Misleading and deceptive conduct claims against insolvency practitioners – a recent commentary

Introduction

The South Australian Supreme Court recently handed down its decision¹ in relation to an aggrieved party’s claims of:

• misleading and deceptive conduct pursuant to equivalent South Australian legislation to section 10 Fair Trading Act 1987 (WA); and
• breach of statutory duties,

against an insolvency practitioner in his capacity as voluntary administrator, and eventually as liquidator of the same companies.

This decision provides an interesting commentary and reminder to insolvency practitioners regarding their standards of practice at various stages of an external administration.

Background

The plaintiff was a director, principal shareholder and creditor of two companies (Companies), both of which are in liquidation.

Misleading and deceptive claim against defendant as voluntary administrator

On 5 December 2001, the plaintiff resolved as sole director of the Companies that each company was insolvent, or likely to become insolvent. 

The defendant was appointed as administrator of the Companies on 5 December 2001.  At this point, the plaintiff approached the defendant, and Mr Bart (an entrepreneur and businessman) to prepare deeds of company arrangement (DOCAs) putting forward proposals for Mr Bart’s company to purchase the Companies.

At the second creditors’ meeting in 21 December 2001, the Companies’ creditors voted in favour of the winding up of the Companies and the defendant was appointed as liquidator.

The plaintiff alleged the defendant engaged in misleading and deceptive conduct by, amongst other things, making various representations to the creditors at the second creditors’ meeting.  He claimed damages for loss of employment (and associated employee entitlements) and losses due to honouring personal guarantees given to the Companies’ creditors.  

Claim for breach of statutory duties against defendant as liquidator

The plaintiff also alleged that the defendant (in his capacity as liquidator) breached his statutory duties by engaging in lengthy and expensive proceedings (Proceedings) for a $28,000 debt owing to one of the Companies.

The plaintiff alleged the defendant continuing the Proceedings (and by continuing to accrue an associated $228,000 in professional and legal fees) was not in the interests of the relevant company. 

The plaintiff also alleged the Proceedings were only continued in order to benefit the defendant personally (by defending and forestalling a foreshadowed professional indemnity claim to be brought against him by the plaintiff).

Issues and legal analysis

Misleading and deceptive conduct claim

After a lengthy discussion of the intent and structure of statutory regime under Part 5.3A and section 447E of the Corporations Act 2001 (Cth) (Act), the Court held:

• The relationship between an administrator, the company, its contributories and creditors is purely a statutory construct. 
• An administrator does not engage in “trade or commerce” (for the purpose of the equivalent of section 10 Fair Trading Act 1987 (WA)) in his or capacity as administrator with creditors of a company in exercising his or her statutory functions, powers and duties under Part 5.3A of the Act.
• It is manifestly inconsistent with the statutory regime of the Act regulating the duties of voluntary administrators to superimpose up on it a common law duty of care owed by the administrator to individual creditors, directors or shareholders to protect them from financial loss by the exercise of reasonable care in discharging his or her statutory powers.  That inconsistency is at its greatest when an administrator must form an opinion and frame a recommendation to the creditors, about whether to trade on, enter into a deed of company arrangement, sell the business and/or wind up the company.
• The exercise of the administrators’ statutory powers must be distinguished from the business management of a company in administration.  The administrator must exercise the skills and care of a competent business manager in negotiating commercial arrangements with third parties.
• In any event, due to various factual matters, the winding up of the Companies was inevitable.  The defendant’s conduct was not causative of the failure of the Companies to enter into the proposed DOCAs and his decision to recommend that the Companies be wound up was reasonable in the circumstances.

Breach of statutory duties

The Court also held:

• Liquidators bear a heavy responsibility to ensure proportionality and public benefit in the conduct of liquidation.
• In the absence of proportionality, a liquidator may generate litigation which is not in the company’s interests but serves instead the financial interests of the company’s professional advisers.  That is contrary to the interest of the company’s creditors and the public more generally.  It was difficult in the present case to see any public benefit in the litigation generated by the company’s liquidation.
• Arguably allowing the creditors to retain the payments would have had greater public benefit than requiring them to disgorge the preference payments made to them only to meet the legal costs of the liquidator and his solicitors.  This very unsatisfactory outcome was plainly foreseeable but neither the defendant nor his legal representatives squarely addressed the issue.
• In addition, the cost effectiveness and strategy of the litigation was not given close consideration by either the defendant, or his legal representatives.

Whilst the initial decision to commence the proceedings was not criticised by the Court, the defendant’s failure to adequately manage the costs of the Proceedings, and his vested personal interests in doing so was deemed a breach of his statutory duties. 

The Court ultimately adjourned the hearing to hear further submissions from the parties regarding the defendant’s removal as liquidator of the Companies and any further disciplinary action to be taken against him.

Lavan Legal comment 

It is noted that after judgment was handed down in these proceedings, the particular insolvency practitioner’s ARITA membership was immediately and indefinitely suspended. 

Insolvency practitioners should accordingly ensure at all times:

• there is proportionality in the conduct of litigation brought on a company’s behalf; and
• professional and legal fees incurred in the course of any litigation are consistently monitored to ensure they are appropriate to the claim.

On a positive note, this judgment also provides guidance from the Courts indicating administrators do not engage in “trade and commerce” in discharging their statutory duties, and therefore are unable to engage in misleading and deceptive conduct, in that context.