The Insolvency Practice Schedule: navigating creditors' new powers

By Matt Edwards, Anna Trevor and Kym Condon

Creditors' greater rights to information and records, and new powers to remove external administrators, are getting a workout in the courts.

The Insolvency Practice Schedule (Corporations) (IPSC) (Schedule 2 to the Corporations Act 2001 (Cth)) commenced in stages throughout 2017, with the objective, in part, to enhance transparency between creditors and external administrators. How are these new creditor powers playing out in external administrations?

Two recent cases examine them, with consequences for external administrators when dealing with:

  • creditors' rights to information and records; and
  • creditors' ability to vote to remove an administrator or liquidator, and when an external administrator ought to exercise a casting vote in favour of their removal.

Creditors' rights to information and records

Under sections 70-45 and 70-55 of the IPSC a creditor may request information, reports or documents from an external administrator. The external administrator must comply with that request, unless the information or records sought are not relevant to the external administration, the external administrator would breach their duties by complying with the request, or it is otherwise not reasonable for the external administrator to comply. Rule 70-15 of the Insolvency Practice Rules (Corporations) 2016 (IPRC) specifies seven circumstances where it is not reasonable for an external administrator to comply with the request, for example where the request is vexatious, or is for legally privileged documents.

The ambit of these new rights was considered in 1st Fleet Pty Ltd (in liquidation) [2019] NSWSC 6.

The liquidation and the remuneration

Messrs Tayeh and Solomons were appointed as voluntary administrators and later became joint and several liquidators of 1st Fleet Pty Ltd (in liquidation) and other companies. Between 25 April 2012 and 1 July 2018, they were paid over $4.4 million in remuneration.

The Commonwealth advanced money to employees under the employee entitlements schemes, and thereafter subrogated to the employees' priority position. The Commonwealth's proofs of debt were admitted in full by the liquidators and it received its first dividend in 2018.

Concerned by the size of the liquidators' remuneration, the Commonwealth sought orders pursuant to sections 70-45, 70-55, 70-90 and 90-15 of the IPSC, requiring the liquidators to provide information and documents relating to:

  • whether certain unsecured creditors were eligible to be members of the committee of inspection (COI), and whether the COI approval of their remuneration was valid (COI Documents); and
  • whether the remuneration was reasonable (Remuneration Documents). 

Guiding principles for the Court's discretion

Justice Black observed that the Court's discretion ought to be exercised by reference to the express purposes of the IPSC as stated in the Explanatory Memorandum, including that:

  • "the current regulatory barriers to creditors obtaining information entrenches the inherent problems creditors face in assessing the quality of insolvency services provided"; and
  • "Creditors and members with a financial interest will be able to make reasonable requests for information that practitioners would be obliged to meet provided there is funds available to meet the request."

The liquidators argued that section 70-55 was narrower in scope than section 70-45 in that it was enacted, "to assist the Commonwealth in the investigation and determination of claims by former employees of insolvent companies for financial assistance in relation to unpaid employee entitlements." Justice Black did not accept this submission, instead finding that the Commonwealth may specify the information it seeks from the external administrator, "without any restriction imported by reference to a perception of its "principal" purpose(s)." He also held that once the prerequisite to section 70-55 is satisfied, there is no limit to the nature of the information that may be requested.

COI Documents

The COI had approved the liquidators' remuneration for future periods to a specified limit that may be drawn "at [the liquidators'] discretion." Further fee approvals would be sought from creditors, the COI or the Court when that limit was exhausted.

The Commonwealth sought information and documents which "established":

  • whether the COI members were eligible unsecured creditors; and
  • the steps taken by the liquidators to satisfy themselves of the COI members' eligibility. 

Justice Black did not make orders for the production of the COI Documents because:

  • the liquidators had conducted appropriate searches and were unable to locate any further documents;
  • to do so would require the liquidators to produce information to "establish" propositions advanced by the Commonwealth; and
  • the Commonwealth had reformulated its request from that which was set out in previous correspondence. As a result of this reformulation, the liquidators had not yet failed to produce some of the COI Documents.
Once the prerequisite to section 70-55 is satisfied, there is no limit to the nature of the information that may be requested.

Remuneration Documents

The Commonwealth sought a breakdown of the calculation of each remuneration payment made to the liquidators, including the charge-out rate, number and description of hours worked by each person.

The following contentions advanced by the liquidators were not accepted:

  • the information provided to the COI at the time of the remuneration approvals was sufficient to demonstrate reasonableness;
  • this information was already offered to the Commonwealth in a summary form; and
  • the time records were likely to contain confidential and privileged information.

Was the request for the Remuneration Documents "vexatious" in part because the Commonwealth was required to establish a demonstrated need to inquire into the liquidators' remuneration? The liquidators thought so; Justice Black did not, commenting that such a finding would be inconsistent with the conferral of additional rights to access information upon creditors.

The second factor in support of the "vexatious" submission was due to the "multitude of requests for documents and information made of the liquidators by the Commonwealth." The fact the Commonwealth had previously requested information on a range of matters did not render the relevant request for information vexatious.

Justice Black held that it was not unreasonable for the Commonwealth to undertake a potentially close review when it had advanced over $9.4 million and the liquidators had been paid over $4.4 million, and that if there were any additional costs, the Commonwealth as the primary priority creditor would probably bear them.

Justice Black ordered that the liquidators provide the Remuneration Documents, and to pay 50% of the Commonwealth's costs of the application. 

Creditors' power to remove external administrators

Creditors also have new powers to remove and replace an external administrator by resolution at any creditors' meeting (section 90-35 of the IPSC). What if the external administrator has the casting vote? Which way should they go?

That was the issue explored in The Owners – Strata Plan 84,741 v Iris Diversified Property Pty Ltd (in Liq) [2018] NSWSC 834, in which a creditor sought relief following the liquidator's failure to exercise his casting vote in favour of a resolution removing and replacing him as liquidator.

The Court held that the liquidator should have exercised his casting vote in favour of the resolution to remove him, when that was the preference of the creditor with a substantial majority in value.

The creditors' meeting

The Owners Corporation had directed the liquidator of Iris Diversified Property Pty Ltd to convene a meeting of creditors, and requested that a resolution be put to that meeting for the replacement of the liquidator.

At the meeting, the Owners Corporation voted in favour of the resolution but a related entity of the company voted against it. This meant that the resolution had been passed by a substantial majority of the creditors by value (as the Owners Corporation held around 90% value of admitted proofs), but not by number. The liquidator exercised his casting vote against the resolution. So the resolution was not passed. The Owners Corporation subsequently applied to the Court seeking removal of the liquidator on several bases under the IPSC.

The Court held, at the outset, that the liquidator did not have the power to vote against the resolution. Rule 75-115(5) of the IPRC permits an external administrator to exercise a casting vote in favour of a resolution for their removal (or to abstain), but not to vote against it.

The Court further ordered that the resolution ought to be taken to have been passed pursuant to section 75-41(3)(d) of the IPSC, which permits the Court to exclude related entity votes from resolutions in certain circumstances. Justice Black also indicated that it would have been appropriate to order that the resolution be passed (pursuant to section 75-43(4) of the IPSC), if that failure was caused by the refusal or failure by the meeting chair to exercise a casting vote in favour of it. He held that the casting vote should have been exercised in favour of the resolution in circumstances where the Owners Corporation had such an overwhelming monetary interest in the company, as opposed to the related entity who had a 10% monetary interest.

The Court ordered the liquidator pay the Owners Corporation's costs of the application personally, without recourse to the assets of the company.

Key lessons for external administrators

The 1st Fleet case serves as a reminder that the seven exceptions in Rule 70-15(2) of the IPRC are exhaustive. Unless one or more of those seven specified circumstances exist, it will be reasonable for the external administrator to comply with the information request. Further, there is no real restriction on the type of information that can be requested. This places a potentially heavy burden on the liquidators of insolvent companies. If they are in funds, creditors have a robust power to require that a liquidator produce information and documents. While we are not advocating against appropriate creditor involvement, this may have the unintended consequence of creating additional administrative cost, particularly in liquidations where there are large amounts of creditors, many of whom may make information requests. Should requests not be complied with, creditors have the power to approach the Court for orders. If orders are made requiring production, there are real risks that liquidators will be required to pay costs orders, without recourse to the assets of the companies.

Similarly, the Iris Diversified case highlights the significant powers of removal held by creditors. This increase in rights, while understandable, may also be costly. For example, it creates an ability for creditors representing certain interests to replace an external administrator by the calling of a meeting of creditors (assuming they have enough creditor support). This will likely impact the costs incurred in a liquidation by reason of the appointment of a replacement liquidator. It creates further considerations for external administrators when considering whether to trade on a business (over and above what may be in the best interests of creditors). In trading on a business, an external administrator will incur personal liabilities. The risk of replacement will now be a significant factor impacting the decision to trade on, given potential issues concerning the recovery of their remuneration and disbursements if replaced. As a consequence, external administrators should consider carefully and, if necessary, take advantage of, their rights to seek directions from the Court in respect of dealings with creditors.

When exercising a casting vote in relation to their replacement, an external administrator must have due regard to the interests of creditors. As demonstrated by the Iris Diversified case, the consequences of a failure to do so can be costly.