Pre-insolvency hacks – trauma for all involved

Articles, Restructuring + Insolvency

ERA Legal has long championed the need for caution when dealing with unlicensed, unregistered and unregulated pre-insolvency advisors. Let’s call them the Pre-Insolvency Traders (the PITs).  We are troubled by the harm the PITS’s inflict, given the often unethical and unscrupulous approach many of the PITs take. We know our concerns are shared by many in the insolvency industry.

A recent decision Asden Developments Pty Limited (in liquidation) v Dinoris (No 3) [2016] FCA 788  clearly demonstrates the mess left as a consequence of reliance on advice  from a pre-insolvency hack which was self-interested, unscrupulous and designed to hide assets from creditors.

The unfortunate consequences in Asden include:

  • The liquidator being held to have breached the duty he owed to the company pursuant to section 180 of the Corporations Act 2001 (Cth);
  • The director becoming bankrupt;
  • The PITs becoming bankrupt (although it should be made clear that the case does not make a finding that the bankruptcy resulted from the facts of the case);
  • A company controlled by the PITs being put into liquidation.

Asden is not only a case study of what the consequences dealing with the PITs can be, but is also an interesting analysis of what constitutes a breach of duty by a liquidator.

Background

Asden was a company incorporated for the purpose of involvement in a property development to be undertaken by various members of the Nichols Family on land owned by members of the family.

Ms Nichols, the sole director and shareholder of Asden was involved as her husband could not be a director due to his bankruptcy.

Ms Nichols asserts that she was misled in relation to the affairs of the company by her husband. When it became apparent that the company was facing financial difficulties she borrowed money from another Nichols family member, for the purpose of paying Asden’s creditors.

At around this time Ms Nichols and her husband separated which caused ill will between Ms Nichols and other members of the family.

Ms Nichols became concerned about the affairs of the company and approached the company’s accountants for advice who referred her to the PITs whose advice she relied on from that time on.

What was the advice?

At the time PITs was approached the company still had the majority of the money that Ms Nicholas had borrowed to pay creditors.

To deal with the situation the PITs designed what the judge described as an ‘elaborate’ scheme. Unsurprisingly it was not a scheme that considered the interests of creditors of the obligations Ms Nichols had as a director. In short:

  1. A company called CJI Investments Pty Limited (of Ms Nichols was the sole director and shareholder) was incorporated;
  2. A bank account in Asden’s name was established at the Bank of Queensland;
  3. Asden’s money was transferred to Asden’s Bank of Queensland Pty Limited (BOQ’s) account;
  4. Asden transferred $236,500 from the BOQ account to Urban Property Pty Limited;
  5. The PITs was the sole director of Urban Property;
  6. Urban Property transferred $180,000 to TJI Investments’ bank;
  7. Asden was placed into voluntary liquidation

One of the liquidators,  Mr Combis was not actively involved in the conduct of the liquidation and no findings were made against him in the case.

It is relevant to note that:

  • Evidence was given that the money at the core of the dispute was borrowed specifically to enable Asden to pay creditors;
  • The transfer of the company’s bank account was made the day before the company was placed into liquidation;
  • The end result of the scheme was that;
    • The PITs received over $50,000 of the money: and
    • The Director’s company received $186,000 : and
    • Asden was left with no money.

Before being appointed, the liquidator was told by the PITs that if the liquidator wished to communicate with the director he should do so through the PITs.

Shortly after he was appointed, the liquidator became aware of the transfer of money out of Asden’s bank account. He telephoned the PITs about it. The PITs said that the monies were not received by Ms Nichols personally and that the liquidator should investigate the withdrawal of the funds.

The liquidator did not telephone Ms Nichols to ask her about the transfer. He did send Ms Nichols what appears from the judgement to be a ‘standard’ letter concerning her obligations in the winding up. The liquidator did not however communicate with Ms Nichols directly about the transfer of funds although he did subsequently seek funding from creditors to undertake a public examination of Ms Nichols.

In subsequent proceedings in the Family Law Court, the original lender obtained a judgement against:

  1. Ms Nichols and recovered the balance of the monies being held by TJI Investments;
  2. The PITs for the money paid to Urban Property.

The claim against the liquidator

At some time, and in circumstances which are not clear, the liquidators were removed as liquidators of Asden and Mr Clout was appointed liquidator in their place.

Mr Clout brought proceedings alleging that the liquidator breached his duty as an officer of the company by failing to telephone Ms Nichols to demand the return of the money transferred as soon as he found out what had happened – which was a day or so after his appointment.

In considering the duty owed to the company by its liquidator the court held:

  • Liquidators are subject to the same statutory duty as directors;
  • Liquidators are also required to meet the high standard and due diligence expected of persons who are paid to exercise their professional skills;
  • the care and skill must be exercised to an extent reasonable in all the circumstances, which include the fact that some decisions and courses of action will be of a business or commercial character and there may be differences of opinion (particularly with the benefit of hindsight) as to what should have been  done;
  • the test is not whether the Liquidator’s conduct was so unreasonable that no reasonable liquidator could have acted in the manner complained of;
  • a liquidator can be liable in negligence for failing to exercise a degree of care and skill which he or she holds out he or she has by virtue of accepting the office of liquidator;
  • the Business Judgment rule defence is not available with respect to the liquidators’ obligations to take custody of and control the property of the company as those obligations do not concern the conduct of any business or commercial activity by a company;
  • the test as to whether a breach is made out is objective and requires an assessment as to whether the conduct demonstrated the required degree of care and diligence that was reasonable in all relevant circumstances having regard to the degree of care and diligence expected of a skilled and professional accountant performing the role of a liquidator.

The Court stated it was not the case that directors should be contacted directly by the Liquidator in every winding up. The Court stressed that its finding in Asden was unique to the circumstances of the case (as it must be given the need to consider the ‘relevant circumstances’) and that the rule did not set ‘an inflexible rule’ nor ‘restrict the general discretion held by a liquidators in relation to the conduct of the liquidation.

In circumstances where monies had been transferred the day before the liquidators’ appointment, the liquidator had obtained a withdrawal slip showing that Ms Nichols signed the withdrawal and where the liquidator had expressed some doubt about the truth of what he had been told by the PITs (that the money was not in Ms Nichol’s account) – the court held that the liquidator should have contacted Ms Nichols directly to enquire about the withdrawal.  The Court held that the failure to do so constituted a breach of duty.

In conclusion the Court said:

…I do not consider the liquidator displayed the care and diligence of a reasonably competent liquidator when he made his decision late on the afternoon of 23 December 2010, and maintained that decision thereafter, not to attempt to make any direct personal contact with Ms Nichols and enquire about the funds that she had withdrawn…”

Such a finding of course, is not one which any professional would wish to have made against them.

Damages

However in the end, the Court was not satisfied that the breach of duty by the Liquidator had caused a loss.

The Court found that even had the Liquidator contacted Ms Nichols directly, the likelihood is that she would not have agreed to pay back the funds that had been transferred out of the company.

The Court found that at that time Ms Nichols was relying on the advice of the PITs and that he would have advised her not to repay the funds to the Liquidator. The Court found that the liquidator had implemented the scheme to protect Ms Nichols from ‘financial ruin.’ The Court noted that Ms Nichols said, throughout the cross-examination, that the PITs had advised her about every step of the scheme and she followed this advice.

Conclusion

The Court’s findings are a devastating critique of the actions of the PITs. While in the circumstances there was a question about whether the monies were the company’s funds or in fact had to be repaid to other members of the Nichols family, one thing was clear, that there was no conceivable way anyone involved could have believed that the money belonged to Ms Nichols.

Notwithstanding this, she was advised by the PITs to transfer some of the money to, effectively, herself and to the PITs who had, in the words of the Court:

“…(a) personal stake in that scheme to the extent of $56,500…”

The case is well worth reading if only for a useful summary of the duties the law imposes on a liquidator.

The case is far more interesting when its particular circumstances are taken into account. The facts demonstrate with devastating force the consequences that can arise from the involvement of unregulated, unscrupulous pre-insolvency “advisors”.

In this instance, the damage caused extended far beyond the usual victims i.e. creditors. .

Here creditors, the director, the liquidator, a solicitor and ultimately the PITs all suffered as a consequence of the implementation of a scheme which by any measure,  lacked commercial morality and was capable of implementation only due to the actions of a the PITs who preyed on and took advantage of a director facing  a time of financial difficulty and who was uncertain about her obligations.

Unfortunately there is nothing rare or uncommon about that happening.

Hopefully Asden will serve as a salutary lesson. Its facts deserve to be published widely and it is hoped the lessons that can be learned from it will be noted and acted upon.

Unfortunately ERA Legal rather suspects that it will take more than a judgment such as this before substantive action is taken to regulate and control what is all too often a predatory and unsavoury aspect of practice of insolvency, behaviour which ultimately damages the good name of all those hard working honourable professional s who work in the insolvency industry.

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