TGIF 30 October 2020 – Received wisdom: when will the conduct of a receiver give rise to an inquiry?

This week’s TGIF considers an application to the Federal Court for an inquiry into the conduct of receivers under the Corporations Act 2001 (Cth).

Key takeaways 

• Receivers will be afforded a degree of latitude in the exercise of business judgment in carrying out their duties.
  
  
• The power to order an inquiry should be reserved for conduct likely to attract sanction or discipline and includes a complaint about lack of diligence.
  
  
• The court retains a discretion to refuse an inquiry where its cost is likely to outweigh the benefit to be derived. 

What happened? 

Josephine Smith was the controller of two companies, Smith & Smith Investments Pty Limited and Nouveau Pacific-A Pty Limited. Ms Smith obtained from Westpac an advance of $5,850,000 to fund the purchase of the Lucky Australian Hotel and the licensed gaming business conducted at the premises.

Following an event of default, Westpac exercised its security interests, appointed receivers and the land and hotel business was sold within 12 months. The receivers incurred a total of $465,941.30 in fees, which included more than $100,000 for a hotel consultant, leading Ms Smith to make an application under s 423(1)(b) of the Corporations Act 2001 (Cth) for an inquiry into the receivers’ conduct.

The substance of the complaint 

Ms Smith’s primary complaint was that the receivers relied too heavily on, and paid too much money to, a hotel consultant, Mr Jack Lucas.  Mr Lucas had been appointed to ensure the hotel operated in accordance with obligations under its liquor licence, to report to the receivers on the trading of the hotel, and to maintain and preserve the integrity of the receivership assets.

The focus of Ms Smith’s argument was both the length of Mr Lucas’ retainer and the fact that his role as a consultant was redundant given the tasks performed by him could have been performed by the new licensee the receivers had appointed or the receivers themselves.  Ms Smith argued that after the initial engagement of Mr Lucas, the receivers displayed a lack of diligence in failing to consider whether his continued engagement was necessary or whether the need for his services could be reduced.

While the receivers described the new licensee as a ‘fine day to day manager’, their evidence was that Mr Lucas had more professional experience in dealing with the management of a gaming hotel.  The receivers had engaged Mr Lucas many times over previous receiverships to which they had been appointed and said that his engagement was necessary to ensure that nothing was done that might breach the hotel’s licence or any legislation.

Did Mr Lucas’ engagement deserve inquiry? 

Section 423 permits a court to order an inquiry where a person complains about the conduct of a receiver.  The threshold to satisfy to enliven the power is low and all that must be shown is a prima facie case for investigation. The court then has a discretion as to whether to permit an inquiry, with factors relevant including:

• the nature of the allegations and any answers which have been offered;
  
  
• the likely amounts of money involved;
  
  
• the availability of funds to pay for an inquiry; and
  
  
• the likely benefit to be derived.

While the Court accepted a complaint about a lack of diligence was within scope of s 423, the request for an inquiry was refused due to the lack of a prima facie case for investigation.  In reaching this conclusion, the Court emphasised that receivers should be afforded a degree of latitude to exercise business judgment in the performance of their duties.  That was especially the case where receivers are confronted with an asset which has a value connected with the maintenance of a statutory licence in an area in which difficulties with compliance might be expected.

Moreover, the Court found that, even if a case for inquiry had been made out, the discretion would not have been exercised due to, amongst other things, the receivers’ evidence about the appropriateness of the retention of the consultant throughout the receivership, the significance of that consultant to the value of the secured asset and because any amount recovered from the fees paid to Mr Lucas would be dwarfed by the costs of actually performing the inquiry.

Comment

This case serves as a timely reminder that, despite the low threshold to enliven the power for an inquiry into a receivers’ conduct, the court retains a discretion and it will be exercised with appropriate caution.

While receivers have no onus to establish their conduct was reasonable, factors relevant to whether an investigation will be ordered include any answers offered, the stage to which the receivership has progressed and, critically, the likely benefit to be derived.