FEDERAL COURT OF AUSTRALIA

Independent Cement and Lime Pty Limited v Brick and Block Company Ltd (In Liquidation) (Receivers and Managers Appointed) [2010] FCA 352

IN THE MATTER OF BRICK AND BLOCK COMPANY PTY LIMITED (IN LIQUIDATION) (RECEIVERS AND MANAGERS APPOINTED)

REASONS FOR JUDGMENT

1                     This is an application under s 503 of the Corporations Act 2001 (Cth) for the removal of a company’s liquidators.  The plaintiff is an unsecured creditor of the first defendant, Brick and Block Company Ltd (in liq) (receivers and managers appointed).  The second and third defendants, Messrs Barnden and Kassem, are the company’s liquidators.  When the originating process was issued the relief sought by the plaintiff was to have set aside a deed of company arrangement made by the company (DOCA).  The deed was terminated when the funds promised were not provided.  The deed administrators then became the company’s liquidators.  Now the plaintiff asks that they be removed from office.  The allegation is that while they were administrators and deed administrators, the liquidators acted improperly in several respects.  Hence, so it is said, the plaintiff has lost confidence in the liquidators’ ability to properly carry out their duties and it is in the interests of all creditors that they be removed. 

2                     Brick & Block was incorporated in August 2003.  It is part of a corporate group associated with one of its directors, Mr Rafidi.  The company was a supplier of construction materials including lightweight brick and block products and ready-mixed concrete.

3                     On 29 October 2009, Messrs Barnden and Kassem were appointed joint administrators of the company.  For a few days they allowed the company to continue trading.  A week or so later, receivers and managers were appointed by the company’s secured creditors.  The receivers took control of the company’s assets.  They continued operating the business with a view to selling it as a going concern.

4                     Following their appointment the joint administrators received a proposal from Alphalite Pty Ltd, a related company, for a deed of company arrangement with creditors.  In brief, the proposal was that Alphalite would incorporate a new company (Newco) which would purchase the assets and business of Brick & Block for around $15.75 million and assume the obligations to satisfy the liabilities due to employees.  The purchase was to be applied first in discharge of the debt to the secured creditors, then payment to priority creditors with the balance to be paid to unsecured creditors.

5                     On 25 November 2009, the joint administrators sent to creditors the report required by s 439A of the Corporations Act for the meeting at which the creditors would decide the fate of Brick & Block.  In their report, the joint administrators recommended that the creditors resolve that Brick & Block enter into the proposed DOCA. 

6                     The second creditors’ meeting was held on 3 December 2009.  A solicitor acting for the plaintiff, Mr Critchley, attended the meeting and raised several concerns regarding the joint administrators’ report and the proposed DOCA.  Nonetheless, the creditors resolved that the company enter into the DOCA under which Messrs Barnden and Kassem were appointed as the deed administrators.

7                     This action was commenced on 24 December 2009 with the plaintiff seeking an order that the DOCA be set aside and that the company be wound up.  At the hearing of the application orders were made (1) requiring the deed administrators to convene a meeting of creditors so they could decide the fate of the DOCA; and (2) giving the plaintiff the opportunity to provide information to the creditors.

8                     The joint administrators convened a meeting of creditors as required.  They sent a report recommending that the creditors resolve to terminate the DOCA and appoint the deed administrators as liquidators of the company.  The reason for this recommendation was that the sale agreement for the business to Newco had not been entered into.  A memorandum to the creditors from the plaintiff advised of their opposition to the appointment of Messrs Barnden and Kassem as liquidators and suggested alternative appointees.

9                     The creditors met on 19 February 2010.  Mr Critchley attended and advocated the plaintiff’s proposal that alternative liquidators be appointed.  Ultimately, the creditors resolved to terminate the DOCA and appoint Messrs Barnden and Kassem as liquidators.

10                  While these events were taking place the receivers sold the Brick & Block business.  The receivers have advised Mr Barnden that they do not expect the secured debts to be paid in full unless the receivers were successful in collecting all of the company’s debts and the proceeds of an outstanding insurance claim that had been made by the company.  At this stage it is unclear whether there will be any surplus assets to distribute to unsecured creditors.  Funds in the liquidation are limited at best, and the liquidators are yet to be paid for the work they have performed as external administrators of the company to date.

11                  Following the resolution to terminate the DOCA and appoint Messrs Barnden and Kassem as the company’s liquidators, the plaintiff was given leave to amend the application so that orders could be sought for the removal of the liquidators and the appointment of the plaintiff’s nominees in their place.

THE PLAINTIFF’S COMPLAINTS

12                  The plaintiff’s various complaints about the liquidators relate exclusively to their conduct as administrators and deed administrators.  It is that conduct which the plaintiff says justifies the liquidators’ removal from office. 

13                  One of several major complaints is that while they were administrators, Messrs Barnden & Kessam failed to properly investigate actions which might be available to the company if it were wound up. If successful, such actions might lead to the recovery of sums which, in aggregate, would see the creditors better off than under the DOCA. 

14                  Before dealing with this complaint, it is necessary to say something about the standard of investigation which an administrator is required to undertake. By reason of s 438A of the Corporations Act, an administrator is under a duty to investigate the company’s affairs so as to be able to form an opinion about what future course of action is in the creditors’ best interests and inform the creditors of that opinion.  If the administrator has insufficient time before the second meeting of creditors at which the creditors will consider the administrator’s advice to form this opinion, he or she may seek an extension of the convening period for the second meeting.  In Bovis Lend Lease Pty Ltd v Wily (2003) 45 ACSR 612, Austin J said that there may be circumstances when the administrator needs to go beyond his statutory duties of investigation. The existence of a duty to make further inquiries would depend on “an assessment of the nature of the question to be investigated, the information in the administrator's hands, the cost and difficulty of making further investigation, and (most importantly) the significance of the issue under investigation to the creditors' decision” (at [325]). Equally, however, an administrator is not required to undertake investigations to the same extent as a liquidator, given the time constraints imposed by Part 5.3A:  Deputy Commissioner of Taxation v Portinex Pty Ltd (2000) 156 FLR 453, [125].

15                  In their s 439A report, the administrators outlined in some detail the investigations they had conducted into potential recoveries.  For example, the administrators identified ten potential preferential payments which totalled a little over $1m.  The report indicated that the Corporations Act provided “certain defences” to creditors and that “any recovery actions will most likely be vigorously defended”. 

16                  In their report Messrs Barnden & Kessam said they were unable to identify any uncommercial transactions or any unreasonable director related transactions.  Nor could they identify any fraudulent disparities or unfair loans. 

17                  Still, the plaintiff points to a number of matters which it says were not properly investigated and reported on.  First there are two potential preferential payments, totalling some $680,000, one to Alphalite, and the other to Bylong Quarries Pty Ltd, another related entity.  The plaintiff deduces these payments were made because the company’s balance sheet as at 30 June 2009 shows those liabilities, whereas the balance sheet as at 30 September 2009 does not.  

18                  The plaintiff’s solicitors first raised this matter with the liquidators in mid-February 2010.  Mr Barnden says it is possible the debts were not paid and that the liabilities identified in the 30 June accounts may have been incorporated into the 30 September accounts in a separate item. Because the accounting records of the company were not properly maintained, Mr Barnden says he cannot be categorical about the matter.  He says that in any event his investigation into Alphalite and Bylong Quarries suggest those companies have no tangible assets to meet any preference claim.

19                  The issue is made more complex because on 27 November 2009 the liquidators were appointed to be the voluntary administrators of Bylong Quarries.  Recognising the real potential for conflict, during the course of the hearing the liquidators offered to resign from their appointment to Bylong Quarries.

20                  Assuming that neither Alphalite nor Bylong have assets to meet any claim, the administrators’ investigation into these potential claims, while not sufficient (there was almost none) has caused no harm.  Nevertheless, criticism is warranted because of the failure by the administrators to deal with this issue in their s 439A report so as to enable creditors to make an informed decision.  

21                  The second more significant complaint concerns the failure to investigate potential claims the company might have in relation to capital improvements made to a leased property at Port Kembla.  Apparently the company spent around $9m on improvements to the Port Kembla property.  What the s 439A report indicated was that “given the Company does not own the [Port Kembla] property, the expenditure has no value to the company.”

22                  A few days before the second creditors’ meeting, the plaintiff’s solicitors complained that the s 439A report did not refer to any possible claim regarding the capital improvements.  This prompted the administrators to seek legal advice, late on 1 December 2009, about whether the company was “able to claim a constructive trust” over the improvements.  The advice received was that the company did not have a constructive trust claim.  This was duly reported to creditors at the second creditors’ meeting.

23                  The plaintiff points out, however, that there may have been other claims, such as under s 588FB (uncommercial transactions) or pursuant to the principles laid down in Barnes v Addy for procuring a breach of directors’ duties.  The plaintiff knows no facts upon which such claims may be founded.  That, indeed, is the problem that has been created by what seems to be a significant short-coming in the inquiries undertaken by the administrators.  It appears that the administrators did not turn their mind to the potential for any claim in respect of the expenditure.  Then, only after prompting by the plaintiff’s solicitors, was legal advice sought as to the existence of a constructive trust.  The advice was given on a very short turn-around.  It did not consider other potential claims.  In fairness to the administrators, it might have been expected that their lawyers would have flagged any other possible claims in their advice.  However that may be, given the amount of money involved, the administrators’ investigation into this issue was unsatisfactory. 

24                  The next matter about which the plaintiff complains is the failure to properly investigate whether the directors have assets to meet a potential insolvent trading claim. The administrators had sought a statement of financial position from the directors and had conducted land registry searches to ascertain whether the directors owned any real property in NSW.  On the other hand, the administrators did not carry out searches to see whether the directors had any shares in other companies.  Mr Critchley said that a search shows that Mr Rafidi holds shares in a company said to be worth tens of millions of dollars.

25                  When questioned about this by Mr Critchley at the second creditors’ meeting, Mr Barnden said that the directors were well advised and that it would be uncommercial to pursue insolvent trading actions.  This does not sound like a considered view.  The apparent failure to carry out shareholder searches is of some significance, given that such searches are relatively easy to carry out and, more importantly, the administrators were aware that Mr Rafidi was involved with a number of companies, several of which were not under external administration.

26                  A fourth matter of complaint is there was no proper investigation whether the company has a potential claim against its holding company, Builvest Corporation Pty Ltd, under s 588V pursuant to which a holding company may be liable for insolvent trading by its subsidiary.  The s 439A report made no reference to a claim under s 588V.  

27                  The plaintiff raised this purported deficiency on the day before the second creditors’ meeting.  This prompted the administrators to indicate at the meeting that they believed Builvest did not have assets to satisfy any potential claim.  Mr Barnden also said that even before the plaintiff raised this issue he had investigated Builvest’s status and concluded that Builvest was acting solely in its capacity as trustee of an investment trust and had no tangible assets.  It is unclear whether the liquidators considered the possibility that, dependent upon the circumstances, a claim under s 588V might be satisfied out of trust assets. The extent of trust assets, and whether Builvest’s equitable lien as trustee would cover any potential liability under s 588V, was not discussed in the s 439A report. 

28                  In addition to complaints regarding the administrators’ lack of proper investigation, the plaintiff also contends that the administrators were wrong in recommending that creditors approve the DOCA which they say “was flawed and against commercial morality”.  

29                  Under the proposed DOCA, Newco was to purchase the business and assets of Brick & Block at a purchase price which was sufficient to pay (1) the amount due to the secured creditors and the receivers for their fees, expenses and trading liabilities; and (2) an amount to cover all accrued employee entitlements in respect to annual leave and long service leave for Brick & Block employees who accepted offers of employment from Newco.  The estimated purchase price was $16.11m.

30                  The proposal also provided for a fund to be established for payment to certain unsecured creditors.  The fund comprised (1) initial $1.5m cash contribution to be paid by Alphalite; (2) 50% of the net after recovery from a book debt owing to the company by Sasso Pre-Cast Concrete Pty Ltd (the Sasso Debt); (3) a third of the net after cost proceeds of an outstanding insurance claim the company had in respect of a fire at one its plants (the Insurance Claim); and (4) cash at bank.

31                  Only some of the company’s unsecured creditors would qualify to receive distributions from the fund. The DOCA identified non-participating creditors with estimated claims against the company totalling around $17.5m.  The DOCA did not make provision for the payment of any part of the debt due to non-participating creditors’ debts.  Nor did it provide for the compromise of those debts.

32                  The plaintiff complains that the balance of the Sasso Debt and the Insurance Claim was to go to the directors pursuant to an agreement reached with the administrators.  The administrators explained the rationale for their arrangement in their report:  “The Joint Administrators note that the above recoveries are unlikely to be successful without the assistance of the directors of the Company. In this regard, the directors have advised that they would not provide their assistance unless they are able to share in the proceeds (if any) realised.”

33                  The plaintiff rightly points out that the directors owe duties to the company, and that the administrators had statutory power to compel the directors’ cooperation.  Notwithstanding this, the administrators proposed ‘buying’ that cooperation.  And the price was substantial indeed.  On some estimates the directors stood to receive millions of dollars for their cooperation.  The s 439A report failed to mention any of this.

34                  At trial, counsel for the liquidators argued that the administrators could not be criticised for agreeing to the arrangement, as it was a matter of their commercial judgment that the DOCA, as an overall package, offered a better return to creditors taking into account the arrangement regarding the Sasso Debt and Insurance Claim.  There are several problems with this argument.  First, there is no evidence to suggest that the administrators actively turned their mind to compelling the directors’ cooperation.  If this had occurred to the administrators, one would have expected to see a discussion about it in the s 439A report.  As well, Mr Barnden’s affidavit is silent on this issue.  Second, a DOCA which was effectively premised on permitting directors to get their hands on a large amount of money in return for what they were in any event required to do was liable to be set aside. 

35                  Next, the plaintiff criticises the administrators for putting forward a DOCA that effectively facilitated a ‘phoenix’ arrangement, where the business of Brick & Block would be sold to a company associated with the very directors who allowed Brick & Block to become insolvent.  The first point to make about this criticism is that the mere fact that a DOCA contemplates a business being sold to an entity associated with existing directors does not, of itself, warrant criticism.  There will be many cases where it makes sense to allow the directors to take back control of a business especially if it will result in a greater return to unsecured creditors.  That said, where a DOCA proposes that an entity associated with existing directors purchase the business, the nature of the new entity – and in particular, its financial viability – may need to be carefully scrutinised by the administrators so that they can be satisfied that the new entity will not suffer the same fate as the old.   If the administrators are not sufficiently satisfied, there will be cases where they should not recommend the DOCA, or at least warn creditors there is a possibility that a court will set aside the DOCA.

36                  In this case, the DOCA was conditional on Newco obtaining debt financing for the purchase of the business, and the receipt of a letter of commitment from private investors undertaking to subscribe a minimum of $6m in new equity in Newco.  The administrators were aware there were a number of credible potential sources of funds.  In these circumstances, the mere fact that the DOCA contemplated the sale of the business to a company associated with the directors does not warrant criticism.

37                  Another complaint is that the DOCA did not provide for the compromise of non-participating creditors’ debts, which totalled some $17.5m.  Counsel for the liquidators accepts that the DOCA would have rendered Brick & Block a ‘shell’ company with substantial uncompromised debts.  However, he argued that non-participating creditors, mindful of this, should be regarded as effectively waiving their debts.  Why this assumption should be made is not clear.  If non-participating creditors intended to ‘waive’ their debts, the DOCA should have made provision for that to occur.  Allowing an insolvent company to return to normal operations should have raised serious concerns in the minds of the administrators.

38                  The plaintiff also complains that the s 439A report contained a number of errors or omissions.  The principal alleged error is that the report underestimated the likely return to ‘priority creditors’ (ie employee creditors other than excluded employee creditors) in a liquidation.  This alleged error, it is argued, was particularly significant, as employee votes played a significant part in ensuring that the DOCA resolution was passed.

39                  The report considered the return to creditors in four scenarios: an optimistic and a pessimistic scenario if the DOCA were passed, and an optimistic and a pessimistic scenario if the company were wound up.  The administrators estimated that in three of the scenarios the employees would receive a dividend of 100 cents in the dollar.  In the ‘liquidation pessimistic’ scenario, the projected dividend for employees was nil.

40                  The plaintiff argues that the administrators’ estimate ignores the employees’ likely relief under the General Employee Entitlements and Redundancy Scheme (‘GEERS’). This is a mischaracterisation of the administrators’ position. The ‘nil’ figure related to a dividend payable to employees. The administrators separately referred in some detail to the employee’s likely entitlements to GEERS.

41                  The plaintiff then says that, even on the administrators’ own figures, employees would receive more than a nil dividend in the liquidation pessimistic scenario.  Mr Barnden disputes this.  The factual basis for the dispute is complicated, and largely relates to the administrators’ belief, based on their experience, that the balance sheet values of the company’s trade debtors and inventories would need to be heavily discounted to reflect the likely recoveries for those items if the company were wound up.  There is also an issue about the amounts which could be retained by the company’s receivers for trading losses incurred whilst trading the business.  I need not rule on these issues.  It is sufficient to say that there does appear to be a reasoned basis for the administrators’ conclusions, and while those conclusions might be open to debate, they are not so obviously wrong as to warrant criticism.

42                  The plaintiff also complains about the manner in which the administrators have conducted themselves throughout the course of Brick & Block’s external administration.

43                  First, the plaintiff alleges that the liquidators (both as liquidators and administrators) have charged inflated fees for work to date.  The plaintiff provides no evidence for this assertion.  Mr Barnden has justified the work done by his firm in considerable detail and the creditors have approved remuneration for that work. I see no basis for accepting the plaintiff’s assertion.

44                  Second, the plaintiff complains about the manner in which their resolution to appoint their nominees as liquidators was dealt with at the third creditors’ meeting.  The plaintiff wanted its proposed resolution voted on before the deed administrators’ resolution to appoint the deed administrators as liquidators was heard.  Mr Barnden, as chairman, refused that request.  A later resolution proposed by the plaintiff, for Messrs Barnden and Kassem to be removed as liquidators, was then not passed.  

45                  Ultimately, I do not think that the plaintiff has much cause to complain. The resolution it wished to propose initially was different from the resolution it had flagged to creditors in the material it distributed prior to the meeting. In any event, its resolution was ultimately put to creditors and dealt with.  Mr Critchley concedes that, even ignoring the votes of related parties or non-participating creditors, the majority of the creditors who voted, in both number and value, voted against the plaintiff’s resolution.

46                  Third, the plaintiff complains that the liquidators have not remained impartial when dealing with the plaintiff and, more particularly, its solicitors.  Correspondence between the plaintiff’s lawyers and the liquidators’ lawyers has, at times, been somewhat acrimonious. The liquidators have staunchly defended their position when subjected to sometimes aggressive questioning by Mr Critchley at creditors’ meetings. Although relations between the liquidators and the plaintiff have been strained, I do not consider this to carry much weight in determining the question at hand.

CONSIDERATION

47                  The principles regarding the exercise of discretion under s 503 are uncontroversial: see generally City & Suburban Pty Ltd v Smith (as liquidator of Conpac (Aust) Pty Ltd (in liq)) (1998) 28 ACSR 328, 336 (Merkel J). For present purposes, it suffices to say that the ultimate question is whether the removal of the liquidators is for the better conduct of the liquidation. In this case, the factors for and against ordering the liquidators’ removal are finely balanced.

48                  The factors which tend against ordering removal are as follows. First, the liquidators are well acquainted with the affairs of the company.  In that circumstance, the onus on the plaintiff to ‘show cause’ is not easy to discharge: Multi-Core Aerators Pty Ltd v Dye [1999] VSC 205, [37].  Second, the creditors as a whole support the liquidators.  In Re Greight Pty Ltd (2006) FCA 17, I noted that “in most applications for the removal of a liquidator it is necessary to find out the wishes of the persons really interested, in this case the creditors” (at [18]).  In this case, the plaintiff was given an opportunity to put its case that the creditors should appoint as liquidator someone other than Messrs Branden & Kassem.  Third, although the plaintiff has raised numerous complaints against the liquidators’ conduct as administrators and deed administrators, no complaint has been made about their conduct as liquidators.

49                  The case for removal is based on conduct which, it must be said, is troubling.  The administrators had a duty to carry out reasonable investigations into potential claims so as to form an opinion as to what future course of action is in the creditors’ interests.  Doubtless the administrators were required to take into account the time, cost and uncertainty associated with litigating actions.  In some cases, a ‘bird in the hand’ logic may justify the recommendation of a DOCA rather than a liquidation. But that decision should only be reached after careful consideration of the claims which can only be brought following a liquidation.  In this case, the impression I have is that the liquidators were too willing to support the DOCA without having fully explored the potential claims if the company were wound up.

50                  In this connection, the administrators’ first creditors’ report is revealing.  There the administrators stated “the purpose of our appointment is to assist the Directors in restructuring the affairs of the Company.”  In many situations this comment might have been disregarded as a throwaway line.  In this case, however, it cannot be so easily ignored.  There were shortcomings in the investigations undertaken by the administrators into potential recoveries, particularly in respect of a large potential claim regarding capital improvements at the Port Kembla site, and the Sasso Debt and Insurance Claim.  In addition, the administrators recommended a DOCA which faced a significant risk of being set aside. It is of particular concern that the administrators were willing to accept an arrangement which ‘bought’ evidence from the directors without acknowledging that such assistance could be compelled by a variety of practices.  On one view, this suggests a deference to directors which justifies a loss of confidence in the ability of the liquidators to pursue claims against the directors.

51                  Not without some hesitation, I have come to the view that it is in the best interests of those interested in the liquidation that the liquidators be removed. I accept that, putting voidable transaction claims and the like to one side, there are aspects of the liquidation which the liquidators would be best suited to perform, given their familiarity with the affairs of the company.  But in regard to voidable transaction and other potential claims which might be pursued in the liquidation, it is best that they be pursued by a process seen to be quite independent of the directors. I did contemplate having special purpose liquidators appointed to undertake the necessary investigations and prosecute any claims. On balance, I think it is more efficient for new liquidators to be appointed for the conduct of the liquidation as a whole, particularly given that a substantial part of the work to be performed by the liquidators would be the investigations.   

52                  The plaintiff has previously indicated that it is willing to fund its nominee liquidators up to $50,000 to investigate such claims.  Ordinarily, I would be reluctant to give much weight to such an offer, lest it be seen as permitting a creditor to purchase its preferred liquidator. In this case, however, the plaintiff has been forced into a position of funding a liquidator’s investigation because of the lack of confidence it has in the present liquidators, a lack of confidence which, in the circumstances, is not unreasonable.   

53                  The plaintiff should bring in, by 4.00 pm on 14 April 2010, short minutes of order to give effect to these reasons.

Associate:

Dated:         13 April 2010