Legal Costs in Insolvency Matters

Articles, Restructuring + Insolvency

Commencing proceedings in Court is an expensive process. The costs of that process can be a very real issue for most people in deciding whether to start proceedings or, if they are sued, to defend those proceedings.

It is usually the case that an unsuccessful party in Court proceedings will pay not only their own legal costs but also the legal costs of the other side. Due to the way in which the amount of costs payable is worked out by the Court, not all of the unsuccessful party costs are likely to be paid by their opponent.  However, the risk that even part of an opponent’s legal costs may be payable can influence decisions taken about continuing or commencing legal proceedings.

It is important to appreciate that where legal proceedings arise out of or in the course of the winding up of a Company by a liquidator, the usual rules in relation to costs may not apply. This means that in practice a person being sued in these circumstance may find themselves at a practical disadvantage.

There are, however, steps that can be taken to minimise this risk.

To understand how this process works and the associated risks, it is necessary to consider the various types of legal matters that may be involved.

The winding up application itself

If the Court makes an order that a liquidator be appointed to a Company, the Court will usually order that the costs incurred by the person applying for that order be paid by the Company.

These costs orders are regulated by the Court and very rarely represent the amount actually spent by the applicant.

More worryingly, the costs order cannot be enforced against the Company but form merely a claim in the winding-up. The costs then are paid by the liquidator of the Company out of the assets of the Company that the liquidator is able to recover. If the Company has no assets then even though the Court has made an order, no costs will be recovered by the applicant.

Even if the Company does have assets the costs may still not be recoverable. If there is a secured creditor for example, the secured creditor may be entitled to payment of its debt in priority to the applicant.

Even if there is not a secured debt, the costs may still not be paid. The costs ordered as part of the winding-up application are treated as priority claim in accordance with section 556(1)(b) of Corporations Act 2001 (Cth.). Those costs are unsecured but enjoy  a priority for payment out of the assets of the Company over other unsecured creditors. However the costs are only paid after any expenses incurred by the liquidator in carrying on any business the Company operates and/or realising and getting in the Comapny’s property. There is always the risk of course, that those costs take up all the money available.  If that occurs then the applicant will not be paid.

Investigations

Once the liquidator is appointed he or she investigates the affairs of the Company.

The office holders of the Company have an obligation to help the liquidator in those inquiries but the liquidator’s inquiries can extend to other parties involved with the Company’s affairs, including creditors and indeed the person responsible for originally winding up the Company.

In the course of those investigations the liquidator may decide to conduct examinations in the Supreme or Federal Court pursuant to Section 596A or 596B of the Corporations Act 2001 (Cth.). If the liquidator properly issues summonses for people to attend Court and be examined by him (via his or her lawyers) in the Supreme Court, the persons being examined often feel it is appropriate to have their lawyers attend Court to protect their interests in the examinations.

Traditionally these examinations are not considered to be proceedings in the usual sense of the word.  This means that at their conclusion no orders for costs are made. The Court does not make any finding as to whether or not any party (i.e. the liquidator) is liable to pay the fees of any other party (i.e. the person being examined).

It is only in the event the Court finds that the examinations were not issued properly or were issued for an improper purpose that the person required to attend Court for an examination is entitled to have his or her costs of the examination paid. Such cases are extremely rare.

Proceedings by the Company

Even though the Company has a liquidator appointed to it, it may be that things have happened in the Company before the liquidator’s appointment which mean that the liquidator is entitled to cause the Company to commence (or continue) legal proceedings.

This can happen where for instance someone owes the Company money or their actions have caused damage to the Company.

If the proceedings involve a claim properly made by the Company then the Company is the applicant in the proceedings. A simple example is where the liquidator believes the Company records demonstrate that someone owes the Company money where invoices are outstanding.

If the Court case is brought in the name of the Company, the usual order made in respect of costs is that, subject to any offers of settlement which may have been made, the losing party pays the winning party’s costs.  The fact that the Company is in liquidation does not automatically change this position.

As a result risks arise in relation to those costs. The fact that the Company is in liquidation may very well mean that the Company does not have enough money to pay the costs it has been ordered to pay at the conclusion of proceedings.

There are steps that can be taken to minimise this risk.

Where a liquidator’s proceedings are funded by someone who has an interest in recovering the money, for example a creditor, a professional litigation funder, a director or anyone else, then an application can be made to the Court to seek an order that the person involved be liable to pay any costs that are awarded against the Company.

The Court has a discretion to order that a party, who appears not to have the money available to pay any costs that may be awarded against it, can be ordered to pay money into Court or otherwise provide security for any costs orders that may be made in the proceedings.

To have such an order made gives comfort to a person being sued and may in some circumstances discourage the liquidator from proceeding further with the litigation. The requirement of the provision of the security may make it impossible for the liquidator to continue with the proceedings if he or she cannot provide the security.

If an application for security is going to be made it is critical that it be made quickly and it should be supported by evidence.  A delay in seeking orders for security may be fatal to the very application itself.

It is also possible in certain circumstances to seek an order that a liquidator be required to pay the costs of the proceedings personally even though he or she is not a party to the proceedings. The Court has a general power to order costs against non-parties but this power is rarely exercised against liquidators. The Court held in Macks v Hedley [1999] FCA1208 that a liquidator is entitled to special protection when costs orders are sought against the liquidator in circumstances where he is not a party to the liquidation.

The Court has recognised that the conduct of litigation is often an integral part of the conduct of winding up proceedings, that the liquidator is not necessarily in possession of all relevant information in relation to the Company and that the liquidator is effectively performing a public duty in performing his or her role. In these circumstances the Court has recognised the special protection that should be afforded to a liquidator. The Court will generally therefore only make costs orders against the liquidator personally where he or she is not a party to the proceedings, if the liquidator’s conduct in bringing the proceedings has been so exceptionally poor that it is clear that the proceedings should not have been brought or the Court could be satisfied that they were brought with some improper purpose.

In essence, the making of such orders is rare.

Proceedings by the Liquidator

The final category of cases in which the issue can arise is where the liquidator brings proceedings in the liquidator’s own name. A typical example is where:

  1. the liquidator seeks to recover money from a person who was a creditor of the Company;
  2. payment was made to the creditor before the Company went into liquidation; and
  3. the liquidator alleges that the payments constitute what are commonly referred to as “preference” payments.

The Corporations Act enables the liquidator to commence recovery proceedings with respect to such payments but specifies that such an application is brought by the liquidator him or herself. In those circumstances the liquidator is a necessary party to the proceedings and costs orders can be made against the liquidator personally in the event the proceedings are unsuccessful (or if a liquidator has refused an offer that was higher than the amount of the final judgment.)

It is noteworthy that liquidators often commence these proceedings by describing themselves as a party “in their capacity as liquidator.” This formula is often used in an attempt to limit the liquidator’s exposure to costs to the assets of the Company available to meet the costs order. While it is not likely the Court would limit costs orders in this way, if proceedings are commenced in this manner, clarification should be sought in writing that the liquidator accepts that any costs liability will be paid by the liquidator personally.

It is also appropriate to consider the operation of Section 556(1) of the Corporations Act 2001 (Cth.). This section provides that costs and expenses incurred by a liquidator in realising assets of the Company are expenses paid as a first priority in a winding up.

If an application to Court  is brought in the name of the Company, clarification should be sought from the liquidator that he or she agrees that any adverse costs orders will be considered such an expense of the winding up so that those costs are payable in priority to the liquidator’s remuneration.  Without such an agreement an application can be made to the Court to rule on the point.  There is little authority in this area and a liquidator may be open to the risk that his or her fees and expenses are deferred behind any adverse costs orders that have been made against him or her.

Summary

The prospects of recovering costs in litigation can be difficult at the best of times. The issue can become significantly more complicated where litigation is commenced where a Company is in liquidation.

The prospects of recovering costs in these circumstances are greatly increased if steps are properly taken to protect a defendant’s position should they find themselves a subject to litigation and these steps should be taken at the earliest opportunity.

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