Going above and beyond: s 439A report leads to removal of liquidators

In Independent Cement and Lime Pty Ltd v Brick and Block Company Ltd (in liquidation) (receivers & managers appointed) [2010] FCA 352, Justice Finkelstein considered the duty of voluntary administrators to investigate and report on potential litigation recoveries in section 439A reports.

Finkelstein J ordered the removal of the liquidators because, primarily, of deficiencies in their investigations during the administration, which lead to a lack of confidence in the capacity of the liquidators to pursue recovery actions for the benefit of the creditors.

Facts

Brick & Block was placed in administration by its directors in October 2009. Alphalite Pty Ltd, a related party of Brick & Block, proposed a DOCA under which the business of Brick & Block would be sold to an entity controlled by the directors of Brick & Block. The administrators recommended the DOCA to Brick & Block's creditors in their section 439A report. A resolution in favour of the DOCA was passed by the required majority of creditors.

Independent Cement and Lime, a creditor of Brick & Block, brought an application in the Federal Court for the termination of the DOCA. Before that application could be determined, a meeting of creditors determined to:

1. terminate the DOCA (due to the failure of the proposed sale of the business of Brick & Block); and
2. appoint the deed administrators as liquidators of Brick & Block.

Independent Cement and Lime amended its application to seek the removal of the liquidators and their replacement with alternate liquidators. The basis of the application was broadly that the liquidators (in their capacity as voluntary administrators):

1. had failed to adequately investigate, and report to creditors on, claims available to the liquidators if Brick & Block was wound up; and
2. recommended a DOCA that was flawed in that it:
   (a) failed to compromise the debts owed to "non-participating creditors" (thus returning Brick & Block to normal trading as an insolvent company); and
   (b) was premised on purchasing the support of the directors, which could have been compelled by the liquidators' statutory powers.

Independent Cement and Lime criticised the administrators' section 439A report for failing to investigate, and advise creditors on, the merits of various recovery proceedings which may have been available to liquidators appointed to Brick & Block. In particular, the administrators failed to properly investigate and report on:

1. 2 possible unfair preference actions against entities related to Brink & Block totalling approximately $680,000;
2. a possible action in relation to capital improvements to a leased property totalling approximately $9 million;
3. the capacity of the directors to meet a potential insolvent trading claim (including the failure to investigate whether the directors owned shares in other companies); and
4. the merits of a claim against Brick & Block's holding company, pursuant to section 588V of the Corporations Act.

In addition to this, the DOCA provided for the directors to share in the proceeds of claims of Brick & Block realised by the deed administrators. In their 439A report, the administrators stated that the claims of Brick & Block were unlikely to be successful without the support of the directors and that the directors would not provide their support unless they were to share in the proceeds of the claims. The administrators did not inform the creditors that such support may be compelled by administrators and liquidators.

Findings

Finkelstein J was critical of the administrators' section 439A report and described their overall conduct during the administration as "troubling". Finkelstein J found that "the liquidators were too willing to support the DOCA without having fully explored the potential claims if the company were wound up." He found that the administrators' willingness to accept an arrangement which bought evidence from the directors (without acknowledging to creditors that such assistance could be compelled) was "of particular concern". Finkelstein J commented that "this suggests a deference to directors which justifies a loss of confidence in the ability of the liquidators to pursue claims against the directors." Finkelstein J ordered the removal of the liquidators and the appointment of new liquidators.

Summary

The decision in Brick & Block illustrates that administrators are expected to conduct more thorough investigations than would normally be the case in an administration where the administrators recommend a DOCA that returns the business of the company to the control of the directors.

The recommendation by the administrators of a DOCA that returned the business of Brick & Block to the directors (through the vehicle of a newly incorporated company) falls within the set of circumstances referred to by Austin J in Bovis Lend Lease Pty Ltd v Wily (2003) 45 ACSR 612 where administrators must go beyond their statutory duties of investigation to protect the interests of creditors.