Litigation on-foot

An insolvency practitioner’s guide to the dance

Upon being appointed, insolvency practitioners are often faced with existing litigation involving the company or person they have been appointed to.

There are a multitude of factors that the practitioner needs to consider in relation to existing litigation. This article sets out some key considerations for administrators, liquidators, receivers and trustees in bankruptcy, as well as the practical steps a practitioner should follow. Although the article refers to practitioners appointed to companies, the principles are also generally applicable for Bankruptcy Trustees.

Legal issues

The litigation is both a potential asset & contingent liability

Regardless if the company is the plaintiff or defendant, the litigation is a potential asset. In addition to payment of the debt, damages or other relief sought in the claim if the company is the plaintiff, it is likely that if the company is successful (whether as plaintiff or defendant) in the litigation, it will be entitled to an order for payment of its legal costs by the other party.[1]

A pending claim against the company is also a contingent liability. Accordingly, the other party to the litigation should be treated as a contingent creditor and sent any circulars to creditors, etc. In light of this, a practitioner should be careful not to disclose the strategy or settlement negotiations regarding the litigation in such communications.

Usually, the other party to the litigation will be an ordinary unsecured creditor. However, depending on the nature of the litigation, it is possible the relief sought may give rise to proprietary rights (e.g. if the dispute is regarding the ownership of an asset or breach of trust).

Claim likely subject to security

A claim of the company is likely to be subject to any security granted over the company’s present and after-acquired property.[2] In these circumstances, if the liquidator intends to prosecute the claim an arrangement should first be reached with the receiver or secured creditor.

Costs

Although appointed to the company, an insolvency practitioner does not automatically become a party to the litigation. Consequently, the practitioner can only have costs ordered against them personally in special circumstances. These circumstances may arise if the company has insufficient assets and the practitioner plays an active part in the conduct of the litigation.[3]

The appointment of the practitioner to the company may also prompt the other party to apply for security for costs against the company if the litigation continues. Security for costs is generally only available if the party seeking it is in substance the defendant to the claim,[4] and may be a significant impediment to the practitioner continuing litigation where the company is the plaintiff.

Stay of proceeding

The appointment of the practitioner may also trigger a statutory stay or moratorium of the litigation.

If a voluntary administrator is appointed, no litigation can be commenced or continued against the company or in relation to any of its property, except with the administrator’s written consent or leave of the court.[5] A stay of proceedings also arises in liquidations, unless leave of the court is obtained.[6]

While the courts are generally cautious to grant leave, since it may distract the administrator from their statutory duties and cause them to incur legal costs,[7] leave is likely to be granted if the plaintiff is claiming their own property from the company.[8]

No moratorium arises upon the appointment of a receiver, although it is common for an administrator or liquidator to also have been appointed and the receiver will gain the benefit of the ensuing moratorium or stay.

Litigation commenced by a person who subsequently becomes a bankrupt is stayed until the trustee elects in writing whether to prosecute or discontinue the action.[9] If the trustee does not make such an election within 28 days after notice of the action is served on them by a party to the litigation, the trustee is deemed to have abandoned the action.[10]

Once the person has become a bankrupt, a creditor cannot enforce any remedy against the bankrupt or their property in respect of a provable debt, or without leave of the court commence a proceeding in respect of a provable debt or take any fresh step in such a proceeding.[11]

Company’s solicitors entitled to lien

If the solicitor that was acting for the company in the litigation has unpaid fees, the solicitor will be entitled to a lien over both the fruits of any judgment and their file. A lien over the fruits of any judgment means the lawyer is entitled to payment in priority of their unpaid fees from the fruits of their work (usually, a favourable judgment obtained in the litigation).[12]

The principles of the solicitor’s fruits of the action lien are:[13]

• The solicitor’s right exists over money recovered through obtaining judgment in litigation and also over money recovered through the settlement of litigation.
• Such right exists over both the amount of a judgment in favour of the client and the amount of an order for costs in favour of the client.
• It exists over money which is in the possession of the solicitor and also over money which is in court.
• The solicitor need not be retained at the time that the money is recovered.
• For the right to arise it must be shown that there is a sufficient causal link between solicitors’ exertions and the recovery of the fund of money. This will be established if a settlement resulting in payment to the client came about as a result of the legal proceedings and the solicitor had acted for the client in those proceedings.

This lien arises in equity. It does not need to be perfected under the PPSA and is likely to rank ahead of any secured creditor’s claim.[14] The lien cannot be used by the solicitor to resist delivering possession of books of the company to a liquidator, although such delivery will not prejudice the lien.[15]

Claims against the solicitor

Litigation is often long running and expensive, and in some instances may itself be part of the reason for the company’s insolvency.

It is possible the company may have a claim that can be pressed by the insolvency practitioner against its solicitors that advised and acted for it in the litigation. Claims can be for negligence (failing to properly advise on the merits of the litigation) or for excessive legal costs (even if the invoices were paid pre-appointment, the company as a client often has the right to have the costs taxed under the relevant legal profession act subject to limitation provisions).

Legal professional privilege

Consideration should be given as to who is the client – the insolvency practitioner or the company. A receiver can claim legal professional privilege over documents relating to legal advice given to them in their capacity as receiver of a company, preventing the company and its directors from inspecting the documents.[16]

For legal advice given pre-appointment, it is a decision for the practitioner whether to waive privilege. While the directors may know the content of pre-appointment advice, once a liquidator is appointed the directors lose their power to manage the company and hence cannot waive privilege.[17]

However, in some cases there may have been pre-appointment advice given to the company which also included personal advice for the directors (such as regarding their personal duties to the company). In this scenario, the directors might be able to claim legal professional privilege over the legal advice received by the company, on the basis of joint privilege or common interest privilege.[18]

Practical steps

Having regard to the above legal principles, the practical steps that an insolvency practitioner should follow upon being appointed to a company that is a party to pre-existing litigation are:

Initial inquiries

The practitioner should consider asking the existing lawyers acting for the company in the litigation for a summary of:

• the quantum and nature of the claim against the company and any insurance coverage
• the quantum and nature of the claim made by the company against the third party
• the amount of legal costs incurred to date and the estimated further costs to obtain judgment
• whether the lawyer has any unpaid fees
• the merits of the litigation (bearing in mind the advice given may not be neutral)
• the status of the litigation (whether pleadings, mediation, pre-trial, trial or awaiting judgment), including whether settlement offers have been and if there is any money held in trust or by the court.

Factors to consider

The insolvency practitioner should then decide whether to continue, settle or abandon the litigation. Relevant factors to consider include:

How far the litigation has progressed. If the parties are awaiting judgment, there may be merit in staying ‘in the game’ to obtain the benefit of any successful orders made even if the prospects are uncertain. On the other hand, if the proceeding is in its infancy then it is likely that substantial further costs will need to be incurred.

The funding available to the practitioner including to pay adverse costs, and the attitude of significant creditors and, in the case of a receiver, their appointor.

The merits of the litigation. Understandably, practitioners often ask their own choice of lawyer to review the proceeding and advise on the merits. Unfortunately, however, it is difficult for lawyers that have not had carriage of the matter to provide advice on prospects without conducting a full review of all material. The appointment of the insolvency practitioner may also have broader implications that affect the merits of the proceeding (for example, if key witnesses are not retained as employees of the company going forward).

The subject matter of the litigation. For example, if the litigation is in relation to a key asset of the company such as a patent, this may have wider implications for the sale of the business of the company.

Continuing the litigation

If the practitioner decides to pursue the litigation, matters to consider include:

• Ensuring the practitioner has obtained any required approval (particularly if a third party will be funding the litigation).
• Whether to retain the company’s existing lawyer or have the practitioner’s choice of lawyer take carriage of the litigation. While there are disadvantages in losing the knowledge of the existing lawyer, a practitioner may prefer their own trusted lawyer who may also have a better understanding of acting for an insolvency practitioner. There is no absolute rule that engaging either the existing company lawyer or a significant creditor’s lawyer will adversely impact the practitioner’s independence. However, this will always turn on the specific facts and caution must be exercised.[19]
• If the practitioner decides to retain the existing lawyer, it should be made clear that the practitioner is only accepting liability for costs incurred in relation to their instructions, and not costs incurred prior to their appointment.
• Undertaking steps to reduce the likelihood of a personal costs order against the practitioner if they take an active role in the litigation include. These include applying to court for directions whether to continue the proceeding, agreeing to provide security for costs, conducting the proceeding sensibly and making reasonable settlement offers.[20]

Abandoning the litigation

If the practitioner decides not to continue the litigation, the practitioner should notify the other parties and ensure the court is also informed. If a related party (such as a director) is also involved in the proceeding, they may continue their involvement in the proceeding to protect their own position. If a receiver declines to take any steps in relation to litigation, it will be prudent to inform the liquidator in case the liquidator wishes to continue the litigation.

A multitude of factors

Litigation has the potential to be a valuable asset. Insolvency practitioners must accordingly act prudently in assessing and deciding whether to continue litigation, which involves considering a multitude of factors.

This article was first published in the Australian Restructuring Insolvency & Turnaround Association Journal, volume 31 2019.

[1] Some jurisdictions, for example the Victorian Civil Administrative Tribunal, do not usually award costs.
[2] Australian Property Custodian Holdings Ltd v Capital Finance Australia Ltd & Ors [2012] VSC 124.
[3] If the liquidator commences the proceeding in their own name, such as when seeking directions, the risk is higher. See McDermott and Potts in their capacities as joint and several liquidators of Lonnex Pty Ltd (in liq) (No 2) [2019] VSCA 62.
[4] See Re Australian Residential Builder Pty Ltd (No.2) [2019] VSC 389 and McDermott & Potts in their capacities as liquidators of Lonnex Pty Ltd (in liq) [2019] VSCA 23.
[5] Section 440D of the Corporations Act 2001 (Cth).
[6] Sections 471B and 500 (2) of the Corporations Act and see Re Grant (1983) 7 ACLR 669 at 744, where McPherson J stated the purpose of the provision is to protect the company from a ‘multiplicity of actions which would be both expensive and time-consuming, as well in some cases as unnecessary’. It is more likely that leave will be granted if the claim is proprietary, see QBE Insurance (International) Ltd v Cycand Pty Ltd [2009] NSWSC 1177.
[7] Re Capital General Corp Ltd (2001) 19 ACLC 848.
[8] Beconwood Securities Pty Ltd v Australia & New Zealand Banking Group Ltd (2009) 27 AC LC 65 and Phisci Pty Ltd v Green Frog Nominees Pty Ltd (in liq) (3) [2009] FCA 43 at [7].
[9] Section 60(2) of the Bankruptcy Act 1966 (Cth).
[10] Section 60(3) of the Bankruptcy Act. There is an exception for a claim in respect of any personal injury or wrong done to the bankrupt, their spouse or de facto partner or member of their family.
[11] Section 58(3) of the Bankruptcy Act.
[12] Abbott v Pilot Development Corporation Pty Ltd [2006] NSWSC 1178 and DLA Piper Australia v Official Receiver of Singapore & Ors [2017] VSC 216 (27 April 2017).
[13] Abbott v Pilot Development Corporation Pty Ltd [2006] NSWSC 1178.
[14] Sections 8(2) and 73 of the Personal Properties Security Act 2009 (Cth).
[15] Section 530B(1) of the Corporations Act. Bennett & Co v CLC Corporation & Ors [2001] WASCA 51 confirmed that s 530B empowers a liquidator to ascertain the affairs of the company, not to gather assets. The liquidator’s decision to pay the solicitors their unpaid costs to discharge their lien over certificates of title was upheld.
[16] Oswal v Burrup Fertilisers Pty Limited (receivers and managers appointed) [2013] FCAFC 9.
[17] Cassegrain v Gerard Cassegrain & Co Pty Ltd (in liq) [2012] NSWCA 435.
[18] Equititrust Ltd (in Liq) (Receivers appointed) (Receivers and Managers Appointed) v Equititrust Ltd (in Liq) (Receiver appointed) (Receivers and Managers Appointed) (No.3) [2016] FCA 738.
[19] In the matter of FW Projects Pty Limited (in liquidation) [2019] NSWSC 892 at [152].
[20] ASIC v Rowena Nominees Pty Ltd (2003) 45 AC SR 419, Pullin J.