Liquidator's lien prevails over secured creditor

Introduction

In a good outcome for liquidators and litigation funders, Atco has overturned a unanimous decision of the Victorian Court of Appeal regarding the application of the Universal Distributing principle. The High Court found that, provided the true purpose of the proceedings is to realise the assets of the company, liquidators will be entitled to an equitable lien over their costs and expenses reasonably incurred in litigation to preserve or realise the assets, even where the litigation is largely unsuccessful and favours an unsecured creditor over a secured creditor.

Universal Distributing principle

The principle in In re Universal Distributing Co Ltd (In Liquidation) (1933) 48 CLR 171 is well known and may be summarised as follows:

A secured creditor may not have the benefit of a fund created by a Liquidator's efforts in the winding up without the Liquidator's costs and expenses, including remuneration, of creating that fund being first met. To that end, equity will create a charge over the fund in priority to that of the secured creditor.¹

Background

The second appellant, Newtronics Pty Ltd (Receivers and Managers Appointed) (In Liquidation) (Newtronics) is a wholly owned subsidiary of the respondent, Atco Controls Pty Ltd (In Liquidation) (Atco). Atco was a lighting manufacturer and Newtronics designed, manufactured and supplied electronic components.

Atco had provided financial support to Newtronics since 1993, including by way of a fixed and floating charge over Newtronics' assets, and the provision of letters to Newtronics' auditors promising to provide funds to allow Newtronics to meet its trading obligations and that Atco would not call up the debt owed to it within the relevant period to the detriment of unsecured creditors.

In January 2002, Atco appointed Receivers to Newtronics after Newtronics was ordered to pay damages of $8.9 million to Seeley International Pty Ltd (Seeley). Newtronics was wound up in February 2002 on Seeley's application and the first appellant, Mr James Stewart, was appointed Liquidator (Stewart).

Seeley, Newtronics' largest unsecured creditor, agreed to indemnify Stewart for his costs and expenses incurred in realising Newtronics' assets. This undertaking included Seeley indemnifying Stewart in respect of all costs and expenses in pursuing an action against Atco. This action was brought in 2006, with Newtronics claiming damages in excess of $13 million and alleging that Atco's promises of financial support meant that it was not entitled to repayment of the monies advanced to Newtronics, nor to enforcement of its security. The Receivers appointed to Newtronics by Atco were joined to the proceedings in December 2006, with Newtronics alleging that their appointment was void and claiming damages for trespass and conversion.

At trial, Newtronics was successful against Atco, but not against the Receivers. Atco appealed from this decision and was successful, with the Court finding that Atco's security was valid and ordering Newtronics to pay Atco's costs of the appeal. Rather than appeal the decision with respect to the Receivers, Newtronics settled with the Receivers on 3 September 2009 for a sum of $1.25 million (Settlement Sum).

Shortly after receiving the Settlement Sum, Stewart paid it to Seeley as reimbursement of the costs and expenses Seeley had incurred in funding the actions against Atco and the Receivers. Stewart took the position that he was entitled to an equitable lien over the Settlement Sum, that the litigation expenses likely exceeded the Settlement Sum, and therefore there would be no monies to meet Atco's charge. Atco appealed Stewart's decision and brought proceedings in the Supreme Court of Victoria under s 1321 of the Corporations Act 2001 (Cth), claiming that the Settlement Sum should have been paid to Atco.

At first instance, Atco's claim was upheld and it was ordered that the Settlement Sum be paid to Atco. On an appeal by way of hearing de novo, Newtronics and Stewart were successful. Atco then appealed to the Court of Appeal. The appeal, discussed below, was allowed.

Decision of the Supreme Court of Victoria - Court of Appeal

In a decision which notably reduced the scope of the Universal Distributing principle, the Court of Appeal found that an equitable lien in favour of the Liquidator did not arise and ordered the Settlement Sum be paid to Atco on the basis that:

• the Liquidator had no existing indebtedness to which an equitable lien could attach because the Liquidator had been remunerated for all costs and expenses under the indemnity given by Seeley; and
• the realisation of the Settlement Sum conferred no 'incontrovertible benefit' on Atco.

The Court of Appeal also applied an 'unconscientious test', which required the Court to consider whether Atco would be acting unconscientiously if it were to assert priority over the assets without the relevant costs, expenses and remuneration having been discharged. Warren CJ considered that in order to answer that question, the particular circumstances of the case would need to be considered, including the conduct of the parties and the nature and context of the litigation.

Decision of the High Court

The High Court was critical of the Court of Appeal's 'unconscientious test', noting that the test would require an in depth factual inquiry and that the Court should not proceed on general notions of justice without consideration of settled principles.

After consideration of the duties of a Liquidator and whether the application of the Universal Distributing principle may be subverted if the cause of action benefits one creditor over another,² the High Court found that there were no facts distinguishing this case which would justify the exclusion of the Universal Distributing principle.

The High Court found that despite the action being in the interests of Seeley rather than Atco, this did not affect the question of whether an equitable lien arose³ because the proceedings in which the Liquidator incurred the costs and expenses were brought for a proper purpose, being the realisation of Newtronics' assets.

Based on a review of the supporting authorities, the High Court concluded that the Universal Distributing principle will apply to prevent a secured creditor unconscientiously taking the benefit of the Liquidator's work without compensating the Liquidator for that work in circumstances where:

• there is an insolvent company in liquidation;
• the Liquidator has incurred expenses and rendered services in the realisation of an asset;
• the resulting fund is insufficient to meet both the Liquidator's costs and expenses of realisation and the debt due to a secured creditor; and
• the secured creditor claims the fund.⁴

Implications

This judgment signals a good result for Liquidators and litigation funders, as it has:

• confirmed that a Liquidator's reasonable costs and expenses incurred in the preservation of assets through litigation will be secured by an equitable lien, provided the Liquidator has acted properly in pursuit of those proceedings; and
• rejected arguments that litigation funding agreements will restrict a Liquidator's right to claim an equitable lien.

Conversely, it extinguishes any excitement secured creditors may have enjoyed following the judgment of the Court of Appeal. Secured creditors are reminded that a Liquidator's lien may rank in priority to their security and that they must allow a Liquidator to recover any reasonably incurred costs and expenses from the funds realised by the Liquidator's efforts, even where those efforts involve a challenge to the creditor's security.