TGIF 14 October 2022 – Court upholds liquidator’s decision to reject proof of debt relating to failed property sale

This week’s TGIF considers a recent case in which the Federal Court of Australia upheld a liquidator’s decision to reject a proof of debt for damages relating to a failed sale of commercial property. 

Key takeaways

• Courts are empowered to make orders that effectively override a liquidator’s decision which can be used alongside the general power to appeal the rejection of a proof of debt.
  
  
• Expert evidence can be highly determinative in a challenge regarding a proof of debt for damages related to devaluation of property and it is critical that such debts be quantified in accordance with accepted principles, including by reference to legitimately comparable sales.
  
  
• Although the prevailing view is that the COVID-19 pandemic had devastating impacts for businesses across the world, courts still require specific proof of the pandemic’s impacts including in relation to commercial property valuations.

In a recent decision of the Federal Court of Australia (Sentinel Orange Homemaker Pty Ltd v Bailey (as liquidator of David Investment Group Holdings Pty Ltd (in liq)) (No 2) [2022] FCA 1200), the Court upheld a liquidator’s decision to reject a proof of debt for the alleged diminished value of a commercial property which had been the subject of a repudiated contract of sale, rejecting expert evidence about the property’s value. The case is a useful look at the mechanism by which liquidators’ decisions can be reviewed and the importance of expert evidence in cases about property value.

Background

On 17 August 2018, Sentinel Orange Homemaker Pty Ltd (Sentinel) contracted to sell a large commercial property to Davis Investment Group Holdings Pty Ltd (DIG) for $3.6 million (the Contract). DIG had been incorporated to own the land, which it would lease for the purposes of carrying on a car dealership business. DIG’s business began to decline in early 2020 following the onset of the COVID-19 pandemic, which impacted car sales around the world. On 31 March 2020, DIG purported to terminate the Contract.

DIG subsequently fell into liquidation on 17 April 2020 and Mr Bailey was appointed as liquidator (the Liquidator). Sentinel recovered its deposit and later lodged a proof of debt for the difference between the purchase price of the property under the Contract and the allegedly diminished value of the property following termination of the Contract.

The amount of $350,000 was claimed on the basis that a property valuer had since priced the commercial property at $3.25 million. Among other things, Sentinel’s expert referred to the sale of similar warehouses Australia-wide and the impacts of COVID-19 on the value of the property following a decline in demand for cars.

The Liquidator rejected Sentinel’s proof of debt on the basis there was no change in the value of the property. Sentinel then lodged an application seeking to ‘appeal’ this rejection.

The application

Sentinel appealed the Liquidator’s decision under regulation 5.6.54(2) of the Corporations Regulations 2001 (Cth) and section 90-15(1) of the Insolvency Practice Schedule (Corporations), found in Schedule 2 of the Corporations Act 2010 (Cth). Regulation 5.6.54(2) allows a person to appeal a rejection of a proof of debt, while section 90-15(1) allows a court to “make such orders as it thinks fit in relation to the external administration of a company”.

In other words, a court is empowered to order that there is a valid proof of debt. Although it is characterised as an appeal, Stewart J noted that the court hears the matter afresh. As such, a court is entitled to hear evidence that was not before the liquidator when the original decision was made.

Applicable law

There was no dispute as to the Court’s ability to overrule the Liquidator’s decision to reject the proof of debt in this case. Similarly, the parties agreed that Sentinel would be entitled to loss of bargain damages if it could show a difference between the Contract price and the market value at the date the Contract should have been performed.

The dispute between the parties was confined to whether there had been such a decline in value. As such, the key issue was the value of the commercial property. Stewart J identified the key principles as follows:

• the test of value of land is determined by asking what a person desiring to buy the land would pay for it to a person willing, but not desirous, to sell;
  
  
• comparable sales are useful in determining market value but must be carefully assessed for similarity;
  
  
• prior sales of the property will only be useful where they are sufficiently close in time and made in good faith; and
  
  
• genuine unaccepted offers to purchase or sell the property may be useful in establishing a ‘floor’ or ‘ceiling’ to the value, but the utility of these examples depends on the circumstances in which the offer was made.

What did the Court decide?

Stewart J upheld the decision of the Liquidator to reject the proof of debt for damages. His Honour found the value of the property had not changed since the Contract was initially entered into for $3.6 million in August 2018.

Referring to the principles he had outlined, Stewart J took particular issue with Sentinel’s expert report. His Honour criticised the expert’s reference to national sales that were not sufficiently comparable. His Honour also pointed out that the expert’s reliance on the impacts of COVID-19 on the value of the property were misplaced, noting that, assuming car dealerships were significantly affected by the pandemic, the commercial space could have been used for a number of other businesses that had not suffered. As such, its value was not tied to the motor industry’s performance.

While his Honour did not explicitly favour DIG’s expert report, he noted the best evidence of the market value of the property was the actual original sale in 2018. This position had not been shifted by subsequent offers, which were either not made in good faith or were not legitimate offers.

Comment

This case is a useful reminder that a liquidator’s decision to reject a proof of debt is not final, and may be appealed to the court. In doing so, parties can adduce new evidence and expert evidence can be critical here. In particular, where a proof of debt relates to the value of a property, experts should be wary of casting their net for comparable sales too widely. Although the courts are not valuers, they will give detailed consideration to the process undertaken by valuers in deciding whether to accept a final figure.

The case is also an interesting example of the pitfalls of relying on what is taken to be ‘common knowledge’. While the prevailing view is that the COVID-19 pandemic had a significant detrimental impact on a range of businesses, parties bear the onus of specifically proving that impact in court.