Secured creditor unsuccessful in challenging liquidator’s lien

Secured creditors should not allow a liquidator to sell a secured asset without first:

• deciding whether they will be better off by letting the liquidator sell the asset; and
• reaching agreement with the liquidator about the terms of sale and the remuneration, costs and expenses that the liquidator will deduct from the sale proceeds.

In the recent High Court case of Stewart v Atco Controls Pty Ltd (in Liquidation) [2014] HCA 15, a secured creditor was unsuccessful in challenging a liquidator’s lien over funds recovered through legal proceedings.

The case provides guidance for liquidators, secured creditors and unsecured creditors regarding the duties of a liquidator, the nature and applicability of a liquidator’s lien and operation of litigation funding.

The facts

Newtronics Pty Ltd (Newtronics) was a wholly owned subsidiary of Atco Controls Pty Ltd (Atco).

Atco provided loans to Newtronics and had a charge over Newtronics’ assets securing repayment of the loans.

Newtronics was placed in liquidation. Before the liquidator was appointed, Atco appointed receivers over Newtronics’ assets to recover debts owing to Atco. The receivers sold Newtronics’ business to a former customer of Newtronics.

The liquidator commenced court proceedings against Atco claiming that the charge was invalid. They also sued the receivers claiming damages for selling Newtronics’ business. The critical issue in both actions was the validity of the charge.

To fund the court proceedings, the liquidator entered into a funding agreement with the largest unsecured creditor of the company, Seeley International Pty Ltd (Seeley).

Under the funding agreement Seeley indemnified the liquidator for the costs of the proceedings and the liquidator agreed that he would ask the court to order that Seeley be paid in priority to other creditors from any funds that were recovered by the liquidator.

During the court proceedings the liquidator settled its claim against the receivers for $1.25 million and continued its claim against Atco. The liquidator was ultimately unsuccessful in setting aside Atco’s charge.

The $1.25 million settlement payment from the receivers created funds in the liquidation of Newtronics.

After the liquidator failed to set aside Atco’s charge, Atco as the secured creditor demanded that the liquidator pay them the $1.25 million.

The liquidator refused, claiming a lien over the funds and arguing that the liquidator was entitled to pay the costs of the litigation before Atco could make a claim to the funds.

The critical issue

The critical issue was whether the liquidator had an equitable lien over the $1.25 million settlement sum for the costs and expenses incurred by the liquidator in the court proceedings against Atco and the receivers.

The liquidator relied upon the following principle stated by the High Court in Universal Distributing Co Ltd (in liq) (1933) 48 CLR 171:

A secured creditor may not have the benefit of a fund created by a liquidator’s efforts in winding up without the liquidator’s costs and expenses, including remuneration of creating that fund being first met. Equity creates a charge over that fund in priority to that of the secured creditor.

The principle would ordinarily apply where for example a liquidator sells a secured asset and the proceeds of sale are insufficient to pay out the secured creditor. In this situation, it would be unfair for the secured creditor to receive the benefit of the sale proceeds without the liquidator being paid its costs and expenses of selling the secured asset.

However, the facts in Atco didn’t involve the liquidator selling a secured asset. Rather, the $1.25 million settlement sum came about because the liquidators sued the secured creditor – i.e. Atco and the receivers.

Given that Atco held a charge over Newtronics’ assets, when the liquidator received the settlement sum, the $1.25 million ironically became subject to Atco’s security giving Atco the right to demand payment of the settlement sum.

Atco’s principal complaint in seeking to attack the lien claimed by the liquidator was that Atco was being sued by the liquidator and that it did not stand to benefit from that court action. Atco argued that it was only Seeley’s interests that were being served by the liquidator’s court proceedings.

Applying Universal Distributing

In deciding that the principles in Universal Distributing applied to the facts of the case, the High Court made the following observations and findings.

• It is not a liquidator’s duty to ensure that court proceedings conducted in the course of the realisation of assets are for the benefit of a secured creditor, or any particular creditor. The liquidator’s duty is owed to all of the creditors and to the court.
• The relevant benefit is that which is sought by realising a company’s assets, namely maximising the assets available for distribution to the creditors. A liquidator is to do what he or she can to maximise the disposable assets of the company.
• While a liquidator must exercise care in determining whether to commence court proceedings, the liquidator in Atco had received advice from a barrister and there was no suggestion that the liquidator’s claims were reckless and had no prospects of success.
• It is part of a liquidator’s duties to scrutinise charges existing over company property and, in certain circumstances, to seek to have them set aside.
• Seeley no doubt considered its interests were served by funding the court proceedings but that did not imply that the court proceedings were in some way wrongful. Nor does it affect the question of whether an equitable interest arose in the $1.25 million settlement sum in favour of the liquidator.
• There is nothing unusual about an unsecured creditor providing an indemnity to a liquidator to enable an action to be brought against a secured creditor and in fact section 564 of the Corporations Act 2001 (Cth) encourages the preferential distribution to a creditor who provides an indemnity to a liquidator for costs and expenses of court proceedings.

Conclusion

For liquidators, the decision of the High Court provides further guidance regarding the duties they owe in deciding whether to commence court proceedings and the principles applying to litigation funding.

Liquidators have been given further reassurance that a lien will arise over funds obtained in a liquidation entitling them to have their costs of realising the asset paid, in priority to a secured creditor’s claim on the fund.

Putting aside the unusual facts of Atco the main take-home messages are as follows:

• Secured creditors should:
  • be aware of the liquidator’s lien for their costs, expenses and remuneration incurred in relation to the preservation and realisation of a secured asset such as mortgaged land, equipment or a business;
  • at an early stage:
    • decide whether they will be better off by selling the secured asset themself or allowing the liquidator to sell the asset;
    • negotiate and agree with the liquidator about the calculation and amount of the liquidator’s costs, expenses and remuneration and other factors like the method of sale, valuations, terms of sale, sale price and where applicable the apportionment of the sale price if part of the assets being sold are not subject to your security; and
    • not allow the liquidator to sell a secured asset without first reaching an agreement with the liquidator about the issues outlined above.
• Any creditor considering funding a liquidator’s court proceedings, should carefully consider:
  • the likelihood that the liquidator will succeed in the court proceedings;
  • whether there is a secured creditor who may be able to claim any of the funds recovered from the court proceedings; and
  • obtaining advice and negotiating with the liquidator the terms of the funding agreement, in particular the payment of costs to fund the court proceedings in priority to other creditors of the company.

If you would like more information about these issues, please contact Graham Roberts or Sarah Dewar on
+61 7 3231 4444.