No priority for financial assistance given to administrators

By Quentin Solomon, Dan Fitts and Christopher O'Donnell.

Key Points:
Creditors that give financial assistance (ie. money or an indemnity) to an administrator cannot rely on section 564 of the Corporations Act to seek priority of payment over other creditors. Secured creditors should ensure appointed receivers establish and maintain a co-operative framework with a liquidator to maximise the likelihood of the court granting them preferred distribution of property under section 564.

It is not uncommon that a liquidator administering a company in liquidation has insufficient funds to initiate examinations of officers and others under section 596A or section 596B of the Corporations Act 2001 (Cth), or to commence legal proceedings in respect of someone against whom it is believed the liquidator has a good cause of action. Section 564 of the Corporations Act contains statutory encouragement to creditors to support a liquidator in his efforts to recover, realise or preserve property for creditors generally.

Section 564 reads as follows:

"Where in any winding up:

(a) property has been recovered under an indemnity for costs of litigation given by certain creditors, or has been protected or preserved by the payment of money or the giving of indemnity by creditors; or
(b) expenses in relation to which a creditor has indemnified a liquidator have been recovered;

the court may make such orders, as it deems just with respect to the distribution of that property and the amount of those expenses so recovered with a view to giving those creditors an advantage over others in consideration of the risk assumed by them."

As can be seen from the section, the inducement to the creditor providing financial assistance (ie. money or an indemnity) to the liquidator to recover, protect or preserve company property or recovery of expenses is an enhanced or preferred distribution.

In a recent case decided in February 2004, Tolcher v National Australia Bank Ltd 48 ASCR 741, two new issues were discussed in respect to the operation of section 564:

• whether sums outlaid by creditors during an administration were sums within the contemplation of section 564; and
• whether the funding by a secured creditor of a receiver's examinations and other activities that assist the liquidator to recover company property or money was within section 564.

Funds expended during administration

In the Tolcher case, one of the creditors (Fuji) outlaid $103,700 to enable the voluntary administrator to carry on the business of Lloyd Scott Enterprises ("LSE") before LSE ultimately went into liquidation. The question Fuji faced was whether sums outlaid by a creditor to enable an administrator to carry on the business of the company in administration are of such a nature as to be within the contemplation of section 564(a) (section 564(b) was unavailable to Fuji as it is expressly confined to indemnities given to liquidators). Fuji argued that the effect of certain sections of the Corporations Act (namely 513A- 513D) was that a winding up is taken to have begun on the day on which the preceding winding up commenced.

The court did hold that Fuji had contributed to the protection or preservation of the assets of LSE. This was so because LSE's assets were saved from the possibility of immediate sale which may have occurred had the administrator not been appointed to carry on LSE's business. However, the court held that the period contemplated by the words "in any winding up" in section 564 does not commence until there is a "liquidator".

The reasoning behind the court's decision was based primarily on the fact that the activities referred to in section 564(a) are those normally associated with a liquidator (recovery, protection, preservation), rather than an administrator. Consequently, financial assistance given by a creditor to an administrator is irrelevant for the purposes of section 564. Fuji was therefore not entitled to have its expenditure counted when consideration was being given by the court as to the preferred distributions to be allocated to creditors under section 564.

Funds paid to a receiver during liquidation

Another creditor in the Tolcher case was the National Australia Bank Limited. National was a secured creditor of LSE and appointed a receiver to recover its secured debt. It also funded its receiver to conduct Pt 5.9 examinations of officers of two related companies, Leasetec Australia Pty Limited and Capital Finance Australia Pty Limited, in order to recover its secured debt. At this point in time LSE had passed into liquidation. The examinations included investigations into certain unfair preferences allegedly received by Key Equipment Finance Pty Ltd.

While it was accepted that National's receiver was ultimately acting primarily in the interests of National as secured creditor, it was important that the likely cause of action against Key that the receiver was investigating was one which only the liquidator could bring under the relevant unfair preference sections of the Corporations Act. This was important for two reasons:

• this led to a finding (in the earlier case of Tolcher v National Australia Bank Limited (2003) 174 FLR 251), that moneys recovered by the liquidator through the unfair preference sections of the Corporations Act were not "property of the company" for the purposes of National's security, but were instead property available to the liquidator for distribution to unsecured creditors. Accordingly National was effectively an unsecured creditor in respect of the recovered monies; and
• the fact that the National knew that it was the liquidator alone who could institute the recovery action meant that the National "must therefore be taken to have knowingly and actively assisted in the achieving of an outcome… which, in the final result (not being the result preferred by the National), yielded proceeds for the benefit of the general body of creditors, not for the National as secured creditor".

This second point opened the door for the National to therefore have its costs relating to appointment of a receiver being considered for the purposes of section 564. Critical to the National establishing this, however, was that the appointment of the receiver went beyond simply creating an opportunity for the liquidator to hear what transpired at the receiver's examinations.

National's receiver in fact went further and established and maintained a co-operative framework with LSE's liquidator when conducting the Pt 5.9 Examinations of officers of Leasetec and Capital.

Evidence of this co-operative framework included:

• notifying the liquidator of the Pt 5.9 examinations;
• invitation for the liquidator to attend and participate (i.e. ask questions) in conferences with Counsel briefed to conduct the examinations (also transcripts of the conferences);
• provision of access to any documents produced by all parties pursuant to orders for production; and
• access to officers of the National for questioning in relation to the subject transactions.

The court held that the ability of LSE's liquidator to recovery LSE's property from Key was enhanced by information elicited by National’s receiver in the course of the Pt5.9 examinations of officers of Leasetec and Capital, and the co-operative framework outlined above.

It was clear from prior cases that if National had funded LSE's liquidator (as opposed to its receiver) to conduct those Pt 5.9 examinations, property recovered as a result of those examinations (such as the property recovered from Key) could properly be made the subject of asection 564 order in favour of National (Deputy Commissioner of Taxation v Currockbilly PtyLtd (2002) 172 FLR 99). The question National faced was whether the principle could be extended to funds provided to a receiver who assists the liquidator to recover property.

The court answered the question in the affirmative for National for three main reasons:

• National's funding of the receiver’s Pt5.9 examinations and the preparations and other activities associated with them played a direct role in enabling LSE's liquidator to recover property from Key;
• National's appointed receiver established and maintained a co-operative framework with the liquidator; and
• the property recovered from Key benefited the general body of creditors of the company.

To summarise:

• funds recovered by a liquidator under the unfair preference provisions of the Corporations Act will no constitute company property for the purposes of security held by a secured creditor;
• a secured creditor may, however, be entitled to a preferred distribution to the extent that any receiver appointed by it assists a liquidator to achieve recovery of such funds for the benefit of creditors generally. The requisite "assistance" to the liquidator is likely to be made out where the receiver establishes and works in a co-operative framework with the liquidator when undertaking the relevant activities.

For further information, please contact Dan Fitts.