TGIF: Debt liquidation: Three good reasons to settle for less – Insolvency/Bankruptcy

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This week’s TGIF reviews the latest of two recent Federal Court decisions approving the compromise of debts owed to a company in liquidation, at the request of the liquidators pursuant to Section 477(2A) of the Companies Act 2001 (Cth) and on confidential terms.

Key points to remember

  • Liquidators seeking to compromise debt over $100,000 without creditor or conflict of interest approval may seek court approval under Section 477(2A) of the Companies Act 2001 (Cth), combined with an order under section 37AF of the Federal Court of Australia Act 1976 (Cth) to maintain confidentiality.

  • To assess whether compromise is in the interest of creditors, liquidators can investigate the debtor’s financial situation to determine:
    • the prospect of a recovery;

    • the risk of a minimum distribution by the debtor; and

    • if the cost of recovery is commercial.


  • A court’s approval of a compromise under Section 477(2A) functions as a permission, not an endorsement.

What happened?

Liquidators have been appointed to Linchpin Capital Group Ltd (Pivot) and Endeavor Securities (Australia) Ltd in 2019 following an ASIC request.

Linchpin was a trustee of an unregistered managed investment scheme known as the Investport Income Opportunity Fund (the
IIOF scheme). Liquidators have also been appointed as the persons responsible for winding up the IIOF plan and a registered and operated plan of the same name.

In assessing Linchpin’s financial condition, the liquidators identified that the assets of the IIOF plan included debts owed by several debtors.

Following inquiries into the debtors’ financial condition and negotiations, the liquidators felt that it was in the interest of Linchpin’s creditors to understand the debts.

In each case, there were broadly three reasons for this decision:

  • Prospect of recovery – that it was unlikely that the pursuit of the Debtor concerned within the framework of a formal recovery procedure would result in a higher settlement or full payment of the debt, taking into account the financial situation of the Debtors concerned;

  • No or minimal distribution risk – that there was a risk that the debtor concerned would be sued by other creditors, or become insolvent or liquidated, which would make a distribution to the IIOF program unlikely or otherwise very minimal; and

  • Collection costs – that the costs incurred to pursue the Debtor concerned with a view to recovering the entire debt would not be commercially justified.

The compromises were then effected by confidential settlement deeds followed by court approvals and suppression orders, as follows.

Settlement acts

In June 2021, the Liquidators initially entered into a settlement agreement with two of the Debtors, providing for the payment of a settlement sum in compromise of debt.

This compromise was approved in February 2022, in Tracy in Linchpin Capital Group Limited (in liq) (No 1)
[2022] FCA 104.

While the deed became binding upon execution, the settlement sum was paid into trust pending the application for approval by the liquidators and the releases were subject to court approval. The act also provided that the liquidators take steps to “cancel” the receipts if certain information from the debtor turns out to be false or misleading.

In May 2022, the liquidators then entered into a new settlement deed in respect of a debt owed by CPG Research & Advisory Pty Limited ACN 052 348 026 (CPG Research and Consulting).

This new compromise was approved by the Court in June 2022, in Tracy in Linchpin Capital Group Limtied (in liq) (No 2) [2022] FCA 739.

This other deed was in similar terms, but with only a portion of the settlement amount paid into trust. This part was to be applied to the liquidators’ costs of the application for approval in the event of failure. Payment of the full settlement amount was subject to court approval.

Approval requirement

The obligation for liquidators to obtain approval for a compromise of a debt if the amount claimed is greater than the prescribed threshold of $100,000 is found in section 477(2A) of the
Companies Act 2001 (Cth) and regulation 5.4.02 of the
Companies Regulations 2001 (Cth).

Approval may be provided by a court or by a creditor review or resolution committee. It is not uncommon for liquidators to seek court approval instead of submitting the compromise to creditors, depending on the relative costs, timing and status of negotiations with the debtor.

The principles applied by a court in an application for approval of this type are well established. They are set forth in His Honor’s two judgments in this matter. In summary, the approval principles are:

  • a court is not concerned with the commercial expediency of the transaction and, although a court will not merely “approve” the liquidators’ assessments, a court will consider the liquidator’s business judgment; and

  • it is not necessary for a court to examine the commerciality of the settlement that has been reached or to guess at the judgments of the liquidators. Rather, the court will focus on ensuring that the proposed transaction is in the interest of the creditors and that there is no error of law or principle, lack of good faith or real reason or substantial to doubt the prudence of the conduct of the liquidators.

Decision

His Honor concluded that the liquidators had satisfied themselves, after having made the appropriate inquiries as to the financial situation of the debtors, that the compromise of the debt was in the best interest of the creditors.

In each case, the evidence referred to the three main reasons identified above, however, the specific evidence as to each debtor’s financial situation appears to have differed. In particular, the evidence between individuals and corporate debtors differed as follows:

  • in the February 2022 decision, His Honor noted that the investigations undertaken extended to the spouse of one of the Debtors and to the Debtor’s business, personal expenses and health issues, which militated against any expected increase in the capacity of gain ; while

  • in the June 2022 decision, His Honor noted that the liquidators’ investigations included an investigation into the potential recapitalization or, alternatively, sale of the debtor’s business.

His Honor ultimately concluded that there was no suggestion that the liquidators’ entry into the settlement deeds was improper or otherwise misguided exercise of powers.

His Honor noted that the approval under Section 477(2A) does not function as an “approval” of the proposed agreement, but merely as an “authorization” for the liquidators to exercise their business judgment.

Privacy

The liquidators also argued that, without a confidentiality order regarding the compromise and negotiations, creditors would be harmed by:

  • the potential reduction in the value of recoveries that liquidators are able to negotiate with other creditors; and

  • the risk of increased asset recovery costs if commercial settlements cannot be reached.

In order to avoid the disclosure of commercially sensitive information about negotiations that might otherwise provide an unfair advantage to other debtors, His Honor has also issued confidentiality orders under Section 37AF of the Federal Court of Australia Act 1976 (Cth).

Comment

While similar rulings have tended to provide more detail about the debt and the proposed compromise, the reasons for these two rulings concisely articulate the essentials. They point to the three reasons which will often lead to a decision to compromise a debt, these reasons being the limited prospects of obtaining recovery against the debtor, the risk that the liquidators will receive a minimum distribution from the debtor (in this case even on a recapitalization) and the non-market cost of further recovery.

Finally, the decisions also refer to the fact that Section 477(2A) approvals are not endorsements. They do not exonerate the liquidators from any liability they may have as a result of the operation.

Liquidators seeking more than just an authorization to compromise a debt may consider applying also under Articles 90-15 and 90-20 of the Calendar of insolvency practices (corporations).

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.





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