Introduction
Prior to 1 May 2017 a liquidator was able to assign certain legal claims, but not others. The Insolvency Law Reform Act 2016 (Cth) introduced a new provision substantially expanding an external administrator’s power to assign legal claims.
This article discusses this amendment to the law and its impact on various stakeholders involved in corporate and personal insolvency situations, including insolvency practitioners (liquidators, provisional liquidators, voluntary administrators, deed administrators and bankruptcy trustees), directors, shareholders, secured and unsecured creditors and litigation funders.
Prior to the amendments
A liquidator always had the power to sell property
A liquidator has always had the power to sell “property” of a company in liquidation pursuant to section 477(2)(c) of the Corporations Act 2001 (Cth) (Act). Relevantly, property of the company included common law legal claims or rights of action, as well as claims in debt, such as trading debts owed by former customers of the company in liquidation. There are equivalent sections in the Bankruptcy Act 1966 (Cth).
A liquidator was unable to sell personal legal claims
However, many of the legal claims available to a liquidator under the Act could not be assigned or sold to a third party for the simple reason that the claims were personal to a liquidator of the company. For example, an insolvent trading claim under section 588M of the Act was personal to the liquidator by reason of the wording of the statute:
“The Company’s liquidator may recover from the director, as a debt due to the company …”
Similarly, a liquidator can pursue a wide range of claims known as voidable transaction claims, such as unfair preference claims. These types of claims are also personal to the liquidator by virtue of the wording of the statute:
“Where, on the application of a company’s liquidator, a court is satisfied that a transaction is voidable…”
New provisions of significance
This restriction on the assignability of certain legal claims personal to a liquidator has been addressed in the new insolvency provisions. These amendments are significant for many reasons. For example, a liquidator is often appointed to a company in circumstances where there are insufficient available assets to fund legal claims such as insolvent trading and voidable transaction claims. Unless the liquidator is able to secure external funding from either creditors or litigation funders, these legal claims may not pursued for the benefit of creditors of the company.
The new provisions
Section 100-5
The new provisions are to be found in a schedule to the Act known as “Schedule 2 – Insolvency Practice Schedule”. Section 100-5 provides that an “external administrator” of a company may assign any right to sue that is conferred on the external administrator by the Act. The Bankruptcy Act 1966 (Cth) has an equivalent schedule known as “Schedule 2 – Insolvency Practice Schedule (Bankruptcy)”, which provides that any right of a bankruptcy trustee to bring a legal claim can be assigned.
Definition of external administrator
An external administrator of a company is defined as meaning either a voluntary administrator of a company, an administrator under a deed of company arrangement, a liquidator of a company or a provisional liquidator of the company, but does not include a person appointed as a receiver, receiver and manager or controller in relation to property of a company.
Conditions for assignment
The right of an external administrator of a company to assign these claims under the Act is subject to certain conditions. If the external administrator has already commenced the claim, he must seek the approval of the Court to any assignment of that claim. As well, before assigning any legal claim, the external administrator must give written notice to the creditors of the company of the proposed assignment. Following the assignment, notice must be given under section 12 of the Conveyancing Act 1919 (NSW) - there are similar provisions in other State legislation.
Consequences of the new provisions
1. Expand opportunity for litigation funders
The most obvious consequence of the new provisions is to expand the opportunity for commercial litigation funding businesses to purchase legal claims from an external administrator. Before the new provisions were enacted on 1 May 2017, litigation funders were required to “fund” those claims that were available only to a liquidator, which in practice required the liquidator to be a party to the proceedings along with the company in liquidation.
2. Finalise a liquidation at an earlier stage
A liquidator can now assign or sell a legal claim for an immediate payment and so avoid the risk and delay of pursuing the legal claim. Even if the liquidator defrays the risk component of the legal claim by using a litigation funder, he must nevertheless await the final determination of the funded legal claim, which can take many years. An immediate early payment can therefore expedite the finalisation of the administration or liquidation of the company, meaning creditors can receive any dividend at an earlier stage. Consideration for an assignment
The consideration payable by the assignee of a legal claim does not necessarily need to be by way of an immediate payment. The deed of assignment might involve a payment by way of instalments, or the payment of a set percentage from funds ultimately recovered in the litigation. If the payment terms involve an arrangement that will last for more than 3 months, a liquidator will need to seek the formal approval of the Court or the creditors under section 477(2B) of the Act.
3. Reducing Phoenix activity
It has been suggested that these new provisions may assist reducing the much criticised practice known as “phoenix activity”, being the practice of directors unlawfully depleting assets of the company and then placing the company in liquidation but leaving a liquidator with minimal assets to fund legal claims against the former directors or third parties who have benefited from misfeasance by the directors. These new provisions may permit claims to be pursued by way of an assignment of the legal claim to a third party, such as a creditor or a group of creditors.
4. Remove legal claims away from a conflicted liquidator
A disaffected creditor or a group of disaffected creditors may form the view that a liquidator is not the best person to pursue a potential legal claim for a variety of reasons. For example, creditors may be concerned that the liquidator is conflicted in some manner and will not pursue the claim at all or with the necessary vigour. The creditor or creditors can thus approach the liquidator and purchase the claim from the liquidator.
5. Killing off a legal claim
A potential defendant to a claim available to a liquidator might also use the new provisions to his, her or its advantage. For example, a creditor may be concerned that a liquidator will pursue an unfair preference claim against that creditor. If so, the creditor has the option of purchasing the claim and effectively “killing it off”.
6. Insolvency practitioners may require Court directions
Insolvency practitioners need to take care when approached by a third party to assign a legal claim. For example, a liquidator may be of the view that the claim sought to be purchased has little merit and might be regarded as a vexatious claim motivated by some personal vendetta. In these circumstances, it would be wise for the insolvency practitioner to take legal advice and/or approach the Court for directions.
Impact on company directors and business owners
When a company is placed into liquidation or voluntary administration it is often the case that directors and/or shareholders are potential targets of recovery claims by a liquidator, including:
- unfair preferences arising from a director being repaid loan monies in preference to other creditors of the company – s588FA;
- transactions for the purpose of defeating creditors - s588FE(5);
- uncommercial transactions - s588FB;
- clawback of director bonuses;
- avoidance of floating charges for want of consideration – s588FJ;
- personal liability for insolvent trading – s588G;
- breaches of duty by directors;
- statutory misfeasance – s598; and
While a liquidator has always had the power to make claims of this nature against directors and/or shareholders, it is often the case that the company in liquidation has insufficient assets available to a liquidator to fund these recovery claims. The new provisions now permit a liquidator to assign these claims to a third party (such as a creditor) with the resources to conduct the recovery claims.
Conclusion
Overall, these changes to the insolvency laws relating to the assignment of legal claims are to be commended. The changes should ultimately result in a wider range of legal claims in an insolvent administration being pursued in the best interest of creditors, including by way of an improved dividend on their creditor claims and the finalisation of the insolvent administration at an earlier date than would otherwise be the case if the liquidator was required to remain a party up to the final determination of the legal claim.
