Who watches the watchers? - Federal Court dismisses application for the appointment of a special purpose liquidator

Who watches the watchers? - Federal Court dismisses application for the appointment of a special purpose liquidator

In the case of Lewis v Battery Mineral Resources,¹ the Federal Court considered an application for the appointment of a special purpose liquidator (SPL) or alternatively a reviewing liquidator (RL) to investigate and report on the sale of the assets of Battery Mineral Resources Ltd (in liq) (BMR) during the voluntary administration of BMR.

The plaintiffs claimed that the sale of BMR’s assets to Weston Energy LLC (Weston), a secured creditor and major shareholder of BMR, had been conducted with undue haste.

The liquidators (and former administrators) of BMR did not oppose the application, but put on evidence to assist the Court in understanding the background to the dispute.

In considering the application, the Court was required to decide whether there was any power and/or proper basis to appoint a SPL or a RL to investigate the conduct of the incumbent liquidators in their previous role as voluntary administrators.

Background

BMR carried out exploration and mining for cobalt, lithium and other minerals used in making batteries.  The first plaintiff, Mr Lewis, founded BMR in 2016 and was its inaugural director and shareholder.

Weston, an American investment company, subsequently became a major shareholder of BMR and its directors held a majority on the board of BMR.  Weston was also a secured creditor of BMR.

In May 2018, BMR entered into an agreement with ESI Energy Services Inc (ESI), a related entity of Weston, for the purposes of ESI funding BMR’s development of a cobalt project in Canada (the ESI Agreement).  Under the ESI Agreement, ESI paid BMR the sum of CAD10m which was said to be non-refundable unless BMR failed to use commercially reasonable efforts to advance the project, in which case the CAD10m would become immediately repayable to ESI.

In early 2019, BMR began experiencing cash flow difficulties and on 11 November 2019 its board resolved to place it into voluntary administration.

At the time that BMR was placed into administration, the company and its subsidiaries had less than $30,000 in cash, and unsecured debts of over $1.8m of which 83% was over 90 days overdue.

The sale process

It appears that very shortly after their appointment, the administrators received an offer from Weston to acquire BMR’s assets for $21.2m, made up of forgiveness of Weston’s secured debt of $9.4m, forgiveness of what was said to be BMR’s liability to repay ESI the CAD10m under the ESI Agreement, cash of $600,000, plus immediate payment of certain key debts of BMR and its subsidiaries of around $1m (the Weston Offer).  The Weston Offer also required completion to occur “as soon as possible, preferably during the week commencing 25 November 2019”.

On 12 November 2019, the administrators sent a circular to shareholders seeking urgent expressions of interest for either a recapitalisation or a sale of its subsidiaries with non-binding indicative offers due by 20 November 2019.

On 20 November 2019, a consortium of BMR’s shareholders (which included the plaintiffs) submitted a $15 million recapitalisation offer for 150m shares in BMR at 10c.  The offer provided that the $15m would be used to clear the $9.4m debt to Weston, with BMR to retain around $4m in working capital and the remainder to be used to pay other creditors (the Shareholder Offer).  The Shareholder Offer was also conditional on (amongst other things):

• due diligence to be completed by 4 December 2019;
• funding being obtained from additional investors; and
• approval/agreement from Weston as secured creditor.

A committee of inspection (COI) was appointed on 21 November 2019, and on 22 November 2019 the administrators provided the COI with a confidential report analysing the Weston Offer and Shareholder Offer, and recommending that the Weston Offer be accepted.  The report noted that it was unclear as to the extent to which the Shareholder Offer would see creditors other than Weston being repaid given the working capital to be retained by BMR under that offer.

The first plaintiff was a member of the COI and argued against the Weston Offer but left the meeting before the COI voted on the matter.  The COI ultimately voted not to object to the administrators’ recommendation to accept the Weston Offer.

BMR and Weston then entered into heads of agreement on 24 November 2019, with a formal share sale agreement executed on 2 December 2019.  The transaction completed on 4 December 2019.

The application

The plaintiffs applied in around February 2021 for the appointment of either a SPL or a RL to investigate the sale of BMR’s assets by the administrators who had since been appointed as liquidators of BMR.  The key concerns raised by the plaintiffs were:

• the short timeframe given to shareholders to come up with an offer;
• the close relationship between Weston and BMR and the fact that Weston’s directors made up a majority of the board; and
• the fact that the administrators had proceeded on the basis that BMR was liable to repay the CAD10m under the ESI Agreement when the evidence suggested that BMR had complied with its obligations and that this amount was therefore non-refundable. 

The liquidators did not oppose the application but put on evidence to show that:

• BMR and its subsidiaries were in a dire financial position as at 11 November 2019 and there were insufficient funds to support continued operations and/or a prolonged sale campaign by the administrators;
• they had inquired into the conditions placed on the Shareholders Offer before making their recommendation to accept the Weston Offer;
• they had sought and obtained advice regarding the treatment of the CAD10m under the ESI Agreement as a liability.

The decision

In considering the matters, Griffiths J separated out the application for an appointment of a SPL from the application for an appointment of a RL.

As to the proposed appointment of a SPL, Griffith J held that:

• the Court has broad powers to inquire into external administrations, and has the power under section 90-15(1) of the Insolvency Practice Schedule (IPS) to appoint a SPL;
• on its face, section 90-15(1) of the IPS is broader than the former power to appoint a SPL under the now repealed section 511 of the Corporations Act 2001 (Cth) (Act), but the authorities dealing with the old section 511 applications continue to provide a useful guide;
• the function of a SPL is to conduct some part or aspect of the administration that cannot, will not, or should not be carried out by the incumbent liquidator;
• an applicant must clearly identify the part or aspect of the administration for which the appointment of a SPL is sought, and the Court must then assess whether this appointment would be just and of sufficient utility to the external administration;
• however, the Court does not have the power to appoint a SPL to investigate the conduct of a liquidator.  This is because an investigation into the conduct of a liquidator is not part of the administration, and therefore cannot be “carved out of the administration” and given to a SPL.  The supervision of liquidators is a matter for the Court.

Griffin J also noted that even if there was power, the discretion to appoint a SPL would not have been exercised as (amongst other things) there was no suggestion that the administrators had acted other than in good faith and with the benefit of appropriate advice, it was unclear whether it would be just and beneficial to the creditors as a whole to appoint an SPL, and it was unclear why there had been such a long delay in the application being brought.

As to the proposed appointment of a RL, Griffith J held that:

• the Court has a new power to appoint a “reviewing liquidator” under section 90-23 of the IPS;
• a RL is different to a SPL as a SPL acts as a liquidator of the company, whereas a RL is not a liquidator (despite their title) and is only to review and report to the Court on specified matters concerning the external administration of the company;
• there is still very limited caselaw on the appointment of RLs;
• the key consideration for the Court in considering whether to exercise its discretion to appoint a RL is whether it is “appropriate” to make the appointment;
• in a case such as this, the question is whether it is necessary to investigate the conduct of an external administrator to uphold the public interest in the honest and efficient external administration of the company;
• the key relevant factors include whether there is evidence to suggest conduct warranting regulation, supervision, discipline or correction, whether the matter for review can be identified with sufficient clarity, whether the appointment would be just and beneficial for the general body of creditors, and the potential cost of the RL in the context of the administration;
• in this case there was insufficient evidence to suggest any conduct requiring supervision, it was unclear whether the appointment of a RL would be just and beneficial for the general body of creditors, and the plaintiffs had not explained the delay in bringing the application.

The application was therefore dismissed.

Lavan comment

This case provides important guidance on the limits on the appointment of SPLs and RLs to investigate the conduct of liquidators, whether as liquidators or in their former roles as voluntary or deed administrators.

The supervision of external administrators is a complex area.  If you have any questions about these types of matters, the experienced Lavan team is ready to help.