Litigation: risky business for liquidators
Before embarking on any litigation, or continuing any litigation that is on foot at the time of the liquidator's appointment, a liquidator should carefully weigh up the benefits and risks of pursuing a particular course of action.
A liquidator can be exposed personally in litigation. We discuss the risks to a liquidator associated with litigation by examining some recent cases where liquidators have been ordered to pay costs personally. We provide guidance on ways to mitigate this risk.
Balancing risk – weighing up competing priorities
A liquidator has the unenviable task of weighing up their duty to pursue meritorious claims (in the interest of maximising returns to creditors), against the inherent risk of litigation including being personally liable for costs.
As a party to a proceeding (or even a non-party where the plaintiff is the company in liquidation and the Court is exercising its inherent jurisdiction to award costs against a third party), a liquidator risks costs being awarded against him or her personally.
Generally, unless a liquidator is negligent, has acted unreasonably, or has misconducted himself or herself in the proceeding, the liquidator will have a right to an indemnity out of the company's unsecured assets for costs (as a priority payment as a cost and expense of the winding up). However, a liquidator is personally at risk if the company's assets are insufficient to meet these costs or the Court orders that the liquidator ought not be indemnified from the company’s assets.
Liquidators have been ordered to pay costs personally
Recently, there have been numerous cases where liquidators have been ordered to pay costs personally, some of which are as follows:
Without indemnification from company assets
- Damcevski v Demetriou  NSWSC 1915 – costs were awarded against the liquidators (who were not a party to the proceeding) on an indemnity basis, where the liquidators had ‘actively defended the proceedings, raised grounds of opposition that dramatically changed over time and defended proceedings in a manner not to the benefit of the creditors’;
- Australia’s Residential Builder Pty Ltd (in liq) v Wiederstein (No 2)  VSC 389 – the liquidator was ordered to pay costs of the appeal on a standard basis up to the date of a Calderbank offer and on an indemnity basis thereafter as the liquidator’s rejection of the offer was unreasonable. The Court found that the liquidator had instituted the appeal for the sole purpose of "meeting his own fees" and not for the benefit of the creditors. The Court stated that the liquidator "should not be able to avoid an adverse costs order by hiding behind the shield of an insolvent company when the proceedings were brought for his own benefit";
- Deputy Commissioner of Taxation v ACN 154 520 199 Pty Ltd (In Liq)  FCA 609 – the general purpose liquidator was ordered to pay the costs of the special purpose liquidator on an indemnity basis as the general purpose liquidator had acted unreasonably in his inquiry into the conduct of the special purpose liquidator;
- Re Azmac Pty Ltd (in liquidation) (No 2)  NSWSC 363 – the defendant liquidator was ordered to pay the costs of the proceedings in circumstances where the liquidator’s actions provoked the litigation in such a way that the defendant liquidator should be regarded as the party who initiated the proceedings, and having failed completely, costs should follow on that basis. The Court held that the liquidator’s conduct was "infused with self-interest" and therefore "unreasonable and unnecessary", ordering that the liquidator pay costs personally;
- The Oak Hotel Cessnock Pty Ltd (in liq) v Deputy Commissioner of Taxation  NSWSC 1589 – costs were awarded against the non-party liquidator on an indemnity basis where the company in liquidation had commenced proceedings prior to the liquidator’s appointment. The Court found that the liquidator had failed to communicate with the defendants’ solicitors for seven months and although the duties under the Civil Procedure Act were imposed on the company in liquidation as a party, that company could only act through the liquidator. The Court was of the view that ordering the company in liquidation to pay the costs would be to visit the consequences of the liquidator’s conduct on the creditors and was not persuaded that this was appropriate since the liquidator "ought be held responsible for his own conduct";
Without displacing a liquidator’s right to indemnification from company assets
- SJG Developments Pty Ltd v NT Two Nominees Pty Ltd (in liq)  QSC 104 – costs were awarded against the non-party liquidators on an indemnity basis where the company in liquidation had issued a statutory demand in circumstances where there was a genuine dispute. In weighing up whether a personal costs order should be made, the Court was of the view that the liquidators should "bear the risk" of any shortfall of assets in the liquidation to meet the costs order; and
- Fairfield Services Pty Ltd (in liquidation) v Leggett  QSC 183 – the liquidators were ordered to pay costs on a standard basis after discontinuing the proceedings just under three weeks prior to trial. The liquidators contended that the discontinuance was because there was no prospects of settlement, and upon reassessment of a cost-benefit analysis the cost of pursuing the proceeding to a conclusion at trial had come to outweigh the benefits likely to be obtained from the trial.
I'm a liquidator – how can I mitigate the risk of paying costs personally?
Before embarking on any litigation, or continuing any litigation that is on foot at the time of the liquidator's appointment, a liquidator should carefully weigh up the benefits and risks of pursuing a particular course of action. A liquidator should:
- investigate matters promptly and with due consideration;
- seek legal advice on the merits of the claim (which may include Counsel opinion);
- estimate the costs (including the liquidator's fees, legal fees and disbursements) and ascertain the likely recovery of a claim;
- be prepared to settle the claim;
- as a preliminary step, consider whether to examine company directors particularly to obtain a better understanding of a claim;
- consider seeking directions of the Court on whether to continue a claim; and
- comply with Court rules and liquidator's statutory duties.
In addition to being cognisant of the matters raised above, a liquidator can mitigate the risk of being personally liable for a costs order by:
- obtaining non-recourse funding from a litigation funder, including an indemnity to pay any adverse costs orders (which is sometimes underwritten by after the event insurance). This form of funding shifts all risk to the funder, as the liquidator is only obligated to repay the funder upon successful recovery of the funded claim. Funding can also be provided for preliminary steps such as investigations and public examinations. With portfolio funding (a facility provided for all claims arising out of a liquidation), a liquidator can run more claims risk-free;
- obtaining funding and an indemnity to meet adverse costs from a creditor;
- ensuring there are sufficient unsecured assets to meet the costs of the litigation, including any adverse costs. However, liquidators should be wary that a Court may order that the liquidator is not entitled to an indemnity from the company’s assets and creditors may not be supportive of liquidators risking funds that would otherwise be distributed, to pursue litigation; or
- considering whether to assign a claim, rather than commence proceedings. This option provides liquidators with an additional means to improve creditor outcomes and reduce the risk of being personally liable for costs in litigation.
This is an edited version of an article that was published in the Australian Restructuring Insolvency & Turnaround Association Journal (Vol 33).
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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.