Thinking | 23 July 2014
ASIC successfully appeals Walton Constructions decision
Last Friday, the Full Court of the Federal Court of Australia handed down its decision in ASIC’s case seeking the removal and replacement of the liquidators of the Walton Constructions group, on the grounds of a perceived lack of independence.
ASIC failed in its case at first instance in February 2014, but succeeded on appeal. A copy of the appeal decision (Australian Securities and Investments Commission v Franklin (liquidator), in the matter of Walton Constructions Pty Ltd  FCAFC 85) is available here.
The case clarifies the standard of independence required by administrators and liquidators, and highlights important considerations for dealing with referrers such as accountants, bankers and lawyers. It may also have ramifications for referral relationships and the selection of insolvency practitioners, particularly where there are pre-appointment transactions involving a referrer which will be investigated.
The key messages from the decision are:
- The decision confirms that administrators and liquidators can be removed if there is an actual or apprehended (perceived) conflict of interest or bias. The test is whether a fair-minded lay observer might reasonably apprehend that the practitioner might not bring an impartial mind to their duties. This is the same standard that is applied to judges.
- Practitioners should be wary of accepting an appointment in circumstances where:
- there is a substantial referral relationship between the practitioner and the person who referred the matter to the practitioner; and
- the person who referred the matter was involved in pre-appointment transactions that the practitioner will need to investigate.
These factors together may give rise to an apprehension of bias.
- In assessing whether there is a substantial referral relationship, the quantum of fees generated from the relationship is relevant and must be assessed from the perspective of a lay observer, not an insolvency practitioner.
- In this case, the referral relationship was new and the number of referrals was increasing. The referral relationship resulted in fees to the insolvency practitioner of $500,000 in the 2012 financial year and $250,000 in the 2013 financial year. The Court held that a lay observer and a creditor would consider these fees to be significant (even though the fees comprised only 2% – 4.4% of the firm’s overall revenue).
- Practitioners should carefully consider their position if their independence is queried by creditors or other parties. Although they may be confident that there is no actual bias, the query itself suggests there may be a perception of bias.
- A pre-appointment meeting between the proposed administrator and the director is acceptable. However, the proposed administrator should be cautious about allowing a third party (not from the administrator’s firm) to attend the meeting. That person will be privy to the advice given by the proposed administrator and so it may appear that they have been favoured. If that person, or transactions they were involved in, may need to be investigated, the practitioner should consider excluding the person from the pre-appointment meeting.
- The Court held that the declarations of relevant relationships and indemnities (DIRRI) made by the administrators in this case complied with sections 60 and 436DA of the Corporations Act 2001 (Cth) (Act). The relevant text of the DIRRI is set out in Part 3 below.
Walton Construction Pty Ltd and Walton Construction (Qld) Pty Ltd were placed in voluntary administration (and subsequently liquidation) in October 2013.
Shortly before the appointment of the administrators, the companies entered into a number of transactions, including various asset sale agreements (ASAs) with entities associated with the Mawson Group. The Mawson Group provides business advisory and restructuring services, and was retained by the companies. The ASAs provided for the transfer of substantive company assets to entities associated with the Mawson Group, and in some instances the only consideration received by the companies for the transfer was the assumption of liabilities. The Mawson Group had a referral relationship with the administrators.
In December 2013, ASIC issued proceedings in the Federal Court of Australia seeking orders that the liquidators be removed and a declaration that the DIRRIs made by the liquidators on their appointment as administrators were deficient.
ASIC’s application failed at first instance (a copy of the decision is available here) and ASIC appealed to the Full Court.
The Full Court considered the same two issues that arose at trial: whether there was a reasonable apprehension that the liquidators lacked independence and impartiality, and whether the DIRRIs were insufficient.
There was a reasonable apprehension of a lack of independence and impartiality
Section 503 of the Act provides that the Court may ‘on cause shown’ remove and replace a liquidator. An application for removal may rely on any conduct or inactivity by a liquidator, such as moral turpitude, bias, lack of independence, incompetence or other unfitness for office.
It is settled law that removal will often be ordered where it appears that the liquidator is in a position of actual or apparent conflict of interest or bias.
ASIC’s case was that there was a reasonable apprehension that the liquidators lacked independence and impartiality in the discharge of their duties, not that there was an actual conflict.
The established test for apprehended bias in the case of a liquidator is the same as the test for assessing apprehended bias in judges, namely whether ‘a fair-minded lay observer might reasonably apprehend that the judge might not bring an impartial mind to the resolution of the question the judge is required to decide’. Interestingly however, the Full Court suggested that liquidators should lean towards declining an appointment more readily than judges, since the public interest in judges not recusing themselves is inapplicable to insolvency practitioners. This issue was not raised by the trial judge.
On the facts in the case before it, the Full Court held there was an apprehension of bias and overturned the trial judge’s findings.
The Full Court examined the following circumstances.
A. The liquidators’ firm received significant remuneration from referrals by the Mawson Group.
The Mawson Group commenced referring work to the liquidators’ firm in 2012.
In the 2012 financial year, the liquidators’ firm received revenue from referrals from the Mawson Group of approximately $500,000, comprising almost 10% of the firm’s insolvency division revenue and 4.4% of the firm’s overall revenue.
In the 2013 financial year, revenue from the referrals was approximately $250,000, which was in excess of 5% of the firm’s insolvency division revenue and almost 2% of the firm’s overall revenue.
The Full Court held that:
- creditors are likely to regard amounts such as $250,000 and $500,000 as significant;
- at the very least, a fair-minded lay observer might apprehend that the liquidators may not wish to put their continued receipt of income of these amounts in jeopardy; and
- this was especially so, where the referral relationship had only recently been formed and the number of referrals had been slowly increasing (this is a reference to the number of referrals, rather than the quantum of fees generated which had decreased over time as noted above).
Accordingly, the Full Court held that these facts gave rise to an apprehension of bias.
B. Circumstances of the appointment of administrators
The Mawson Group contacted one of the administrators, and arranged for him to attend a meeting with the sole director of the companies. The meeting was held at the offices of the Mawson Group and attended by the administrator, director of the companies and a representative of the Mawson Group.
The Court did not accept ASIC’s argument that these matters indicated an unacceptable closeness of a relationship between the administrators and the Mawson Group. It held that the meeting appeared consistent with the ordinary means of the referrals, and that a fair-minded observer would know it is commonplace for proposed administrators to meet company directors before their appointment.
However, the Court found that the Mawson Group appeared to have influenced the decision of who would be appointed as administrators and investigate their own pre-appointment conduct. This added to the apprehension of bias.
The Court also noted that by allowing an employee of the Mawson Group to be present at the meeting, the administrator had allowed him to be privy to any initial advice given to Mr Walton, indicating some favouring of the Mawson Group. This issue was not raised by ASIC, and so the Court did not take the point further. It will no doubt be relevant in subsequent cases.
C. Shortcomings in DIRRIs and subsequent disclosure
ASIC raised a number of issues with the DIRRIs, which are dealt with in Part 3 below. In addition to these issues, ASIC relied on the following alleged shortcomings as giving rise to an apprehension of bias:
- The DIRRIs did not disclose that the administrators or liquidators may need to investigate pre-administration transactions, including transactions involving members of the Mawson Group, and that the administrator’s meeting with the company director had been held at the office of the Mawson Group in the presence of an employee of the Mawson Group.
- At the first creditors’ meetings, the administrators did not disclose the Mawson Group’s close involvement with the purchase of the assets under the ASAs.
- Similarly, the section 439A reports to creditors did not disclose the Mawson Group’s close involvement with the purchase of the assets and that they may need to investigate pre-administration transactions involving the Mawson Group.
The Court did not agree with ASIC, and held that the above matters would not have been given any significance by a fair-minded observer. In the case of large and complex administrations, it is not practical at creditors’ meetings, in particular the first creditors’ meeting, to canvass all matters of this kind in detail.
Further, the Court noted that at the first meeting the administrators had flagged these issues at a high level which was sufficient.
D. Concerns raised by creditors
At the creditors’ meetings, there were questions raised by creditors regarding the independence of the administrators. There were also unsuccessful attempts made to replace the administrators.
The Court held that these matters tended to support ASIC’s contention that a fair minded observer not only might have, but did have, a reasonable apprehension that the administrators might not discharge their duties independently and impartially.
The DIRRIs were sufficient
In every corporate and personal insolvency appointment (other than the appointment of controllers and liquidators in a members’ voluntary liquidation), the practitioner must provide to creditors a DIRRI.
The obligation to provide the DIRRI in corporate insolvency appointments is imposed under the Act by sections 449DA (administrators) and 506A (liquidators), and the requirements of the DIRRI are set out in section 60.
The administrators of the companies issued the following DIRRI:
i. Circumstances of Appointment
Mr Franklin had one meeting with Mr. C. Walton, the company’s director, on 27th September 2013 for the purposes of discussing the financial position of the company and the insolvency options available.
We received no remuneration for this advice.
This does not affect our independence for the following reasons:
The courts and the IPA’s Code of Professional Practice specifically recognise the need for practitioners to provide advice on the insolvency process and the options available and do not consider that such advice results in a conflict or is an impediment to accepting the appointment.
This meeting … set out the insolvency options available, the process involved in each option and the ramifications under alternative options. The advice will not influence our ability to be able to fully comply with the statutory and fiduciary obligations associated with the voluntary administration of the company in an objective and impartial matter [sic].
ii. Relevant relationships (excluding professional services to the insolvent)
iv. No other relevant relationships to disclose
The [companies were] referred by Mr. P. McCurry of Mawson Group, who refers us insolvency type matters from time to time. Referrals from solicitors, business advisors and accountants are common place and do not impact on our independence in carrying out our function as Administrators.
Other than this, there are no other known relevant relationships, including personal, business and professional relationships, from the previous 24 months with the company, an associate of the company … that should be disclosed.
ASIC argued that the DIRRI was insufficient, on the grounds that creditors were not given full reasons why the administrators believed that their referral relationship with the Mawson Group did not result in a conflict of interest or duty in circumstances where the administrators would need to investigate entities associated with the Mawson Group.
The Court held that section 60 requires a statement of the administrators’ reasons for their belief that there is no conflict. Section 60 does not require the administrators to give reasons why there was no perception of a conflict.
ASIC were unsuccessful on this issue, and the trial judge’s finding was not overturned.
ARITA (formerly IPA) Code
ASIC made submissions in relation to the Insolvency Practitioners Association of Australia’s guide (Code of Professional Practice for Insolvency Practitioners) (Code). The Court noted that the relevant provisions of the Code reflect the principles canvassed by the Court, and so it was unnecessary to separately address these provisions.
As a technical matter, the Court noted that the Code cannot be taken into account in construing sections 60 and 436DA of the Act.
For lawyers, this is an unsurprising finding: extrinsic material is only allowable when interpreting an Act, if the Act is ambiguous or the ordinary meaning leads to a manifestly absurd result. Even when extrinsic material is permitted, it is generally limited to parliamentary documents (section 15AB of the Acts Interpretation Act 1901 (Cth)).
However, as ASIC v Fernandez (CALDB 02/VIC13) and ASIC v Dunner  FCA 872 illustrate, the Code has an important place in regulating insolvency practitioners. It is relevant in deciding whether a liquidator has failed to properly carry out the duties of a liquidator under section 1292(2), and in inquiries under sections 423 and 536 of the Act.
Where to now?
The Full Court’s decision indicates that insolvency practitioners are held to a high standard of impartiality and independence (the same standard applied to judges).
We expect the decision will embolden ASIC to carefully scrutinise appointments where the referrer was involved in pre-appointment transactions that require investigation, and the involvement more generally of unregulated advisers in the twilight of insolvency.
Although in this instance the DIRRIs were held to satisfy section 436DA of the Act, we expect ASIC will continue to closely scrutinise DIRRIs.
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