TGIF 19 June 2020 – Supreme Court favours receiver appointment in lieu of liquidator to avoid misconceptions of insolvency during COVID-19

This week’s TGIF considers a recent decision in which the NSW Supreme Court appointed a receiver to a hospitality business, in lieu of a provisional liquidator, due to fears the COVID-19 pandemic would cause creditors to question insolvency. 

Key takeaways

• Given the risk that an appointment of a provisional liquidator would be poorly understood by creditors, an interim receiver may be a preferable course to control a business whilst management is deadlocked.
  
  
• The damage caused by a management impasse is likely to be exacerbated in the current trying and changeable commercial environment. As such, it is critical for business to have independent decision makers who can communicate and make decisions as events unfold and operational requirements change.
  
  
• Before approaching the court for an order to appoint an external controller, careful consideration should be given to the terms of any loan documentation to ensure the appointment does not trigger an event of default. 

What happened? 

In December 2010, Crow Inn Pty Limited was incorporated as the operating company for an international hotel. Crow Inn had two directors with each having an investment vehicle that owned shares in the company in a 70 / 30 split.

The hotel was a family run venture with one of the directors, Basil Berrigan, the son of the owner of the land and the other director – Joel - a grandson who had been gifted his interest in the business after helping with the construction and management of the hotel.

In November 2017, Joel incorporated a new entity which acquired a commercial property 1.8km from the existing business with a view to developing a new hotel.  This purchase was objected to by Mr Berrigan for, amongst other things, the conflict of interest created once the new hotel was developed.

The purchase was the catalyst for a significant deterioration in the relationship between the two business partners which ultimately led to claims by Joel of significant unpaid wages by the hotel, attempts to adjust the existing share register, allegations of directors’ duty breaches and the ultimate resignation by Joel as the general manager of the hotel.

And then COVID-19 struck.   Occupancy rates dropped to 35% of previous levels with the hotel barely breaking even.

The Application

This action, commenced ex parte with orders made for short service, sought the appointment of a provisional liquidator to manage the hotel on an interim basis until the substantive proceedings were resolved.

The key question for determination was whether such an extraordinary step was necessary to preserve the status quo or if there was an alternative regime that would result in stable governance until the Court decided whether the company should be wound up.

The competing contentions

Central to the submissions in opposition to any external appointment was the concern that appointing a liquidator in the current pandemic environment would be extremely damaging to the hotel.  This was due to the fact that putting a hospitality business in the hands of a liquidator could be seen by creditors, patrons, lenders and staff to be a direct consequence of COVID-19.

Further, in circumstances where the business was solvent, and the assets were not ‘in jeopardy’, the involvement of an external controller, and the irreparable harm to the business that might cause, was said to favour the interim regime proposed by Joel (notwithstanding this effectively excluded Mr Berrigan from any management role within the hotel).

The thrust of Mr Berrigan’s submissions was that:

• there had been a fundamental breakdown in trust and confidence which meant the directors could no longer hold a cordial conversation; and
  
  
• as a consequence, the hotel had no management placing a substantial business at risk to the disadvantage of creditors and employees.

It was contended that an experienced, independent decision maker was needed to trade the business during the pandemic and any potential destruction of goodwill by reason of the appointment could be managed by the liquidator.

The Decision

The Court ultimately made an interim appointment.  What proved crucial to the determination was the need for an external official to make decisions as events unfold and introduce stability to the business given the damage being caused by the impasse (which had been amplified by the pandemic).

In reaching this conclusion, her Honour was satisfied that:

• the sustained deadlock and history of antipathy between the directors was such that there was a reasonable prospect a winding up order would be made on just and equitable grounds; and
  
  
• having regard to the whole of the circumstances, there was good reason to appoint an interim controller and the balance of convenience favoured that course.

However, the Court did not appoint a provisional liquidator and, instead, placed the hotel under the control of a receiver.  This was considered to be a “better course” given the potential damage to the hotel’s goodwill caused by the appointment of a liquidator in the financially uncertain times surrounding COVID-19 and where the difference between a provisional liquidator appointed by reason of a deadlock between directors, and a liquidator appointed due to solvency issues, may be poorly understood by creditors.

Comment

There are a myriad of reasons why the management of a company can be frozen due to deadlock between directors.  The instability this creates, and the damage to enterprise value, is heightened during a pandemic and when a business is operating in trying and changeable times. The appointment of an external controller in such a scenario can have a drastic effect on a company’s business and requires urgency, or unusual circumstances such as danger to assets, lack of control, deadlock or some public interest element to support the decision.  

This case is a reminder that, given the distinction between the function of a provisional liquidator and interim receiver is, in a functional sense, not great, a receiver appointment may be more attractive as the Courts recognise the business community may not have a comprehensive understanding of the fact that a provisional liquidator can be appointed in circumstances that do not involve a company’s insolvency.