TGIF 23 August 2024 – Liquidators succeed in claim against ‘restructuring’ adviser

This week’s TGIF considers a recent Federal Court of Australia decision (Connelly (liquidator) v Papadopoulos, in the matter of TSK QLD Pty Ltd (in liq) [2024] FCA 888). In the case, it was determined that a restructuring adviser who engineered an asset-stripping scheme may be found liable for the full value of the loss arising out of the scheme.

Key Takeaways

• This judgment highlights that an adviser who designs an asset-stripping scheme may be found liable for the full value of the loss arising out of the scheme – not just amounts retained by them, nor transactions they are directly involved with.
  
  
• The degree of knowledge of specific transactions was not to the point, given the adviser’s knowledge of all the essential facts of the scheme’s design and that it involved a breach of fiduciary duty by the company’s director. The adviser’s knowledge of and involvement with (or lack thereof) precise transactions within the scheme was irrelevant.
  
  
• Whilst it was possible the liquidators would also recover against other parties, the Court was opposed to future-proofing against double recovery by the liquidators.

What happened?

TSK QLD Pty Ltd (in liquidation) (Company) was a business that provided recruitment and labour hire services to energy industries. The Company had significant revenue, but also tax liabilities.

In 2021, the Company was subject to an asset-stripping scheme, set up by an accountant adviser who held himself out as a ‘restructuring’ specialist. During 2021, approximately $10.3 million was withdrawn from the Company’s account and paid to the Company’s director, senior management, the adviser and their corporate entities.

The payments were structured as:

1. a sale agreement whereby the Company purportedly sold its business to an entity controlled by the Company’s CEO; and
   
   
2. a debt collection scheme whereby the Company allegedly appointed entities associated with the restructuring adviser to collect the Company’s debts, purportedly valuing the Company’s assets at nil.

The plaintiffs (the liquidators of the Company and the Company) commenced the proceedings in the Federal Court, alleging that the Company had suffered loss and damage as a result of the scheme, in the amount of $8.9 million.

The adviser and his companies were the only defendants to appear at trial. Default judgment was entered against the Company’s director and his related company. The liquidators had settled with all other defendants (other than the adviser and his companies) prior to trial. 

Prior to the Company’s liquidation, the Company’s director had proposed a deed of company arrangement. The director proposed contributing $1.1 million to the deed fund in return for control of the Company being returned to the director. As majority creditor, the Australian Taxation Office voted against the deed of company arrangement proposal. The Company’s creditors subsequently voted to appoint liquidators.

Main issues

The dispute primarily concerned quantum rather than liability, in particular circa $2 million in transactions. Liquidators also raised issues as to whether the orders should be staggered or structured to reflect the fact that the liquidators had entered into settlement agreements with other parties.

Adviser liability

The adviser had already effectively conceded liability for the scheme at trial. However, he argued that he had no direct involvement with the circa $2 million in transactions that occurred as part of his scheme.

The Court found that there was evidence of awareness of the relevant transactions (in particular, in the form of a file note diagram). However, it was not to the point that the adviser did not know and had no direct involvement with the precise transactions. The point was that the adviser knew of all the essential facts of his design, and the breach of fiduciary duty by the Company’s director was the design of the scheme that was.

Impact of third party settlement deed on adviser liability

The other issue was whether the judgment should be staggered or structured to reflect the fact that the liquidators had entered into settlement agreements with other parties. One of these contemplated payments being made into the future, to avoid in advance double recovery in favour of the liquidators.

The adviser sought a novel order whereby payments of the judgment sum were only required in the event of default by other parties with whom the liquidators had settled with. This was sought on the basis that liquidators would recover a significant proportion of the Company’s loss and damage if all payments were made under the settlement deeds.

The Court refused to make the orders sought by the Whitehouse Defendants on the basis that:

1. The liquidators should not be denied the opportunity of immediate recovery from the adviser and his companies. Immediate recovery would lead to an earlier finalisation of the liquidation which would benefit creditors.
   
   
2. The orders sought were based on the Court exercising its power pursuant to rr 41.03 and 41.11 of the Federal Court Rules 2011 (Cth) to temporarily stay its orders, or execution of them, to avoid ‘irremediable harm’ or ‘serious injury’ to a party. There was no evidence suggesting that enforcing a judgment against the adviser and his related company would cause ‘irremediable harm’ or ‘serious injury’, despite the adviser hinting that judgment against him would create a bankruptcy risk.

Implications

This case is a recent example of a professional adviser being found liable for a breach of directors’ duties.[1] Previous cases have highlighted the need for liquidators to scrutinise ‘restructuring’ transactions where, as here, the restructuring adviser (or related entity) takes an assignment of the company’s debt and has a personal interest in the outcome of the ‘restructuring’.[2] Since 2020, the ARITA professional code has also extended to pre-appointment advice.[3]

The Court’s determination of liability in this case was straightforward because the adviser had:

• already effectively conceded liability for the scheme;
  
  
• was intimately involved in both the design and implementation of the scheme; and
  
  
• there was evidence demonstrating the adviser’s granular level of awareness of precise transactions within the scheme.

It remains to be seen how Courts will determine liability for advisers who have a lesser degree of involvement, and what will constitute ‘designing’ a scheme.

The judgment also demonstrates that the Court is not willing to get involved in future-proofing possible double recovery in favour of the liquidators. The Court agreed with the plaintiffs that avoiding double recovery had no immediate role to play. This was given that the Company had not recovered the full loss and damages arising from the scheme pursuant to the settlement deeds (and full recovery relied on future instalments being paid until 2029).

The adviser had submitted that the Company’s creditors (including the Australian Taxation Office, being the funding creditor) had approved a settlement deed that was structured in payment instalments. This demonstrated that the creditors were amenable to receiving compensation over time. In declining to make the orders proposed by the adviser, the Court noted that an immediate recovery and prompt finalisation of the Company’s liquidation would be to the benefit of the Company’s creditors.

The Court was not concerned with bankruptcy risk if judgment was made against the adviser. The Court noted the fact that he did not have real property in his own name did not mean that he did not have access to resources, which would enable a judgment sum to be satisfied.

^{[1] ASIC v Somerville & Ors [2009] NSWSC 934, concerning liability for involvement in a contravention of the Corporations Act 2001 (Cth).}

^{[2] McCann, in the matter of Walton Construction (Qld) Pty Ltd (In Liq) v QHT Investments [2018] FCA 1986.}

^{[3] ARITA Code, 4th ed., from 1 January 2020.}