TGIF 18 October 2024 – When might a court appoint a provisional liquidator?

The Federal Court in Hema Maps Pty Ltd v HemaX Digital Pty Ltd, in the matter of HemaX Digital Pty Ltd [2024] FCA 1127, appointed a provisional liquidator to preserve the status quo until the determination of a winding up application. This winding up application was due to a deadlock and an irreparable breakdown in relations between shareholders, and mismanagement of the company.

Key Takeaways

• Provisional liquidators may be appointed to preserve the status quo of a company where there is a deadlock or irreparable breakdown in relations between shareholders and mismanagement.
  
  
• A court must be satisfied that there is a valid winding up application, and urgency and sufficient reason for intervention prior to the final hearing of the winding up application.
  
  
• Courts take a cautious approach to the appointment of a provisional liquidator, given the significant intrusion into a company’s affairs. However, where there is a total and irreparable breakdown of the relationship between shareholders and a deadlocked board, which has the effect of frustrating commercially sensible operations resulting in a threat to the solvency of the company, the balance of convenience weighs heavily in favour of a court appointing a provisional liquidator.

Background

The plaintiff, Hema Maps Pty Ltd, and the interested party, Cindy Gail Derry as trustee for the Derry Family Trust (Derry Trust) held shares equally in the defendant company, HemaX Digital Pty Ltd (HXD). On 13 August 2024, Hema Maps filed an application seeking orders that HXD be wound up on just and equitable grounds on the basis of a shareholder deadlock. Hema Maps subsequently filed an interlocutory application, seeking the appointment of provisional liquidators. The Derry Trust initially opposed the appointment of provisional liquidators but withdrew its opposition by the time of the hearing on 25 September 2024.

O’Bryan J made orders pursuant to s 472(2) of the Corporations Act 2001 (Cth) (the Act) appointing provisional liquidators to HXD pending further orders in the winding up application.

Decision

In his reasons, O’Bryan J canvassed the relevant legal principles as to the appointment of provisional liquidators. The purpose behind the appointment of provisional liquidators prior to the winding up application hearing is traditionally to preserve the status quo until the winding up application is determined. The principles governing the appointment of a provisional liquidator are broadly analogous to the considerations relevant to granting other interlocutory relief to protect assets.

Relevant considerations include:

1. the strength of the applicant’s case; and
   
   
2. the potential practical consequences likely to flow from the relief sought.

As to the first, O’Bryan J noted that a winding up application must have been filed and there must be a ‘reasonable or sufficient prospect’ that a winding up order will be made on the application. It was therefore relevant for the Court to consider the principles governing an application to wind up a company on the just and equitable ground under s 461(1)(k) of the Act. The evidence before his Honour indicated that – by reason of the shareholder dispute and their impact on business function – HXD was unlikely to remain solvent.

As to the second, O’Bryan J considered there must be urgency and sufficient reason for intervention. That may be in the public interest, or in the company’s interest to protect assets. It has been described in Re Brylyn No 2 Pty Ltd (1987) 12 ACLR 697 at 707 as ‘some good reason’ for example ‘urgency, or unusual circumstances such as danger to assets, lack of control, deadlock, or some public interest for [the provisional liquidator’s] appointment’. Given the impact on the company’s business and threat to solvency in this case, his Honour considered that intervention was required.

Factors that may be relevant to a judge’s discretion to make orders appointing a provisional liquidator include where there is:

• a quasi-partnership company dependent on both parties fulfilling their respective obligations;
  
  
• irreparable breakdown in relations between the shareholders;
  
  
• various, unsuccessful, attempts to bring the relationship to a consensual end;
  
  
• decisions unable to be made unanimously;
  
  
• failure by one party to provide services central to the company’s business;
  
  
• allegations of misconduct and mismanagement; or
  
  
• significant doubts as to the solvency of the company.

In this case, O’ Bryan J found there had been a total breakdown of the relationship between the two shareholders, Hema Maps and the Derry Trust, so that the board of HXD was deadlocked and could not make decisions. There appeared to be no goodwill or trust between the protagonists. HXD was essentially caught in the middle of two feuding shareholders, each of which had (either directly or through a related entity) a day-to-day commercial relationship with HXD and on which HXD relied for its continued operations.

The breakdown resulted in delay on software releases to its customers, disagreement over whether certain payments were due, and failures in negotiations. Given the deadlock had the effect of frustrating HXD’s commercial operations, and the harm being caused threatened HXD’s solvency, O’Bryan J found the balance of convenience weighed heavily in favour of making orders to appoint provisional liquidators.

O’Bryan J limited the powers of the provisional liquidators by excluding the power to sell or otherwise dispose of all or any part of company proper, and the power to obtain credit. This can be considered in light of the courts’ general hesitation to appoint provisional liquidators given the ‘drastic’ intrusion into companies’ affairs – including the displacement of directors and assumption of control of the company.

Comment

Courts are reluctant to appoint provisional liquidators given the significant intrusion into the affairs of a company. However, where there is a total breakdown of relationship between shareholders and a deadlocked board, which has the effect of frustrating commercial operations resulting in a threat to the solvency of the company, the balance of convenience will weigh heavily in favour of a court appointing a provisional liquidator. If such situations arise, the appointment of a provisional liquidator will, at a minimum, serve to maintain the status quo until the winding up application is determined. It may also bear greater significance in more serious circumstances, such as if there is a threat of insolvency due to mismanagement.