Yesterday the Supreme Court published its long-awaited decision in the Joe & Joe Developments litigation.

The litigation has been the subject of much gossip in the industry as it concerned allegations of rampant overcharging by insolvency practitioners and their lawyers. Commentators and industry observers have been poised, salivating, waiting for the scandal to break.

In the event, as is often the case with gossip, the facts were found not to justify the hype.After laying the facts bare, the court did find that the deed administrators had managed the company’s affairs in a way that was prejudicial to members, but found that the key issue was a process failure (rather than wilful dishonesty or deliberate misconduct) and, because the administration was almost at an end, declined to remove the deed administrators and reserved the question of costs.

 

Background

Joe & Joe Developments Pty Ltd (SDOCA) [2014] NSWSC 1444 concerned an application by a group of disgruntled shareholders to remove the administrators of a deed of company arrangement as a result of alleged impropriety on a number of fronts.

The shareholders’ main contention was that the deed administrators had paid themselves, and their lawyers, far more than they should have, thereby diminishing the return to shareholders.

An allegation of harm to shareholders is unusual in the context of a system where returns to shareholders are rare, but this was an unusual case. As the decision records:

• the administrators were appointed in the context of a shareholder dispute;
• at the time of the appointment, the company owned a block of units which was largely unencumbered;
• the projection in an early report to creditors was that, after sale of the units and payment of creditors and the costs of the administration, a surplus of $2.09 million would be returned to the shareholders;
• however, some years later, as a result of the matter dragging out and several hundred thousand dollars of unforeseen remuneration and over $730K in unforeseen legal costs being incurred, the parties ended up staring down the barrell of a shortfall of more than $550K.

 

Analysis

The judgment is long and involves analysis of a litany of complaints. Throughout the 111-page decision, the court considered attacks made by the plaintiffs on the administrators’ conduct on several different fronts.

The court was, however, hesitant to criticise the deed administrators’ conduct to the extent urged by the plaintiffs, referring to the need for courts to exercise restraint when second-guessing business and commercial decisions made by liquidators and trustees in bankruptcy.

Further, the court found that many of the complaints against the deed administrators were unsubstantiated, or inadequately took into account the impact of the shareholders’ own behaviour. For example:

• With regard to complaints that the DOCA was unduly complex, the court pointed out that the deed administrators could not be blamed for the complexity in circumstances where they were the ones who proposed the DOCA, and their lawyers were closely involved in the drafting.
• The evidence led by the plaintiffs about fair and reasonable legal costs was also found to be unsatisfactory. The court found that the plaintiffs’ expert opinion about what was fair and reasonable did not adequately recognise the complexity of the matter, as a result of which the figure the plaintiff suggested as reasonable was of no assistance.
• The plaintiffs also urged the court to accept that the deed administrators had paid their solicitors “without caring” about whether the amounts claimed were properly and reasonably claimed, but the court found that criticism unjustified, observing that the lack of scrutiny was fundamentally a process failure, and “a failure of process is not the same as indifference”.

This last matter – the deed administrators’ failure to give sufficient scrutiny to sums charged by their lawyer and a consultant – was the matter of most concen to the court. However, the failure was found to have had its genesis in imperfect bureaucratic procedures within the deed administrators’ office – a very important thing to fix, but hardly the stuff of headlines.

The court adjourned the matter to enable the deed administrators to put on evidence about the reasonableness of the sums paid and foreshadowed that, if they are ultimately found to have paid too much, they will need to pay the difference back – a fairly orthodox and unremarkable outcome, which will be disappointing to those hoping for fire and brimstone.

 

Take-away points

There have been a number of recent cases about the need for insolvency practitioners to think carefully about what they are charging (see previous updates on the AAA Financial decision and the On Q and Hellion decisions).

This case is a reminder that practitioners should give equal scrutiny to out-of-pocket expenses – a duty described by the court as “an insolvency practitioner’s responsibility to exercise care and closely monitor fees as they are incurred”.

It is also timely to recall what the court said ten years ago in Stockford:

An insolvency practitioner stands in a fiduciary relationship with the creditors. He must act with the same care as a prudent businessman would act in his own affairs at his own cost and risk. A prudent businessman will run litigation as a last resort and when he embarks upon litigation he will keep it under close scrutiny. A prudent businessman will shop around to ensure that he obtains the services of good lawyers (solicitors and counsel) at the best possible rate. Personal relationships should not obscure the practitioner’s duty. The sole selection criteria should be the benefit to him as a litigant. So he will avoid cosy relationships with solicitors and counsel. He will negotiate over fees with both solicitors and counsel. He will closely monitor the fees as they are incurred. (In some jurisdictions contingency fees are permitted and where they are they should be exploited). Overall, this approach is likely to cause disquiet among the profession. Lightman J said that the requirement of adopting the perspective of the insolvency practitioner expending his own money in place of the perspective of spending his client’s money is a “sea change”. If made it is a change that will restore public confidence in this area of commercial life.

As always, practitioners in doubt about their rights and obligations in a specific scenario should seek the advice of experienced, competent insolvency lawyers.