Seeking forgiveness, not permission: approval of litigation funding

A liquidator of a company must not enter into an agreement on the company’s behalf where the term of the agreement may end, or the obligations of a party to the agreement may be discharged, more than 3 months after the agreement is entered into, without the approval of the Court, the committee of inspection or of a resolution of creditors.¹

However, the recent decision of Justice Gleeson of the Federal Court in Deputy Commissioner of Taxation, in the matter of ACN 154 520 199 Pty Ltd (in liq) v ACN 154 520 199 Pty Ltd (in liq) (No 2)² confirms that a Court may exercise its discretion to grant retrospective approval of a litigation funding agreement.

Background

On 18 November 2016, the primary liquidator of ‘EBS’ entered into a funding agreement with ABC Refinery (Australia) Pty Ltd (Funder) capped at $30,000.  The purpose of the funding agreement was to enable the liquidator to investigate the legitimacy of the tax assessments made by the Australian Taxation Office which assessed EBS’ tax debt in an amount equating to over 99% of EBS’s total debts, and to conduct of an appeal against those assessments.

In the course of his investigations, the liquidator determined that unfair preferences may have been paid by EBS to the ATO and that the costs associated with continuing his investigations would exceed the funding agreement cap.  On 6 April 2017, the liquidator brought an application in the Federal Court to approve the funding agreement nunc pro tunc and for approval to enter into a variation to the funding agreement which removed the monetary cap.

On 6 April 2017, special purpose liquidators (SPL) were appointed to EBS on the application of the Deputy Commissioner of Taxation (DCT).  At the time of bringing the application to appoint the SPL, the DCT also sought an order that leave be granted for the special purpose liquidators to enter into a funding agreement with the DCT.

The liquidator did not oppose the proposed SPL funding agreement on the condition that (amongst other things) the agreement did not affect or impede the liquidator’s duties, any adverse costs orders made against the SPL and/or EBS did not affect the liquidation and rights of existing creditors, and any recoveries of preference payments made by the liquidator could not be accessed by the SPL to indemnify them for any costs orders made against them or EBS.

The DCT subsequently revised the SPL funding agreement to address the concerns of the liquidator.

Factors considered in granting approval of a funding agreement

A Court may give retrospective approval to an agreement in appropriate circumstances.³  In considering whether to grant approval of a funding agreement, a Court will:⁴

1. consider whether the entry into an agreement on behalf of the company is a proper or bona fide exercise of a liquidator’s powers;⁵ and
2. review the liquidator’s proposal, paying due regard to his or her commercial judgment and all of the circumstances of the liquidation.⁶

Importantly, the Court will not “reconsider all of the issues which have been weighed up by the liquidator in developing the proposal”.⁷  Generally, it will only intervene where there is reason to suspect that there has been a lack of good faith, some error of law or principle, or real and substantial grounds for doubting the prudence of the liquidator’s conduct.⁸

Approval of funding agreement nunc pro tunc

Justice Gleeson approved the funding agreement nunc pro tunc and the variation.  Her Honour concluded that the liquidator’s entry into the funding agreement and the variation was not ill-advised, was a proper exercise of his power, and that the liquidator was not subject to any unusual control by the Funder in pursuing his investigations or an appeal of the tax assessments.

Her Honour also approved the revised SPL funding agreement, recognising that the SPL needed funding to carry out their appointment.

Costs

Generally, a liquidator is entitled to an order that his or her costs of a successful application for funding approval be costs in the winding up of the company.⁹  Consequently, the primary liquidator and the DCT were both awarded costs in the liquidation of EBS.

Lavan comment

Generally speaking, a liquidator must obtain the Court’s approval before entering into a long term agreement on behalf of a company in liquidation.  However the Court may exercise its discretion and retrospectively approve a litigation funding agreement.  If successful, a liquidator will generally be entitled to an order that his or her costs be costs in the winding up of the company.