TGIF 8 May 2020: Court finds plenty of rough among the conduct of Merlin Diamonds

This week’s TGIF considers the Federal Court’s decision in Australian Securities and Investments Commission v Merlin Diamonds Limited (No 3) [2020] FCA 411, in which, consequent on finding a number of contraventions of the Corporations Act  2001 (Cth), the Court ordered the winding up of that company.

Background

On 20 September 2019, Messrs Algeri and Norman of Deloitte Financial Advisory (Provisional Liquidators) were appointed as provisional liquidators of Merlin Diamonds Limited (Merlin) following an application to the Federal Court by the Australian Securities and Investments Commission (ASIC). ASIC also sought an order that Merlin be wound up. While at the time of appointment, Merlin had four directors, being Mr Joseph Gutnick, Mr Mordechai Gutnick, Dr David Tyrwhitt and United States resident Mr Henry Herzog, by 26 November 2019 Messrs Gutnick and Gutnick had resigned as directors and company secretary.

Following the filing of the report by Provisional Liquidators on 1 November 2019, ASIC filed an amended originating process which sought the winding up of Merlin upon the ground of insolvency under section 459B of the Corporations Act 2001 (Cth) (the Act), or in the alternative, on just and equitable grounds under s 461(1)(k) of the Act.

Opposition to the Application 

ASIC’s application was opposed by 22 shareholders and 9 convertible noteholders, representing approximately 20.5% of Merlin’s issued share capital (Interested Parties). The Interested Parties proposed that instead of winding up Merlin, an administrator should be appointed to provide an opportunity for a deed of company arrangement (DOCA) to be proposed and voted upon. 

The Interested Parties also submitted that, if a winding up order were made, the court should appoint an alternate liquidator of their nomination.

Decision

Having regard to Merlin’s uncontroversial insolvency and its state of affairs at the time of the appointment of the Provisional Liquidators, the Court considered that the appointment of a liquidator was necessary for the protection of Merlin’s shareholders and creditors and to ensure, in the public interest, an independent investigation and appropriate redress for any breaches of the Act by current and past directors, was undertaken.

Breaches considered by the court

In considering the competing applications, the Court observed the following:

1. a failure to appoint a company secretary for considerable periods of time in contravention of section 204A(2) of the Act;
   
   
2. a failure to lodge half-yearly reports as required by section 320 of the Act;
   
   
3. Merlin was involved in related party transactions in contravention of section 208 of the Act, including the application of Merlin’s own monies to fund the subscription by Chabad Properties Pty Ltd (Chabad), for convertible notes issued by Merlin in the amount of $900,000 and advancing loans to Axis Consultants Pty Ltd (Axis) in each of the financial years from 2012 to 2018 totalling $13,752,125 as at 30 June 2018;
   
   
4. a failure to keep proper accounts in contravention of section 286 of the Act; and
   
   
5. a failure to appoint the minimum number of 3 directors and failure to appoint a minimum of 2 directors who ordinarily reside in Australia, in contravention of section 201A of the Act.

The Court found the related party transactions involving Axis and Chabad to be the most serious contraventions and in the absence of evidence that any of the directors had sought to prevent the transactions occurring, amounted to a “serious failure of governance of the company”. O’Bryan J also considered the failings associated with the creation and completion of the accounts of the company to create a significant impediment to its continuing existence. 

 Appointment of an administrator

 In opposing ASIC’s application for a winding up order, the Interested Parties submitted that the appointment of an administrator would allow for the preparation and presentation of a DOCA to creditors, which, if accepted would allow for a new board of directors, a capital restructure, and relisting on the ASX to “preserve and restore as much value as possible for the minority shareholders and creditors”.

The Court rejected these submissions on the basis that the evidence in support of a potential DOCA was uncertain, speculative and conditional. The Court also considered that the appointment of liquidators did not foreclose the possibility that an administrator be appointed by those liquidators according to their powers under section 436B of the Act.

Appointment of an alternative liquidator

The Court also rejected of the application by the Interested Parties that an alternate liquidator be appointed. The Interested Parties contended that the Provisional Liquidators  did not have the support of the creditors, had not shown any inclination to appoint an administrator and had incurred significant costs. The Court did not accept any of these submissions as founding a reasonable basis for appointment of an alternate liquidator as that course would inevitably result in a duplication of costs to the detriment of creditors and shareholders.

Comment

This decision confirms the court’s unforgiving approach to improper conduct by a company and its officers.  O'Bryan J considered that Merlin did “not appear to take its legal obligations seriously," nor express “contrition” for contraventions involving breaches of duties and the maintenance of proper accounts of the company. 

The decision also reiterates the importance of the public interest, as well as the interests of shareholders and creditors, when the Court considers whether to order the winding up of a company rather than place it into administration.