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17 Sep 2020

Pride and prejudice (but not for creditors): Disclaimer of property set aside where liquidators hold indemnity

By Nick Poole, Anthony Burke and Michael Damevski

Liquidators need to be mindful that a disclaimer of property may be challenged. The Supreme Court of Victoria underscored a key issue in establishing "prejudice" to creditors in a liquidation, holding that a disclaimer of property may be set aside where the liquidators are indemnified.

A liquidator may disclaim a company's property for a number of reasons including where it is unsaleable, if it gives rise to monetary liabilities or other onerous obligations, or where the costs to realise the property exceed the proceeds of realising the property. In limited circumstances, however, the Court may set aside a disclaimer. Relevantly, a disclaimer may be set aside (before taking effect) if the disclaimer would cause prejudice to those with an interest in the property so grossly out of proportion to the prejudice that would be suffered by the creditors if the disclaimer was set aside.

Liquidators, at times, have used the ability to disclaim company property as a means to deal with contamination liabilities. The ability to disclaim property in a liquidation may no longer be so clear-cut however, following the recent decision by the Supreme Court of Victoria in EPA & Anor v Australian Sawmilling Company Pty Ltd (in liq) & Ors [2020] VSC 550. This decision dealt with the issues of "prejudice" to creditors where the liquidators were indemnified, and whether setting aside a disclaimer would be contrary to public policy.

The liquidators disclaim an interest

The Environmental Protection Authority (EPA) and the State of Victoria (State) to the Supreme Court of Victoria to set aside a disclaimer made by the liquidators of the Australian Sawmilling Company Pty Ltd (in liquidation) (TASCO). The liquidators were appointed by way of a creditors' winding up and had disclaimed TASCO's interest as registered proprietor of land which had been used as a sawmill. Since 2016, the land contained large stockpiles of industrial waste and remained unsaleable at the time of the hearing.

Dongwha Australia Pty Ltd was the sole shareholder of TASCO from 2012 to 2018. Dongwha Australia was also a creditor of TASCO. Dongwha Australia indemnified the liquidators against any shortfall in available assets to meet environmental liabilities to induce them to accept the appointment.

Did the disclaimer cause prejudice?

The Court had to determine whether the liquidators' disclaimer would cause prejudice to the EPA and the State so grossly out of proportion to the prejudice that would be suffered by TASCO's creditors if the disclaimer was set aside.

The Court held in favour of the EPA and the State, as the setting aside of the disclaimer would not cause prejudice to TASCO's creditors (other than delay in finalising the liquidation), whereas the prejudice the EPA and the State would suffer was significant (being liability for clean-up costs). The creditors were unlikely to receive dividends in any circumstances, and Dongwha Australia could have met the unlimited indemnity in respect of environmental liabilities if required. It is important to note that Dongwha Australia's role as indemnifier was treated as being separate and unrelated to its role as a creditor. It was therefore found that Dongwha Australia would not have suffered prejudice in its capacity as a creditor if the deed of indemnity was called upon.

Who bears the burden?

The Court subsequently held that it would exercise its discretionary powers and set aside the disclaimer.

It accepted the EPA and the State's submission that the financial consequences of a liquidation should not be avoided. It also agreed that a disclaimer should not be used as a device to avoid environmental responsibilities, nor to impose unwanted burdens on the taxpayers. Additionally, the Court observed that, given the indemnity extended to the liquidators' remuneration, the liquidators were unlikely to suffer any material prejudice if the disclaimer was set aside.

Key takeaways for creditors and liquidators

The key takeaways from the Supreme Court's decision are two-fold.

Firstly, creditors are unlikely to suffer prejudice from a court order to set aside a disclaimer where the company's liquidators have been indemnified.

Secondly, the case demonstrates that the courts may set aside disclaimers where the liquidators are indemnified, as passing liability onto the State goes against public policy. Courts will also be wary of disclaimers where they are used to avoid environmental responsibilities, or to impose unwanted burdens on the taxpayer.

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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.