TGIF 16 September 2022 – Court relieves administrators of liability for entry into funding agreement with creditor

This week’s TGIF considers a recent decision of the Federal Court of Australia in which the Court relieved administrators of liability for entering a funding agreement with a major creditor in order to keep the company trading.

Key takeaways

• While the default legislative position is that administrators are personally liable for debts incurred in the performance of their functions, a court is generally willing to grant administrators relief from personal liability where it is clearly beneficial to the creditors, who remain the court’s core concern.
  
  
• Incurring further debt is not, as a matter of principle, a bad strategy for a company under administration where there is a possibility that the company will recover in the long-term.
  
  
• Administrators should always negotiate with key creditors before ceasing trading, particularly where winding up will devalue the business and shrink the returns available to creditors. 

In a recent decision of the Federal Court of Australia (Lord, Re Invigor Group Limited (admins appt) [2022] FCA 1064), administrators were granted relief in respect of a funding agreement they entered with the company’s primary creditor in order to keep the company trading. The case is a reminder of the importance of negotiation in the administration process, which is not the death knell it is sometimes considered to be for companies.

Background

The Plaintiffs were appointed joint and several administrators (the Administrators) of Invigor Group Ltd (administrators appointed) (Invigor or the Company) on 24 August 2022. As at 31 July 2022, the Company had debts totalling around $3.5 million to 40 known creditors, of which Allectus Capital Limited (Allectus) was the largest secured creditor, with a debt of around $1.4 million.

Invigor’s key assets were customer contracts which would likely be terminated in the event the Company ceased trading. The Administrators calculated that, in order to continue trading the business as a going concern, Invigor would require an additional $859,199 for critical trade creditor and wage-related expenses.

Following discussions with the Administrators, Allectus agreed to enter a funding agreement that would provide Invigor up to $860,000 to cover the costs of trading while a DOCA was negotiated and agreed. This amount was to be provided on a staged, interest-free schedule on the condition that Allectus would not seek recourse against the Administrators or Company in respect of these funds.

The application

The funding arrangement with Allectus was conditional on a successful application by the Administrators for relief from the default position that administrators are liable for debts incurred in the performance or exercise of their functions pursuant to section 443A of the Corporations Act 2001 (Cth) (the Act).

The Administrators applied for relief under section 447A(1) of the Act and section 90-15 of the Insolvency Practice Schedule (Corporations), which give the Court discretion to make appropriate orders in respect of administration. The application was not contested.

Applicable Law

After setting out the relevant legislation, Yates J noted that it has become common for administrators to seek relief modifying the operation of section 443A in circumstances where funding is necessary to facilitate trading during the administration period.

His Honour accepted the principle that administrators should not be expected to expose themselves to substantial personal liability on account of such funding. In particular, Yates J referred to a case where it was emphasised that the function of a court’s power to grant such relief is to confer a level of protection on administrators whose actions are designed to benefit the creditors of the company.

What did the Court decide?

Yates J granted the relief, ordering that the Administrators’ liability for entering the funding agreement would be limited to what had been stipulated in the funding agreement. His Honour was satisfied there was an urgent need for funding in order to ensure Invigor’s ongoing trading.

Yates J accepted the Administrators’ evidence that it was unlikely more attractive funding could be obtained. His Honour also referred to the Administrators’ evidence that allowing the Company to continue trading would yield benefits including:

• increasing the pool of funds available to creditors by continuing to trade the business (where winding up would see the Company lose significant value);
  
  
• maximising the value of the business and improving the likelihood of the Company continuing after administration; and
  
  
• avoiding the crystallisation of termination entitlements and claims under the Company’s current service contracts.

His Honour noted that, without such funding, the Administrators would need to take immediate steps to cease operating Invigor’s business and this would hurt the value of the business and the return to creditors (including Allectus).

Comment

This case is a useful restatement of the principles a court will consider when deciding whether to relieve administrators from liability for debts. Specifically, the case reaffirms that the emphasis is traditionally on whether and how the increased debts will impact creditors.

A court will also give weight to the likelihood that incurring further debt will allow a company to recover and continue trading. These factors should always be at the forefront of an administrator’s evidence supporting an application for relief. However, administrators should take comfort in the courts’ willingness to relieve administrators from personal liability in appropriate circumstances.

Additionally, this case is an interesting example of the importance of negotiation in the administration process. Large creditors may not always be willing to put up further funds on the mere possibility of recovery. However, this case shows funding arrangements can be critical to outcome. As such, in appropriate circumstances, administrators should attempt to negotiate with larger creditors for assistance in securing ongoing trading.