Can liquidators enter into funding agreements?

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26 August 2011

In the decision of Fortress Credit Corporation (Australia) II Pty Ltd v Fletcher [2011] FCAFC 89, the Federal Court of Australia considered the powers of liquidators under the Corporations Act 2001 (Cth) (Act) to enter into and perform their obligations under funding agreements.

FACTS

In 2009, joint liquidators (Liquidators) were appointed to Octaviar Limited (Octaviar) and Octaviar Administration Pty Ltd (Funder).  Fortress Credit Corporation (Australia) II Pty Ltd (Fortress) is a secured creditor of Octaviar and claimed that it was owed approximately $71 million.

The Liquidators caused Octaviar to enter into two separate funding agreements with the Funder:

  • one in relation to examinations of officers of Fortress (Investigation Agreement); and
  • one in relation to commencing litigation against Fortress (Litigation Funding Agreement).

Since the Funder was in liquidation, an issue arose as to whether the Liquidators had the power to cause Octaviar to enter into the funding agreements.  The Liquidators, the Funder and Octaviar made an application to the court under section 477(2B) of the Act for approval to enter into the Litigation Funding Agreement. They subsequently made a second application to the court under sections 477(2B), 479(3) and 1322(4)(a) of the Act for approval to enter into the Investigation Agreement and a declaration that the Investigation Agreement was not invalid by reason of its having been entered into without prior approval of the court.

Decision at first instance

The primary judge observed that it is not unusual for a company in liquidation to seek litigation funding in order to proceed against a third party and that the power of liquidators to enter into such agreements is well accepted. A court will not interfere unless there has been some lack of good faith, error of law or principle, or real and substantial grounds for doubting the prudence of liquidators’ conduct. The primary judge was satisfied that the court should approve the entry of the Liquidators into the agreements. 

Application for leave to appeal the decision

Fortress then applied for leave to appeal the orders made by the primary judge claiming that the approval of the agreements by the primary judge had the result that the value of Fortress’s security would be diminished. 

The critical issue on appeal was whether the Litigation Funding Agreement was necessary for winding up the affairs of the Funder and distributing its property within the meaning of section 477(2)(m) of the Act.  The Court observed that the Act does not grant an explicit power to liquidators to lend money or enter into funding agreements. The Court also held that section 477(2)(m) of the Act would not support the provision of litigation funding by a liquidator to an entirely unrelated litigant, simply on the prospect of obtaining a monetary return. Such arrangements would not, without something more, be necessary for the winding up of the affairs of a company and distributing its property.

The Court found that the primary judge had erred in her decision on the basis that she:

  • did not determine positively that the Litigation Funding Agreement was authorised by section 477(2)(m) of the Act; and
  • made no finding as to how the proposed arrangements are in the interests of the creditors of the Funder as a whole, beyond the potential commercial return to be earned as consideration for lending the money.

The Court therefore concluded to set aside the primary judge’s decision and allow the appeal.

Comment

Whilst liquidators are given fairly broad powers under the Act, this case serves as a reminder that the powers of liquidators are to be applied in a manner which assists in the winding up of a company and is in the best interests of creditors as a whole.

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