Creditor Rights and Financial Assistance in Winding Up Process

The court ruled that a creditor who provided significant financial assistance during the winding up process should receive preferential treatment in the distribution of assets, ensuring they receive a larger share of the available funds.

Supreme Court New South Wales

Medium Neutral Citation: In the matter of [COMPANY] [2011] NSWSC 1540 Hearing dates: 5 December 2011 Decision date: 14 December 2011 Jurisdiction: Equity Division - Corporations List Before: Barrett J Decision:

1. Order that property available for the payment of debts in the winding up of [COMPANY] shall be distributed in such a way that [COMPANY] has an advantage by receiving in respect of its debt 81.66% of that property, with the balance of 18.34% of that property receivable by [NAME] in respect of its debt.

2. Order that the plaintiff's costs of these proceedings be an expense of the winding up of [COMPANY]. Catchwords: CORPORATIONS - winding up - whether creditor who financially asserted recovery by [NAME] should be given advantage over other creditor - where assisting creditor provided a substantial sum which has been repaid - where other creditor had no opportunity to consider whether to contribute assistance Legislation Cited: Corporations Act 2001 (Cth), ss 564, 596A Cases Cited: Household Financial Services Pty Ltd v Chase Medical Centre Pty Ltd (1995) 18 ACSR 294 Jarbin Pty Ltd v Clutha Pty Ltd [2004] NSWSC 28; (2004) 208 ALR 242 Re Manson; Ex parte Official Assignee (1897) 18 LR (NSW) (B&P) [COMPANY] New South Wales v Brown (2001) 38 ACSR 715 Category: Principal judgment Parties: [NAME], as [NAME] of [COMPANY] - Plaintiff [NAME] - by leave Representation: [NAME] - Plaintiff [NAME] - by leave [NAME] - Plaintiff Australian Taxation Office - by leave File Number(s): 2011/00340646

Judgment 1Mr [NAME] is [NAME] of [COMPANY]. He applies for an order under s 564 of the Corporations Act 2001 (Cth). That section is as follows: "Where in any winding up: (a) property has been recovered under an indemnity for costs of litigation given by certain creditors, or has been protected or preserved by the payment of money or the giving of indemnity by creditors; or (b) expenses in relation to which a creditor has indemnified a [NAME] have been recovered; the Court may make such orders, as it deems just with respect to the distribution of that property and the amount of those expenses so recovered with a view to giving those creditors an advantage over others in consideration of the risk assumed by them." 2Two creditors have proved debts in the winding up: [COMPANY] ("[NAME]") and [NAME] ("[NAME]"). Their proofs have been admitted in the sums of $281,275 and $374,706 respectively. 3After realisation of assets, there will be some $310,000 available for application towards the creditors' admitted claims. Rateable participation by [NAME] and [NAME] would see them receive $132,850 and $177,150 respectively. 4The [NAME] contends that [NAME] gave financial assistance to him which enabled him to achieve a settlement of a claim against the company's sole director that yielded substantial proceeds; and that that assistance warrants preferred treatment of [NAME] in respect of its debt. 5The company was a building company. It became subject to an order for winding up in insolvency in March 2004. [NAME] was the plaintiff in the winding up proceedings. Its claim arose from its having met an insurance claim made by an architect who, in November 2001, recovered damages of more than $125,000 against the company in proceedings the principal aspect of which was a personal injury claim by a person injured on premises in the construction of which both the company and the architect has played a role. 6In May 2004, the company's sole director signed a report as to affairs that was entirely uninformative as to the company's assets and liabilities. So far as [NAME] could determine, there were no assets. [NAME] examined the sole director under s 596A. [NAME] financed the examination which took place in October 2005. 7As a result of the examination (and with the assistance of documents produced under compulsion by the director and an accountant), [NAME] ascertained that, before the winding up order was made, the company sold its sole asset (real estate) and thereby realised some $5 million after payment of a mortgage debt; that about $2.5 million was paid by the company to the director in discharge of a long-standing debt to him; that about $2.5 million was paid as a dividend on shares of a particular class held by the director's son; that the son lived in the United Kingdom; and that the son directed the company to make payment to the director, by way of gift by the son to the director. 8The [NAME] formed the view that the company had causes of action against the director and his son. As a result of negotiations, [NAME] received $650,000. [NAME]'s affidavit gives his reasons for deciding that the settlement should be accepted. The settlement amount was received in September 2008. 9The [NAME] also formed the view that events in relation to the dividend had given rise to a liability of the company for dividend withholding tax (he ascertained that the director had received but apparently ignored advice from his accountant to this effect before the dividend was paid). In December 2008, therefore [NAME] gave relevant information to [NAME]. Tax was assessed and a proof of debt was subsequently lodged by [NAME]. 10A formal funding agreement had been entered into between [NAME] and [NAME] in February 2006. [NAME] entered into this agreement on the express footing that he would pursue a claim for favoured treatment of [NAME] on account of the assistance given by it. 11The financial assistance provided by [NAME] amounted in all to $269,781.50. This amount has been repaid to [NAME] by [NAME],. 12The chronology thus makes it clear that [NAME]'s investigations (funded by [NAME]) and the subsequent steps (also funded by [NAME]) which resulted in the $650,000 settlement had all been completed before [NAME] informed [NAME] of the events concerning the dividend that caused [NAME] to issue a tax assessment and to lodge a proof of debt. 13The [NAME] says that, given the extent of [NAME]'s financial assistance and the results it produced (proceeds of $650,000 in circumstances where, without funding, [NAME] would have achieved nothing), the "just" result under s 564 is that [NAME] should be paid 100 cents in the dollar in respect of its debt - a result that would see [NAME] receive $28,725 being some 7.66 cents in the dollar in respect of its debt. 14ATO appeared by counsel upon the hearing of [NAME]'s application. [NAME] accepts that [NAME] deserves some measure of preference but says that 100 cents in the dollar is not warranted. 15The approach to be taken in s.564 cases remains as stated by [NAME] in Household Financial Services Pty Ltd v Chase Medical Centre Pty Ltd (1995) 18 ACSR 294 in the following passage at pp.296-7 (approved by the Court of Appeal in [COMPANY] New South Wales v Brown (2001) 38 ACSR 715): "The last words s 564 provide for, and the authorities accent the need to assess the risk run by the indemnifying creditors, for whose benefit an application is made, but the authorities show that it is also appropriate to look to the sum recovered (or the value of the property recovered), the failure of other creditors to provide the indemnity, the proportions between the debts of the indemnifying creditors and the other debts, the public interest in encouraging creditors to provide indemnities so as to enable assets to be recovered, and, generally, the totality of the circumstances; and there has been a tendency in recent times to adopt a more liberal approach, in favour of indemnifying creditors. See Re Bavistock (1946) 14 ABC 30; [NAME]; Ex parte Official Receiver (1974) 36 FLR 187; [NAME];; Ex parte Official Receiver (in liq) (1984) 56 ALR 181 at 186; [COMPANY] (in liq) (1987) 11 ACLR 767; 5 ACLC 811 at 819; [COMPANY] (in liq) (1994) 14 ACSR 610; 12 ACLC 1071." 16The comprehensive nature of the relevant inquiry has long been recognised. The task of the court under a forerunner provision of New South Wales bankruptcy legislation was said by [NAME] in Re Manson; Ex parte Official Assignee (1897) 18 LR (NSW) (B&P) 38 to be that of "weighing all the circumstances, the amount of risk run, the amount recovered, the proportion between the debts of indemnifying creditors, and those of non-indemnifying creditors and all other matters". 17It is pertinent to refer also to what was said by Spigelman CJ in [COMPANY] v [NAME] (above) at [40] - [41]: "[40] Santow J said that the exercise of the statutory power to give funding creditors 100% of recovery will be rare. I agree. (Little is added by adding an adjective, for example "extremely rare": cf [COMPANY] , above, at 297 per [NAME].) [41] The cases in which 100% has been awarded have had particular features. In [NAME] the amounts were very small. Creditors had advanced $4000 and were permitted to retain the net recovery of $7000. In [NAME] the amounts were also small: $36,000 expended for a net return of $114,000. Furthermore, no unsecured creditor opposed the distribution of costs to the funding creditors. That was also the position in [COMPANY] but, in view of the absence of explicit disclosure in [NAME]'s letter to shareholders about the proposal to seek a 100% order under s 450, [NAME] gave leave to any creditor to apply to vary the order. In that case some $65,000 had been advanced for a net return of $215,000." 18Hodgson JA (with whom [NAME] agreed) said at [91] - [92]: "[91] I accept that it is not the object of the section to encourage litigation for the sake of litigation, or for the private benefit of creditors who provide the indemnity or the funds. In my opinion, there are two public purposes involved in the encouragement of pursuit of claims by liquidators, namely to benefit creditors and shareholders generally, and to recover property from wrong-doers and thus discourage misconduct in relation to corporations. [92] In my opinion, both purposes may be advanced by the grant of an advantage of 100% of the recovered funds to supporting creditors in appropriate cases. Plainly, such a benefit can support the objective of recovering property from wrong-doers. In my opinion also, the grant of a 100% advantage in cases where recovery turns out to be relatively small can also support the objective of benefiting creditors generally, by encouraging the support of litigation in cases where there is a prospect of a large recovery which would inure for the benefit of all creditors, but which may in certain eventualities result only in a small recovery. Of course, if a 100% advantage is too readily granted in such cases, this could unduly encourage the settling of claims for less than their reasonable value; but this risk can be taken into account when settlements are approved, as well as in applications by supporting creditors to be given an advantage." 19These, however, are statements about the award of 100% of recovered funds to an assisting creditor and, in any event, Campbell J, in Jarbin Pty Ltd v Clutha Pty Ltd [2004] NSWSC 28; (2004) 208 ALR 242 at [60] and following made a survey of cases covering more than a century and concluded that there were "many cases" in which an assisting creditor had been awarded the full amount recovered. 20This is not a case where it is proposed that the assisting creditor should receive 100% of the recovery. The proposal is, rather, that that creditor should receive 100 cents in the dollar, with the only other creditor ([NAME]) receiving 7.66 cents, where rateable participation in the ordinary way would see each receive 47.24 cents. 21One relevant factor is the expressed attitude of other creditors to the possibility of funding. By and large, creditors who have been invited to give financial assistance and have declined to do so have been seen as less deserving of protection from inroads under s 564. 22In the present case, [NAME] had no opportunity to provide financial assistance or even to consider doing so. This is because all necessary funding had been provided by [NAME] and all funded activities resulting in recovery had been completed before [NAME] even knew of the circumstances giving rise to the debt for which it successfully proved. There is no evidence of what [NAME] would or might have done if invited at an earlier stage to contribute financial support. But that, to my mind, is beside the point. The simple facts are as I have stated them: [NAME] provided no financial assistance; it was not asked for financial assistance; and, by the time [NAME] was notified of the matters grounding the conclusion that it is a creditor, there was no longer any need, on [NAME]'s part, for financial assistance. 23In those circumstances, the situation must be regarded as one in which [NAME]'s success in making recovery was wholly achieved by the financial assistance provided by [NAME] but that, because [NAME] was not asked for assistance, the absence of assistance from it should not be regarded in any negative (or disentitling) way or as somehow reinforcing the merit of [NAME]'s claim. 24The real question is that posed by the section itself, that is, whether [NAME], as a creditor, merits "an advantage over others in consideration of the risk assumed by it" and, if so, what the appropriate advantage, by way of consideration, is. 25I am comfortably satisfied that [NAME] deserves an advantage over [NAME]. As I have said, [NAME] accepts this. 26As to quantification, the compelling consideration is that, without the outlay by [NAME] of what was, in the context, a substantial sum ($269,781.50), [NAME] would have had no funds for application towards creditors' debts. The fact that [NAME] hazarded such a large sum and thereby produced a situation where both creditors, treated on the usual rateable basis, would receive 47.24 cents in the dollar indicates that a very substantial advantage is appropriate. 27I do not think, however, that 100% is appropriate. [NAME] is not out of pocket for any part of the $269,781.50 and, on a rateable basis, it would fail to recoup slightly more than 50% of its debt (52.77% to be precise). Its reward should be, in my view, that [NAME] recoups 90% of its debt, that is $253,147.50. That leaves $56,852.50 for [NAME]. This is better expressed in terms of percentages: 81.66% for [NAME] and 18.34% for [NAME]. 28The orders are:

2. Order that the plaintiff's costs of these proceedings be an expense of the winding up of [COMPANY].

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