How close is too close? Court gives guidance to liquidators about independence

The directors of a financially distressed company will often engage specialist advisers to assist them.  It is not unusual for these advisers to recommend that the company go into external administration, such as voluntary administration or liquidation, and often they will also recommend a particular insolvency practitioner (IP) for the job.

But in order to do their job properly, an IP must be able to assure creditors that they are not influenced by relationships with directors, creditors, or other stakeholders in the insolvency process. They must be both independent and be seen to be independent.  If a “hypothetical, fair-minded observer” would think that an IP might lack independence or impartiality in particular circumstances, this alone can be grounds for their removal, even in the absence of any actual conflict of interest or duty.

This creates particular problems for IPs who are referred jobs on a regular basis by creditors, banks or company accountant and advisers, because in some cases the IP might need to investigate the actions or advice of people who give the IP a lot of work.

These problems were illustrated two years ago in the case of Haulotte Australia Pty Ltd v All Areas Rentals Pty Ltd.  The liquidator of a company had been referred work by the company’s accountant.  That accountant had done certain things prior to liquidation that clearly had to be investigated by the liquidator.  The court found that the liquidator could not give the required appearance of independence necessary for him to carry out his role. Although the liquidator had not done anything wrong, this was an important factor in his removal from the company.

When accepting an appointment to a company, an IP is required to complete a Declaration of Independence, Relevant Relationships and Indemnities (DIRRI) which identifies any relationships the IP may have with the company, or the people involved in the company’s affairs, or any other relationships which may be of interest to creditors.  The purpose of the DIRRI is to allow creditors to make an informed decision about the independence of an IP who accepts an appointment as liquidator or administrator.

The Australian Securities and Investment Commission (ASIC), which supervises corporate IPs, has since 2009 focussed closely on these disclosure obligations. It found that in 2011, 46.9% of DIRRIs were “inadequate”, a figure which increased to 56.3% in 2012.  On 1 January 2014 the Australian Restructuring, Insolvency and Turnaround Association (ARITA), the peak professional body for IPs in Australia (known until recently as the IPAA) introduced a revamped code of conduct for its members which, among other things, beefed up the disclosure requirements with respect to referrers of work.

Against this background, it is not surprising that the appointment of three IPs to Walton Construction Pty Ltd and a related company (together referred to as Walton) in Melbourne came under scrutiny late last year.

Walton got into financial difficulty and engaged the Mawson Group, a business advisory and restructuring firm, to assist them. After certain asset sales and debt assignments had taken place, the Mawson Group referred Walton to a Melbourne insolvency firm. Three IPs from that firm became the companies’ liquidators on 8 November 2013.

ASIC then applied to the Federal Court to remove the liquidators. It pointed to the fact that whoever was appointed as Walton’s liquidator was going to have to investigate the Mawson Group’s involvement in the pre-liquidation asset sales and transactions.  ASIC alleged that the Mawson Group had referred 6 other jobs worth significant fees to the liquidators, who might therefore consciously or unconsciously favour the Mawson Group’s interests over the interests of Walton’s creditors; to put it another way, a “hypothetical fair minded observer” couldn’t be satisfied that the liquidators were independent and impartial in these circumstances.

ASIC also argued that the same observer would be even more troubled by the fact that, although the liquidators’ DIRRI revealed that the Mawson Group did refer them work from time to time, it made no reference to the possibility that the liquidators might have to investigate the Mawson Group.

But the judge took a very different view. She dismissed ASIC’s application, and allowed the liquidators to remain in place. The judge pointed out that the hypothetical observer must not only be fair minded, but appropriately informed.  Professional relationships did not necessarily bring impartiality and independence into question when one had regard to an IP’s statutory obligations, and the judge found that nothing about the conduct of other jobs which the liquidators had received from the Mawson Group would affect the perception of their independence in relation to Walton.

The failure of the DIRRI to mention that the referrer of the work might have to be investigated was not found to be further evidence of a lack of independence. Indeed, the judge found that the liquidators had done everything necessary to comply with the Corporations Act by mentioning the referral relationship in the way they did.

In sporting terms, the decision represents a significant goal against the run of play for IPs in Australia. For the moment, the courts may be taking a more flexible view than ARITA and ASIC of the circumstances in which a liquidator or administrator can act, and what they have to tell creditors when they do act.

ASIC v Franklin & ors, in the matter of Walton Construction Pty Ltd (in liq) [2014] FCA 68

For more information on this update or any other insolvency matters please contact us on (08) 9321 3755.

The information published on this website is of a general nature and should not be construed as legal advice. Whilst we aim to provide timely, relevant and accurate information, the law may change and circumstances may differ. You should not therefore act in reliance on it without first obtaining specific legal advice.