A shot across the bows

Articles, Restructuring + Insolvency

Do liquidators have a duty of care to the guarantors of secured debt?

A recent decision of the Victorian Supreme Court has built on a 2007 South Australian decision suggesting that they do. Perpetual Nominees v McGoldrick & Anor [2014] VSC 152 (link) serves as a reminder that liquidators need to consider the interests of guarantors of secured debt when selling encumbered assets.

This is a considerable expansion of a liquidator’s customary duties, which are directed towards the interests of creditors.

The facts

Perpetual Nominees advanced funds to Rasco Pty Limited on the security of:

  • a fixed and floating charge;
  • mortgages of Rasco’s two properties; and
  • guarantees provided by Mr McGoldrick and Mrs Bentley.

Rasco defaulted but, rather than appoint a receiver or take possession of the properties, Perpetual Nominees used its power under section 436C of the Act to appoint administrators, who eventually became the company’s liquidators.

The liquidators sold the two security properties, but the proceeds were not sufficient to satisfy the whole Perpetual debt. Perpetual sued the guarantors for the shortfall.

The defence

The guarantors defended Perpetual’s claim on the basis that:

  • the liquidators owed them a duty to obtain proper value for the security property;
  • the liquidators had breached that duty in various ways; and
  • Perpetual was liable for that breach by reason of its overall involvement.

They said that, if the properties had been sold for their proper value, the whole guaranteed debt would have been discharged. They relied on a 2007 decision, Mills & Ors v Sheahan [2007] SASC 365 (link), in which the Supreme Court of South Australia concluded that liquidators may have a duty to the guarantors of secured debt.

The response

The liquidators denied the existence of any duty to the guarantors. They said that the choice made by Perpetual to appoint administrators (rather than receivers) had the effect of limiting the scope for complaint by the guarantors.

Perpetual supported the liquidators’ submission and added that, even if such a duty did exist, there was no legal basis to hold Perpetual responsible if the liquidators had breached it.

The decision

With regard to the liquidators’ submission, the court observed that:

If the contentions advanced by the liquidators were to be taken to their natural conclusion, it would mean that administrators appointed by a mortgagee to sell mortgaged property could never be held accountable by guarantors of the mortgagor, even though a sale might have been made in breach of the duties imposed on external controllers.

The court was reluctant to accept this proposition, saying:

I am satisfied that there is a basis to allege a breach of duty by the liquidators for which Perpetual is liable. Such a case is not hopeless… In my opinion, the defendants’ case… has some prospect of success…  It is not hopeless, or fanciful. It has a real prospect of success…

The court also refused to accept that there was no proper basis to hold Perpetual responsible for the actions of the liquidators:

I am satisfied that if the defendants were to establish that Perpetual relevantly directed the conduct of the administrators or liquidators in the sale of the mortgaged property… the defendants would have some prospect in succeeding in a claim against Perpetual.

In such circumstances it might be said that the liquidators were, in relevant respects, acting as Perpetual’s agent, or under its direction.

Having dealt with the arguments, the court also identified an important public policy issue, observing that the “interests of justice” required further examination of the question:

…whether a choice made by a mortgagee, to pursue a sale of mortgaged property through the appointment of administrators, will have the effect of stripping guarantors, in the position of the defendants, of remedies.

In light of those findings, the court refused to strike out the guarantors’ defence.

Implications for liquidators

Liquidators are now squarely on notice that the guarantors of corporate debt may be entitled to claim damages from them if they fail to achieve proper value for encumbered assets.

Implications for secured creditors

McGoldrick also opens the door for liability for a liquidator’s conduct to be sheeted home to a secured creditor who has been involved in that conduct.

It is not clear how, in a particular case, it will be determined whether a secured creditor’s involvement has been sufficient to enliven this liability. The question may be resolved by something resembling the legal test for shadow directorships, i.e. whether the liquidator was accustomed to acting in accordance with the secured creditor’s wishes.

Conclusion

The McGoldrick decision is a shot across the bows for secured creditors and liquidators alike. If it takes root, it will represent a significant erosion of the benefit which secured creditors seemingly receive from appointing an administrator instead of a receiver.

That said, the risks presented by the decision may be able to be minimised through the implementation of appropriate procedures and documentation. Secured creditors or liquidators who require advice specific to a particular situation would be well advised to consult with expert insolvency lawyers.

Acknowledgement

The writer gratefully acknowledges the assistance of Timothy Brooks in the preparation of this article.

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