TGIF 3 December 2021 – Liquidators and long-term contracts: the importance of court approval

This week’s TGIF considers the recent Federal Court decision in Alfonso, in the matter of Pinnacle Fire Protection Pty Ltd (in liq) v Woods [2021] FCA 1402, where liquidators sought Court approval to enter a long-term settlement agreement.

Key Takeaways

• An expeditious winding up is, generally, in the best interests of creditors. However, in some cases liquidators may need to enter long-term agreements that could slow down liquidation.  Before doing so, the liquidator must obtain approval of the Court, the committee of inspection or the creditors.
  
  
• When the Court is called to give its approval for such an agreement, it will give due deference to the commercial judgment of the liquidator. The Court will only ensure that there is no error of law, the liquidator has acted with good faith and propriety and that the agreement is consistent with an expeditious and beneficial winding up.
  
  
• Court approval of a long-term agreement does not exonerate the liquidator from liability if a creditor later challenges the propriety of the agreement. Liquidators should, as always, take care to assess the commerciality of any long-term agreement.  

Background

Pinnacle Fire Protection Pty Ltd (Pinnacle) went into liquidation in September 2019. Its primary creditor was the Australian Tax Office.  One of Pinnacle’s major assets was a claim against its former director, Darren Woods (Woods) for breaching his duties as a director by withdrawing funds from the Company’s accounts for his personal expenses. The claim was in the amount of $310,336.56. 

By a court order made in August 2021, Woods paid $116,438 into trust as security for Pinnacle’s claim. His only other major assets were $30,000 cash and a share in the proceeds of sale of his matrimonial home. Those proceeds of sale were tied up in a solicitor’s trust account pending the resolution of family law proceedings. 

The liquidators reached a settlement with Woods for $175,000. Woods did not have sufficient liquidity to pay that amount immediately. As such, the settlement agreement required Woods to pay $116,438 immediately and pay the outstanding amount upon resolution of his family law dispute. It was unclear when that dispute would resolve, but it was likely to be ongoing for at least three months. 

Application for approval to enter settlement agreement

The liquidators sought approval to enter the settlement agreement under section 477(2B) of the Corporations Act 2001 (Cth) (the Act).  Under that provision, liquidators require the approval of the Court, the committee of inspection or the creditors before entering any agreement that could take longer than three months to perform.  

What did the court decide?

Cheeseman J ultimately gave the Court’s approval for the liquidators to enter into the settlement agreement. 

The factors the Court should consider before giving its approval are not set out in the Act. Instead, Her Honour relied on the authority of In the matter of One.Tel Limited [2014] NSWSC 457 (One.Tel). 

Court does not approve underlying transaction

In One.Tel, Brereton J described the principles relevant to applications under section 477. His Honour noted:

• the Court’s role is not to reconsider every issue that the liquidator considered, or to come up with alternative courses of action;
  
  
• instead, the Court will give due regard to the liquidator’s commercial judgment and their knowledge of the liquidation; and
  
  
• the Court must only satisfy itself that:
   
  • the liquidator has not made an error of law;
    
    
  • there are no grounds for suspecting bad faith or impropriety; and
    
    
  • the relevant agreement is consistent with the expeditious and beneficial administration of the winding up.

Accordingly, the Court’s role in reviewing an application under section 477 is a narrow one. In that sense, applications under section 477 differ from, for example, judicial advice applications where the Court will review the proposal with more scrutiny. 

Under section 477, the Court merely empowers the liquidator to take their proposed course of action it does not give its approval for the underlying transaction itself.  

Approval does not exonerate liquidator

As a result, the consequences of gaining court approval are more limited: the approval does not exonerate the liquidator from liability in respect of the transaction. As such, creditors may still challenge the liquidator’s actions in future proceedings.

Cheeseman J noted that the liquidators had obtained legal advice and had given evidence that the settlement would provide more funds to the company than would otherwise be available. Her Honour noted that the settlement would extend the liquidation but the benefit to creditors would outweigh the detriment of delay. 

The liquidators had not sought the views of the ATO (Pinnacle’s major creditor) before seeking court approval. Her Honour accepted the liquidator’s evidence that approaching the ATO could cause a substantial delay in the winding up and the ATO was also unlikely to receive any material portion of the settlement funds in any event given that the funds would be applied in payment of the costs of the liquidation. Therefore, the ATO’s approval was not necessary. 

Comment

Liquidators have a broad discretion over how the liquidation should proceed. Where a liquidator requires court approval under section 447 of the Act to enter a long-term agreement, the Court will give deference to the liquidator’s judgment. 

However, the Court’s approval under that provision is not approval for the underlying transaction. The liquidator may still be held liable if they enter an agreement that lacks propriety. Liquidators should carefully consider whether a long-term agreement is in the interests of the expeditious and beneficial administration of the winding up of the company.