TGIF 13 November 2020 – Sweat the small stuff: defect in formation of COI invalidates resolutions

This TGIF considers Tayeh v Commonwealth of Australia [2020] FCA 1323, where the Federal Court found that irregularities in the formation of a Committee of Inspection rendered invalid resolutions of the committee, including resolutions concerning liquidator remuneration.

Key takeaways 

• The Federal Court has emphasised the importance of the Committee of Inspection (COI) as a mechanism for ensuring effective creditor representation in the winding up process.
  
  
• If there are defects in the formation of the COI which affect creditor representation – such as failing to properly identify the members of the COI – there is a real risk that the formation of the COI, and the resolutions passed by it, will be invalidated.
  
  
• This is the case even where the defects occurred many years ago, and invalidating the COI resolutions will cause substantial cost and inconvenience.

Background

This proceeding arose out of the liquidation of the 1^st Fleet Group (Group). The Liquidators had first been appointed as voluntary administrators of each of the Group companies in April 2012. 

At a meeting on 2 July 2012, creditors of the Group passed a resolution purporting to create the COI (Resolution).  

The COI then passed a resolution authorising the Liquidators to draw down remuneration of $5,654,228. Between 2012 and 2019, the COI held 11 meetings and the Liquidators drew down some $3,861,476. 

In 2018 the Commonwealth, a creditor of the Group, notified the Liquidators of several concerns it had that the resolutions approving remuneration were invalid due to a failure to properly constitute the COI. 

The Liquidators then applied to the Court for declarations validating the appointment of members to the COI and the resulting COI resolutions.

The alleged irregularities

The alleged irregularities were as follows:

1. The COI was formed under Section 548 Corporations Act 2001 (Cth) and not the correct provision for a pooled group, Section 548A;
   
   
2. The Resolution failed to determine the number of members of the COI; and
   
   
3. The Resolution purported to appoint persons who were not themselves creditors, and were therefore ineligible to sit on the COI. For example, it appointed a representative of the Transport Workers Union of Australia. The union was not itself a creditor but was rather the representative of a number of employee creditors. The Resolution did not specify that the union was appointed as the representative of those creditors.

The Liquidators characterised these matters as ‘procedural irregularities’ that could be cured by the Court.

Decision

The COI was invalidly constituted

In relation to each of the irregularities, Justice Jagot found:

1. The reference to Section 548 and not to the correct provision, Section 548A, was an ‘obvious error’ that did not have a bearing on the validity of the COI.
   
   
2. There was no requirement that the Resolution separately state the number of members of the COI. It was enough for the Resolution to identify the members of the COI.
   
   
3. However, the Resolution failed to properly specify whether two of the named COI members were to act as representatives for creditors. Accordingly, the COI was invalidly constituted.

Liquidators argued that the intention was for the ineligible COI members to act as proxies for creditors. They argued that the failure to make that explicit was a ‘mere procedural irregularity’ which should not invalidate the formation of the COI.

However, Jagot J held that the COI members represented several creditors, the result being that it was impossible to say which creditors those members in fact represented for the purpose of their appointment. 

Accordingly, the indeterminacy of the Resolution did not constitute a ‘mere procedural irregularity’. It was a defect in substance which made it impossible to identify who the members of the COI were. 

Her Honour emphasised the importance of the COI, stating that what occurred in this case ‘strikes at the heart’ of the legislative intention to ensure effective creditor representation in the winding up process. Her Honour considered that the ‘effective disenfranchisement’ of creditors was a substantial injustice.

The COI resolutions were also invalid

Justice Jagot considered that the presence of unauthorised parties at the COI meetings rendered the COI resolutions invalid.  

Comment

This decision is a reminder of the central importance of the COI in the winding up process, and the seriousness with which the Courts treat any improper exclusion of creditors from the voting process.

The Court will accept some procedural irregularities which do not cause substantial injustice. But where the irregularity affects the representation of creditors at the COI, it has the potential to invalidate years of resolutions. 

While Jagot J was cognisant of the cost and inconvenience of invalidating the COI and resolutions passed by it – particularly 8 years after the COI was formed – the injustice for creditors admitted no other outcome. 

For practitioners, this decision emphasises the importance of ensuring that the COI is properly formed, including by clearly identifying the members of the COI.