest arising from the role of Sim and Dr Teo as directors of both the company at the time of the events giving rise to the litigation and of the funding entity, and from the role of Sim as a substantial shareholder in the funding entity; and

(c) the prejudice said to arise from the risk that there will be no proper investigation of the company's affairs or prosecution of proceedings arising from such an investigation.

25 I will deal with each of these areas of alleged prejudice in turn, but before doing so, will offer some general observations on the question which is to be addressed.

The Construction and Application of Section 600A

26 As I have noted, the case advanced by the respondent below was not a case based upon an allegation that the passage of the resolution was contrary to the interests of the creditors as a whole, but rather, was expressly advanced on the basis of a claim that the passage of the resolution had prejudiced or would prejudice, or be reasonably likely to prejudice the interests of the respondent to an extent that was unreasonable.

27 When an application is brought under s 600A on the ground that the passage of the resolution has prejudiced or is reasonably likely to prejudice the interests of the creditors who voted against the proposed resolution (construed, for the purposes of this case, as extending to a creditor who would have voted against the proposed resolution but for the wrongful rejection of his proof of debt), it is clear that the mere identification of prejudice, or the likelihood of prejudice flowing from the resolution will not, of itself, satisfy the pre-condition for the making of an order under the section. Rather, the question which the Court must address is the question of whether the identified prejudice is unreasonable, and the Court is further required to address that question having regard to two specified factors and any other relevant matter. The two factors which the Court is specifically obliged to take into account are the benefits resulting to the related creditor or creditors and the nature of the relationship between the related creditor or creditors and the company. In this case, it is clear that each of the three alleged sources of prejudice which I have set out above falls within one or other of the two specified factors which the Court is obliged to take into account.

28 But in addition to taking account of those two specified factors, the Court must, before exercising the powers conferred by the section, arrive at the conclusion that the prejudice which has been suffered or is reasonably likely to be suffered, is "unreasonable". Two conclusions seem to me to flow from the adoption of that criterion by the legislature. The first is that the evaluation of prejudice, to be undertaken by the Court, is a qualitative process in which the nature, degree and extent of the prejudice is to be weighed and its significance assessed by the Court. The second conclusion and which is related to the first, is that the process of qualitative evaluation which I have described, will also require the Court to take into account any other matter that is relevant to the qualitative evaluation of whether or not the prejudice is unreasonable. This will require the Court to identify the consequences which the passage of the resolution would have on parties or interests other than those of the related creditor or creditors and the creditor voting against the proposed resolution, including creditors generally, the liquidator, and the public interest, and then to qualitatively weigh and evaluate those interests and to assess the extent to which consideration of those other interests might ameliorate or negate the conclusion that the prejudice which has been or is likely to be suffered by the opposing creditor is properly characterised as unreasonable.

29 Put another way, by requiring that the Court must be satisfied that the prejudice which has been or is likely to be suffered by the opposing creditor is unreasonable before exercising the powers conferred by the section, the legislature has expressly countenanced a circumstance in which the Court lacks jurisdiction to make an order because, even though the passage of the resolution has caused, or is reasonably likely to cause, prejudice to the opposing creditor, that prejudice is not unreasonable. Thus, the character of the inquiry to be undertaken by the Court is one of identification of the various consequences likely to flow from the passage of the resolution, followed by the qualitative evaluation of those various consequences, undertaken for the purpose of arriving at a conclusion as to whether or not any prejudice that has been identified as flowing to the interests of the opposing creditor or creditors is properly characterised as unreasonable.

30 This approach to the construction and application of s 600A is supported by authority. Support for the proposition that a two-stage process is involved, namely, that of first identifying any prospective source of prejudice and then, second, undertaking a qualitative evaluation of the nature and significance of that prejudice is found in Khoury v Zambena Pty Ltd [1999] NSWCA 402 per Fitzgerald JA at [60]. Support for the proposition that the determination of whether or not the relevantly identified prejudice is unreasonable, involves a process of weighing and balancing all relevant competing and conflicting interests and considerations is found in Network Exchange v MIG International Communications (1994) 12 ACLC 594, 599 per Hayne J; Kantfield v Plastamatic (Aust) Pty Ltd (1994) 14 ACSR 687, 694 per Hayne J; Wood v Laser Holdings Ltd (1996) 14 ACLC 801, 821, per Hansen J; Konica Australia v Aprolab Flashpoint (1999) 17 ACLC 1651, 1659; BGC Contracting Pty Ltd v Kimberly Gold Pty Ltd (2000) 18 ACLC 894, 909; Natrajan v ACIB Accumulas Pty Ltd [2006] VSC 22; (2006) 56 ACSR 356 and Deputy Commission of Taxation v Pontinex Pty Ltd [2000] NSWSC 99; (2000) 34 ACSR 391 at [89] - [92].

31 It may also be observed that the task to be undertaken by the Court when assessing whether identified prejudice is unreasonable for the purposes of s 600A, is not dissimilar to that undertaken by a Court when assessing whether a Deed of Company Arrangement is unfairly prejudicial to a creditor under s 445D(1)(f)(i) of the Act: see Sydney Land Corporation v Kalon Pty Ltd (1997) 16 ACLC 95; Fleet Broadband Holdings Pty Ltd v Paradox Digital Pty Ltd [2005] WASC 261.

32 It follows from this enunciation of the process of evaluation required by the section (where a case is brought on the basis of unreasonable prejudice), that the identification of a source of prejudice flowing from the passage of the relevant resolution is merely the commencement of the process, which must then extend to an evaluation of the nature, extent and significance of the prejudice. The latter part of the process must be undertaken in order to determine whether the identified prejudice is properly characterised as unreasonable, having regard to the two specific matters which the Court is obliged to take into account, and any other relevant matter, including any and all matters that might ameliorate, mitigate or justify the identified prejudice.

33 I will endeavour to apply this approach to the three matters which I have identified above as possibly giving rise to prejudice to the respondent in the circumstances of this case.

34 It will be apparent from my description of the reasons for decision provided by the trial Judge that he appears to have taken only the first step in the process I have described - that is, the identification of actual or prospective sources of prejudice. He does not appear to have taken the subsequent step of evaluating the nature, extent or significance of that prejudice for the purpose of making the qualitative assessment of whether or not it is unreasonable. For the reasons that follow, in my opinion, that omission caused his Honour to fall into error.

35 There can be no doubt that the inclusion of a covenant not to sue Sim as a term of the funding agreement is at least a prospective source of prejudice to Mr Kammal, in his capacity as a creditor of the company, because of the possibility that distributions to creditors in the liquidation might be reduced by reason of the company's inability to sue Sim.

36 However, consistently with the approach I have set out above, having identified the covenant as a potential or prospective source of prejudice to the respondent, it is then necessary to qualitatively evaluate the nature, extent and significance of that possible source of prejudice in order to assess whether it leads, either singly or in combination with other possible sources of prejudice, to the conclusion that the prejudice is unreasonable.

37 The first point to note about the covenant not to sue is that it is not a release by the company. Accordingly, notwithstanding the covenant by the company to the effect that it would not proceed against Sim, pursuant to s 588R of the Act, the respondent could, with the consent of the liquidator, commence proceedings against Sim claiming compensation in respect of the debt owed to him if Sim has contravened the provisions of s 588G of the Act relating to insolvent trading, pursuant to the entitlement to compensation created by s 588M of the Act.

38 The terms of the covenant not to sue which is to be provided by the company and the liquidator pursuant to the funding agreement, would not appear to preclude the liquidator giving consent pursuant to s 588R of the Act (assuming without necessarily accepting, that a liquidator could ever effectively enter into a valid undertaking in respect of the exercise of the duty conferred by s 588R of the Act). It is therefore to be assumed that the liquidator will exercise the powers and duties conferred by s 588R of the Act in relation to the grant or refusal of consent properly and in accordance with his duties as an officer of the Court. There is therefore no reason to conclude that consent would not be available to the respondent if he desired to take such a course of action.

39 However, it must be observed that there is not the material before the Court to enable a meaningful evaluation of the likelihood of the respondent successfully pursuing such a claim for compensation against Sim. But the same observation must be made in relation to the prospect of the company successfully pursuing a claim against Sim - that is, there is simply not the material before the Court to enable the Court to undertake any meaningful evaluation of the strength or value of that claim.

40 However, there is evidence in the form of the report by the liquidator to creditors to the effect that if and to the extent there is a good cause of action by the company against Sim, that cause of action will also be available against each of Dr Teo, another director of the company, Mr Adrian Lee, and the holding company of the company, Rustic Haven. Of course, in that context, before it would be possible to evaluate the worth of the potential claim against Sim, it would be necessary to evaluate the creditworthiness of the other prospective defendants, and to evaluate the strength of the claims against them. Once again there is very limited, if any, material before the Court to enable that process to be undertaken, although the liquidator has expressed the view in his report to the creditors that the potential defendants other than Sim have the capacity to meet in full any claim or compensation order. Such limited evidence as there is therefore suggests that a covenant not to sue Sim may not detract significantly, or at all, from the company's prospects of successfully recovering on a claim for insolvent trading.

41 The other prospect which must be brought to account in evaluating the weight or significance of the covenant not to sue Sim is that, of course, that covenant would not preclude the Australian Securities & Investments Commission itself taking action against Sim for contravention of the Act by insolvent trading, after which a compensation order could be made in favour of the company pursuant to s 1317H of the Act.

42 Accordingly, taking into account these various considerations, in my opinion, while the covenant not to sue Sim is undoubtedly a prospective source of prejudice to the respondent, the materials before the Court do not enable any particular value or significance to be attached to that prejudice. On the contrary, such materials as there are would support the conclusion that the prejudice, if any, is of no particular significance, because of the availability of identical remedies against other creditworthy parties.

Conflict of Interest/Compromise of Integrity

43 I have already set out the portion of the reasons for decision of the trial Judge in which he refers to this possible source of prejudice. His reference to the compromise of the integrity of the Court's function and the decision of French J in QPSX Ltd v Ericcson (Australia) Pty Ltd (No 3) [2005] FCA 933; (2005) 219 ALR 1 is presumably to be taken as connoting a reference to the following passage from that decision:

"The integrity of the court's primary function may be compromised where litigation is conducted in order to serve the interests of a stranger to the controversy before the court. That is because decisions may be taken, in the name of a party to litigation, for purposes foreign to the proper purposes for which that party may prosecute or defend the proceedings. The question whether there is an unacceptable risk of abuse of the court's processes arising out of litigation funding arrangements is to be assessed by reference to functional considerations including the role and the powers, if any, assumed by a funder in relation to the conduct of the litigation." (at [50])

44 However, the complaint made by the respondent in the present case is not based upon a compromise to integrity by reason of the intervention of a stranger, but the exact converse; namely, an allegation of compromise arising from the involvement of two of the directors of the proposed litigation funder in the events giving rise to the litigation. But, of course, the involvement of a person funding litigation in the events giving rise to that litigation is the norm - cases involving insurers and private litigation funders being the most significant exceptions to that normal circumstance. It follows that the assertion of the trial Judge that:

"The integrity of the court's function is arguably compromised as the funding agreement is not at arm's length in that the liquidator relies upon the testimony of the directors of Ravenswood Resort ..."

can only be sustained if there is something more to the relationships than disclosed by that passage because, of course, the financial interest of a witness in the outcome of the proceedings is an every day occurrence.

45 The trial Judge made no findings of fact that would identify any aspect of the relationship between the directors of the proposed funding entity, Sim and Dr Teo, and the issues likely to arise in the litigation, as creating the risk of compromise to the integrity of the function of the Court. He did not make specific findings as to the issues likely to arise in the litigation, and the nature of those issues is less than clear from the material that was tendered in evidence before him and before us.

46 However, some hint of the prospect of a conflict of interest between the role of Sim as a director and shareholder in the funding company and the issues that arise in the litigation is provided by the passage in the report to creditors from the liquidator dated 4 August 2005 to which I have already referred. No further reference to that issue is made in the subsequent report to creditors dated 23 August 2005.

47 The submissions to the trial Judge, his findings, and the submissions to us on the subject of the prospect of a conflict of interest arising as a result of the role of Sim as a director and shareholder in the funding entity, do not condescend to the identification of any particular issue in the litigation in which that conflict arises; but rest at the general level of an assertion that Sim was involved in the matters giving rise to the litigation by reason of her directorship of the company. For the reasons I have already given, the fact that a person involved in the funding of litigation was involved in the events giving rise to the litigation, is in my view, incapable of giving rise to any conclusion of conflict of interest of itself. It might give rise to a community of interest which would cause a Court to question the veracity of evidence given, but as I have already observed, the interest of a witness in the outcome of litigation is commonplace.

48 The closest the argument before us came to the identification of a conflict between the interests of Sim arising from her involvement in the litigation funding agreement and the interests of the company in the litigation is the suggestion that it will be in the company's interest in the course of that litigation to assert that it was trading whilst insolvent, but contrary to Sim's interest as a director for that assertion to be made good because of its possible consequences for her personal liability. The first point to be made in relation to that submission is that no such finding was made by the trial Judge, nor is it at all clear from such materials as were before the Court, either at first instance or on appeal, exactly how the issues are likely to unfold in the litigation and whether, in fact, such a conflict will arise. However, assuming for present purposes that there was a prospect of such a conflict arising in the course of the litigation, it must also be observed that it is a conflict of the kind which arises in every case in which a company relies upon its insolvency at the time a relevant transaction was undertaken and seeks to rely upon the evidence of its officers to establish that insolvency. It should further be observed that the conflict is present whether or not the funding agreement is entered into, because of the tension between Sim's duties to the company as one of its directors, and her own personal interests. In the present case, such a conflict would be compounded by Sim's interests as a major creditor of the company and as the holder of all but one of its shares, quite irrespective of her interest in the proposed funding agreement.

49 A version of the company's defence to the proceedings commenced by Rustic Haven, being the defence dated 10 March 2005, was in evidence before the trial Judge. In that defence, the company alleged a breach of fiduciary duty on the part of Sim, essentially by entering into a transaction for the sale of the company's land at under value.

50 Similar observations apply in relation to that potential source of conflict of interest as have already been made in relation to the potential conflict arising from an allegation of insolvent trading being made in those proceedings. Firstly, it is not at all clear whether the allegation of breach of fiduciary duty will be maintained, or whether it is critical to the defence of the company's claim, and the trial Judge made no finding in that regard.

51 Secondly, assuming for the sake of argument that such a conflict did arise, it is a conflict which exists in any event because of Sim's duties to the company as one of its directors and her interests as a major creditor and the substantial shareholder in the company.

52 It must also be steadfastly borne in mind that because of the way in which the case was presented to the trial Judge, the prejudice to which the Court is to have regard in this case, is the prejudice to the interests of the creditor who would have voted against the proposed resolution - that is, Mr Kammal. So, in the present case, before any prejudice to Mr Kammal's interests could be identified, it would be necessary to establish that the existence of the conflict of interest or compromise to the integrity of the function of the Court will somehow inhibit or constrain the litigation taking a course that would otherwise benefit the company and, through the company, the creditors, including Mr Kammal. No finding to that effect was made by the trial Judge, nor could any such finding be made by this Court on the basis of the incomplete and inconclusive material relating to the course of proceedings which the litigation proposed to be funded is likely to take.

53 It must also be remembered in this context that the litigation will be conducted by the company at the direction of the liquidator. The liquidator is an officer of the Court, and in the absence of evidence to the contrary, it can reasonably be assumed that he will exercise his duties as liquidator responsibly, and direct the litigation in the best interests of the company and its creditors. It can also be assumed that, should any irreconcilable conflict arise between the interests of the company in that litigation, and the interests of Sim as a party interested in the funding agreement, he will take appropriate steps to resolve that conflict. As I have already noted, the taking of such steps was specifically foreshadowed in the liquidator's first report to creditors.

54 For these various reasons, in my opinion, the findings made by the trial Judge do not sustain a conclusion of actual prejudice or prejudice which is reasonably likely to flow to the respondent from the alleged conflicts of interest arising from the proposed litigation funding agreement, nor can any such findings be made on the basis of the materials before the Court.

Risk of a Lack of Proper Investigation into the Company's Affairs

55 As I have observed, in his reasons for decision, the trial Judge placed reliance upon the reasoning of Austin J in Bovis (supra), and made specific reference to [310] of the reasons for decision in that case. In that paragraph, Austin J found that the resolution of creditors to execute the proposed deed of company arrangement delivered no benefits to the company or its creditors and at the same time deprived those creditors of the benefit of further investigations into the prospect of recoveries for insolvent trading, unfair preferences and uncommercial transactions, and deprived them of the prospect of recovery under such claims. It is perhaps therefore to be inferred that the trial Judge made a finding that such prejudice would flow from the approval of the proposed litigation funding agreement in this case, and that proposition was pressed on behalf of the respondent in argument before us.

56 However, it is clear from the reasons for decision that the trial Judge made no specific findings of fact that would enable such a conclusion. Nor does the evidence enable such findings of fact to be made by this Court.

57 The first point which must be noticed in relation to this assertion is to again note that the liquidator who is responsible for the investigation of the affairs of the company is an officer of the Court. There is no evidence that would support an inference that he will fail to discharge his responsibilities properly if adequately funded.

58 The second point to note under this heading is that there was no finding by the trial Judge, nor any evidence to support a finding as to any particular matter or matters that required investigation that were unlikely to be investigated if the litigation funding agreement was approved, nor of any prejudice to either creditors generally or more particularly Mr Kammal in the event that such investigations were not conducted. In the absence of identification of such an issue, it is difficult, if not impossible, to undertake any qualitative evaluation of the weight or significance to be attached to any such prejudice.

59 The third point to be made is that on the uncontradicted evidence before the Court, in the absence of approval of the litigation funding agreement, there was unlikely to be any funding available for the pursuit of recovery action as a consequence of such investigations in any event. In the liquidator's report to creditors dated 4 August 2005, he reported that cash at bank as a consequence of the liquidation was approximately $70,000. In that and his subsequent report, he advised creditors that despite approaches to six prospective litigation funders, the only offer of funding that remained open was that provided by Megacity. In my view, there is a clear inference available from this evidence to the effect that in the absence of approval of the litigation funding proposal, the company will have difficulty in funding the defence of the proceedings brought by Rustic Haven and very little prospect of pursuing any recovery action against other parties. On this view of the evidence, it seems to me that the better view is that approval of the litigation funding agreement will enhance the prospects of the proper investigation of the past affairs of the company and the pursuit of any appropriate recovery action arising from such investigations.

60 Accordingly, if it is to be inferred that the trial Judge made a finding to the effect that approval of the litigation funding agreement was likely to inhibit the proper investigation of the affairs of the company and the pursuit of recovery action against persons involved in those affairs, in my opinion, such a finding was not open on the evidence.

61 In relation to the three areas of actual or prospective prejudice which could possibly be said to flow from the approval of the litigation funding agreement, in my view, in the case of two of those matters, the trial Judge did not find the facts necessary to sustain the conclusion that they would in fact be sources of prejudice to creditors including Mr Kammal, and the evidence does not sustain any such findings of fact. In relation to the term of the litigation funding agreement to the effect that neither the company nor the liquidator will sue Sim, for the reasons I have given, it is not possible to conclude that any particular or significant prejudice will flow to creditors including Dr Kammal from the inclusion of such a term in the litigation funding agreement.

62 On the other hand, by reason of the evidence to which I have just referred, it seems to me to be clear that unless the litigation funding

agreement is approved, it will be difficult, if not impossible, for the company to defend the proceedings which have been brought against it by Rustic Haven, and there is little or no prospect of any funds being available for the pursuit of recovery action by the company in the interest of its creditors. Accordingly, when these considerations are weighed in the balance, it does not appear to me to be possible to conclude that any prejudice suffered or likely to be suffered by any creditor, including Dr Kammal, is unreasonable.

63 Accordingly, for these reasons, I would allow the appeal and set aside the order of the trial Judge and instead substitute an order that the application be dismissed with costs.

• Summary
• Reasons
• Section 600A
• The Meeting of Creditors
• The Decision at First Instance
• The Issues on Appeal
• The Construction and Application of Section 600A
• The Covenant Not to Sue
• Conflict of Interest/Compromise of Integrity
• Risk of a Lack of Proper Investigation into the Company's Affairs
• Conclusion