TGIF 22 July 2022 – Liquidating debts: three good reasons to settle for less

This week’s TGIF considers the latest of two recent Federal Court decisions approving the compromise of debts owed to  a company in liquidation, on the application of liquidators pursuant to section 477(2A) of the Corporations Act 2001 (Cth) and on confidential terms.

Key takeaways

• Liquidators seeking to compromise a debt of more than $100,000 without creditor or COI approval can apply for court approval under section 477(2A) of the Corporations Act 2001 (Cth), combined with an order under section 37AF of the Federal Court of Australia Act 1976 (Cth) to maintain confidentiality.
  
  
• In assessing whether the compromise is in the best interests of creditors, liquidators can investigate the debtor’s financial position to determine:
  
  
  • the prospect of recovery;
    
    
  • the risk of a minimal distribution from the debtor; and
    
    
  • whether the cost of recovery is commercial.
    
    
• A court’s approval of a compromise under section 477(2A) operates as a permission not an endorsement.

What happened?

Liquidators were appointed to Linchpin Capital Group Ltd (Linchpin) and Endeavour Securities (Australia) Ltd in 2019 following an application by ASIC.

Linchpin was trustee of an unregistered managed investment scheme known as the Investport Income Opportunity Fund (the IIOF Scheme). The Liquidators were also appointed as persons responsible for the winding up of the IIOF Scheme and a registered managed Scheme of the same name.

In assessing Linchpin’s financial position, the Liquidators identified that the property of the IIOF Scheme included debts owed by several Debtors.

Following investigations into the financial positions of the Debtors and negotiations, the Liquidators formed the view that comprising the debts was in the best interests of Linchpin’s Creditors.

In each case, there were broadly three reasons for this decision:

• Prospect of recovery – that it was unlikely that pursuing the relevant Debtor in formal recovery proceedings would result in a higher settlement or payment of the debt in full, given the relevant Debtors’ financial position;
  
  
• Risk of nil or minimal distribution – that there was a risk of the relevant Debtor facing action by other Creditors, or becoming insolvent or wound up, which would make a distribution to the IIOF Scheme unlikely or otherwise very minimal; and
  
  
• Costs of recovery – that the costs to pursue the relevant Debtor for recovery of the whole of the debt would not be commercially justified.

The compromises were then effected by confidential settlement deeds followed by court approvals and suppression orders, as follows.

Settlement deeds

In June 2021, the Liquidators initially entered into a settlement deed with two of the Debtors, providing for payment of a settlement sum in compromise of the debt.

This compromise was approved in February 2022, in Tracy, in the matter of Linchpin Capital Group Limited (in liq) (No 1) [2022] FCA 104.

Whilst the deed became binding on execution, the settlement sum was paid into trust pending the Liquidators’ approval application and the releases were contingent on court approval. The deed also provided for the Liquidators to take steps to ‘void’ the releases if certain Debtor information turned out to be false or misleading.

In May 2022, the Liquidators then entered into a further settlement deed in respect of a debt owed by CPG Research & Advisory Pty Limited ACN 052 348 026 (CPG Research & Advisory).

This further compromise was approved by the Court in June 2022, in Tracy, in the matter of Linchpin Capital Group Limtied (in liq) (No 2) [2022] FCA 739.

This further deed was in similar terms, but with only a portion of the settlement sum paid into trust. This portion was to be applied towards the Liquidators’ costs of the approval application if unsuccessful. Payment of the full settlement sum was contingent on court approval.

Requirement for approval

The requirement for liquidators to obtain approval for compromise of a debt if the amount claimed is more than the prescribed $100,000 threshold is found in section 477(2A) of the Corporations Act 2001 (Cth) and regulation 5.4.02 of the Corporations Regulations 2001 (Cth).

The approval can be provided by a court or by a committee of inspection or creditors’ resolution. It is not uncommon for liquidators to apply to court for approval instead of putting the compromise to creditors, depending on the relative costs, timing and state of negotiation with the debtor.

The principles applied by a court in an approval application of this type are well-settled. They are outlined in both of his Honour’s judgments in relation to this case. In summary, the principles for approval are that:

• a court does not concern itself with the commercial desirability of the transaction and, although a court does not simply ‘rubber stamp’ liquidators’ assessments, a court will pay regard to the commercial judgment of the liquidator; and
  
  
• it is not necessary for a court to consider the commerciality of the settlement that has been struck or to second guess liquidators’ judgments. Rather, the court will be concerned to ensure that the proposed settlement is in the interests of creditors and there is no error of law or principle, no absence of good faith or any real or substantial ground for doubting the prudence of the liquidators’ conduct.

Decision

His Honour found that the Liquidators had satisfied themselves, having made appropriate inquiries as to the financial position of the Debtors, that the debt compromise was in the best interests of the Creditors.

In each case, the evidence referred to the three main reasons identified above, however, the specific evidence as to each Debtor’s financial position appears to have differed. In particular, evidence between individuals and corporate debtors differed as follows:

• in the February 2022 decision, his Honour noted that the investigations undertaken extended to the spouse of one of the Debtors and to the Debtor’s business, personal expenses and health issues, which militated against any expected increase in earning capacity; while
  
  
• in the June 2022 decision, his Honour noted that the Liquidators’ investigations included investigating the potential recapitalisation or, alternatively, the sale of the Debtor’s business.

His Honour ultimately concluded that there was no suggestion that the Liquidators’ entry into the settlement deeds was not a proper exercise of powers or otherwise ill-advised.

His Honour noted that approval under section 477(2A) does not operate as an ‘endorsement’ of the proposed agreement but merely as ‘permission’ for liquidators to exercise their commercial judgment.  

Confidentiality

The Liquidators also submitted that, without a confidentiality order in respect of the compromise and negotiations, Creditors would be prejudiced by:

• the potential reduction in value of recoveries the Liquidators are able to negotiate with other Creditors; and
  
  
• the risk of increased costs of recovering assets if commercial settlements could not be achieved.

In order to avoid disclosure of commercially sensitive information on negotiations that might otherwise provide an unfair advantage to other Debtors, his Honour also made confidentiality orders under section 37AF of the Federal Court of Australia Act 1976 (Cth).

Comment

Whereas similar decisions have tended to provide more detail as to the debt and proposed compromise, the reasons in these two decisions articulate concisely the essential elements. They point to the three reasons that will often lead to a decision to compromise a debt, these reasons being the limited prospects of obtaining recovery against the debtor, the risk of liquidators receiving minimal distribution from the debtor (in this case even on a recapitalisation) and the uncommercial cost of pursuing recovery.

Finally, the decisions also mention the fact that approvals under section 477(2A) are not endorsements. They do not exonerate the liquidators from any liability they may have in respect of the transaction.

Liquidators seeking more than mere permission to compromise a debt can consider also applying under sections 90-15 and 90-20 of the Insolvency Practice Schedule (Corporations).