- Liquidation is the legal process that occurs when a company is formally wound up.
- In most cases (though not all), a company enters liquidation due to insolvency: being unable to pay debts as they fall due and payable.
- The key impact of liquidation is that, while the process is underway, ‘unsecured creditors’ (those who are owed by the company, but have no ‘security’ in its assets such as a mortgage), cannot commence or continue legal action against the company to recover the debt (except via leave of the court).
- The process is overseen by an independent and impartial professional called a ‘liquidator’. See here for more on the liquidation process.
We have written previously about the relevant considerations when appointing a liquidator, but what happens where questions arise about the conduct of a liquidator once they are in the job? What if, for example, a creditor suspects a liquidator of being ‘in cahoots’ with the directors of the company to facilitate illegal ‘phoenix activity’?
In this article we look at the options available to interested parties, including directors, creditors and regulators to review the conduct of liquidators and, in some cases, have them replaced. We explain:
- the different types of liquidation;
- the role of the liquidator;
- liquidator independence;
- removal of liquidators via resolution of creditors;
- court applications;
- appointment of a ‘Reviewing Liquidator’;
- committees of inspection.
Types of liquidation
Liquidation can be initiated in various different ways. The different types of liquidation are:
- A members’ voluntary liquidation (MVL). This process can be initiated where the shareholders of the company (‘the members’) resolve to wind up the company, but it is not insolvent. This might be initiated, for example, in the case of company restructuring;
- A creditors’ voluntary liquidation (CVL). This is a voluntary liquidation where the company is insolvent. It can be initiated following a creditor vote at the end of voluntary administration or following a terminated ‘deed of company arrangement’ (DOCA). You can read more about these processes here and here. As with a MVL, it can also be initiated by a resolution of the shareholders.
- Court liquidation. In court liquidation, a liquidator is appointed by the court to wind up an insolvent company. The application may be made by a range of interested parties including the creditors, directors, the Australian Securities and Investments Commission (ASIC) and the company itself.
The role of the liquidator
In overseeing the liquidation process, the liquidator must:
- ascertain the assets of the company and protect those assets;
- investigate and report to creditors about the company’s affairs;
- investigate the failure of the company, considering the committing of any offences and then reporting the result of any such investigation to ASIC;
- distribute the proceeds of the winding up according to creditor prioritisation rules and accounting for the costs of the liquidation.
On appointment, the liquidator must give creditors notice of their appointment and advise them of a range of matters, including:
- the right to request information;
- the right to give directions;
- the right to appoint a reviewing liquidator;
- the right to remove and replace the liquidator.
Depending on the type of liquidation, this notification must be given within 10 or 20 business days.
In today’s article we are focused on how creditors may use their powers to review or direct the behaviour of liquidators.
Section 532 (1) and (2) of the Corporations Act 2001 set out the requirements that an appointed liquidator of a company must be a registered liquidator and not be in a set or restricted relationships with the company or its directors. The latter condition in the Corporations Act 2001 as well as a long line of judicial decisions confirm the need for liquidators to be ‘independent’ of the company. The independence of the liquidator is also preserved by the requirement of a liquidator to make a declaration as to relevant relationships and indemnities prior to appointment.
Note, however, that under section 532(4) of the Corporations Act 2001, in the case of an MVL, if a company is a proprietary company, the appointed voluntary liquidator is not required to be a registered liquidator and can be an officer of the company or other professional with the necessary expertise.
Independence can be seen as a component of the obligation of a liquidator always to act in the interests of creditor, not directors. Independence ensures that liquidators are in a position to impartially investigate directors and pursue legal action against them where necessary.
A common reason that creditors or other interested parties might have to review the conduct of a liquidator is a conflict of interest/perceived conflict of interest or lack of independence. In light of this we consider below two important considerations in evaluating liquidator independence:
- The test of independence
- The duty to investigate.
The test for independence is an objective one. It is not enough that a liquidator has actually acted independently – a hypothetical fair-minded observer would also need to perceive the behaviour as independent (Australian Securities and Investment Commission v Franklin (liquidator), in the matter of Walton Construction Pty Ltd (in liq)  FCA 68). The recent case of Hooke v Bux Global Limited (No. 6)  FCA 1545 emphasised the importance of liquidators being seen to be independent. In this case an administrator had his appointment as the liquidator of the company rejected by the court. The court emphasised that there was no one factor which disqualified the administrator from being appointed, rather it “must be viewed in the context of the particular circumstances in which this company is being ordered to be wound up.”
In the circumstances of that case, the fact that there were serious questions about whether fraud had occurred in the final days of the company, and the fact that the company had only been trading with the support of a related company which had itself provided funding to the administrator, meant that the administrator did not satisfy this test. It was not a proven lack of independence but a perception of independence that was lacking.
In a practical sense, how should this duty of independence impact on how the liquidator carries out their role? In a recent newsletter, ASIC declared a key compliance focus on registered liquidators who have not been asking sufficient questions of the company and its officers when carrying out their role. In particular, ASIC expressed concern at liquidators not asking sufficient questions about changes to company officers shortly before liquidator appointment.
ASIC emphasised that there is a question as to the ability of directors to form judgements as to company solvency when they have just been appointed (recall, that this determination is a requirement for many liquidations). ASIC observed that this lack of investigation into officer behaviour could be seen as lessening creditor confidence in liquidator independence.
Creditor’s resolution to remove and replace a liquidator
In many cases, it will be the creditors, rather than any other party, who are dissatisfied with the conduct of the liquidator. After all, the liquidators are obligated to the creditors, not to the directors of the company or the company itself. Creditors have the right, at any time, to propose the removal and replacement of the liquidator.
Before requesting such a meeting, a creditor must approach a registered liquidator and get their written consent that they will act as liquidator. Also, at that time, the proposed liquidator must make a declaration as to relevant relationships to be submitted with the proposal to replace the liquidator. The creditor seeking a replacement liquidator must request the existing liquidator to call a meeting. The existing liquidator is not required to comply with that request if the request is ‘not reasonable’ (section 75-250 Insolvency Practice Rules (Corporations) 2016).
In the notice calling the meeting, details of the proposed resolution must be included as well as consent from the new liquidator to be appointed and a declaration of their relevant relationships. The removal of an existing liquidator will take affect from the passing of a resolution to appoint a replacement liquidator.
Power to apply to the court for replacement of the liquidator or declarations about liquidator’s conduct
There are times when a creditor resolution to replace a liquidator will not be effective. For example, where it is impossible to get other creditors to agree to that resolution, where a non-creditor wants to replace the liquidator (such as ASIC), or where replacement is not sought.
Under section 447A of the Corporations Act 2001, the court has broad powers to make orders as it sees fit in relation to liquidation. See here for a discussion of the application of this power in the case of voluntary administration.
This application to the court allows creditors, others with a financial interest and directors apply to the court for an order:
- For a determination in relation to any matter related to the liquidation;
- An order that an individual be replaced as the liquidator;
- Remuneration orders.
If creditors are concerned about fees or costs incurred or to be incurred by the liquidator, there is another mechanism available. A ‘Reviewing Liquidator’ can be appointed to review fees and/or costs incurred (Insolvency Practice Rules).
There are two mechanisms for appointing a reviewing liquidator:
- by a resolution of creditors. If this occurs the costs of appointing the reviewing liquidator are simply added to the costs of liquidation;
- without a resolution, but with the consent of the liquidator. If this occurs, the applicant creditor must bear the costs of appointing the reviewing liquidator.
The liquidator and their staff are required to cooperate with the reviewing liquidator and the reviewing liquidator may look into:
- approved remuneration over the previous six months;
- costs or expenses incurred during the previous 12 months.
Committee of Inspection
If creditors wish to ensure that they have influence over the liquidators before any problems arise, one useful option could be to form a ‘Committee of Inspection’ (Insolvency Practice Rules). This committee:
- monitors the conduct of the liquidator;
- may give directions to the liquidator (though note, the liquidator only need ‘have regard’ to such directions).
A Committee of inspection may be formed by resolution at a meeting called for that purpose and creditors themselves will choose the members.
There are a range of options available for reviewing the conduct of a liquidator, or in some cases, replacing that liquidator. Note, however, that these are primarily options for creditors who are concerned with the behaviour of liquidators, particularly those who are not acting independently or seen to be doing so. Of particular note are the powerful options of a ‘committee of inspection’ or appointment of a ‘reviewing liquidator’ that do not require resorting to expensive court action.
For directors of companies, however, options are very limited for replacing or reviewing the conduct of a liquidator. In light of this, it is all the more important that directors seek specialist advice about liquidation well before insolvency is imminent.