1. What is the examination power?
Under sections 596A and 596B of the Corporations Act 2001(Cth), liquidators have the power to summon directors (as former officers of the corporation) before the Court for examination. This examination is carried out in public by the liquidator, usually before a Registrar. This application for an examination can also be made by other parties, and in other types of external administration, such as the voluntary administrator, provisional liquidator or the Australian Securities and Investments Commission (ASIC). A receiver can also apply where they have permission from ASIC.
This power is usually used by liquidators when they are unable to get adequate information under their ordinary investigation powers (such as the obligation to hand over books and records) or where they would like a director’s answers recorded on oath (eg. for future possible litigation).
This process is designed to be helpful to liquidators. They don’t need to prove a claim — just being the liquidator is enough to examine the directors. In this respect, it is completely different from standard civil litigation where the applicant needs the ’cause of action’ to be clearly in sight.
The examination power is an intentional element of the overall insolvency regulatory framework in Australia. It is presumed that directors in an insolvent liquidation might be less than forthcoming.
2. Is the examination power commonly invoked by liquidators?
No. Liquidators do not apply for an examination if they can avoid it. As with most forms of court proceeding, it is expensive and time-consuming. Given that assets in an insolvent liquidation in Australia tend to be scarce, the liquidator will often need a third-party funder if they are to proceed. However, if there is a liquidation with a large asset base and significant potential litigation it may be expected that the liquidator will use an examination process to obtain evidence and test theories.
Where liquidators do go down this route, they will need a robust ‘theory of the case’ in advance — this is not a fishing expedition. One example might be where the liquidator wants to see whether the director is capable of paying a voidable transaction.
Liquidators will also be aware before pursuing this route that directors may evade being ‘served’ notice of these proceedings. There is also a risk that, at the examination, directors will not have the information sought or will be systematically obstructive in answers – the “I don’t know” response. Examination proceedings can sometimes turn into a farce unless the counsel undertaking the examination is skilled and has a good brief (ie. complete background information).
3. Does the scope of examination extend to personal assets?
As the assets of insolvent small to medium-sized enterprises (SME) in Australia will usually be small (that’s why the company is insolvent in the first place), liquidators will understandably be interested in whether they can make a claim against directors that will snag their personal assets. So, can they?
Yes. Section 597 of the Corporations Act 2001 (Cth) sets out the permissible scope of the examination. Through section 597(5B), the court can look into any ‘examinable affairs’ which are in turn defined in section 9 of that Act to include any of the affairs of a ‘connected entity’ (which can include the director), which may be relevant to the insolvent corporation or it’s winding up.
This can include questions about the director’s personal assets because:
- the director may have personally guaranteed debts of the corporation
- the liquidator may wish to recover in relation to an unfair preference or an unreasonable director-related transaction
- the liquidator may suspect wrongdoing such as phoenix activity that the director benefited from
4. Is there anything that the director can do to protect their assets from an inquiring liquidator?
No, not once the winding up is underway. As part of prudent asset planning and management, many directors may have used alternative ownership mechanisms, such as putting properties in the name of a family member or in a family trust. However, this will not necessarily ensure confidentiality as the scope of the examination power is very broad. The definition of a ‘connected entity’ includes trusts.
Note also that the director does not have the ‘privilege against self-incrimination’ in this scenario. That is, the right to refuse to answer questions on the grounds that those answers may be incriminating. However, the director does have right under section 597(12A) of the Corporations Act 2001 (Cth) to demand that any criminal admissions not be used against them in criminal proceedings (other than proceedings relating to this section or for perjury).
The Courts recognise some limitations on this examination power:
- They will not permit ‘fishing expeditions’, ie. questions have to line up with some ‘theory of the case’ that the liquidator has.
- There can be no abuse of process (see, for example, Simionato & Farrugia v Macks & Macks (1996) 19 ACSR 34). This means, for example, that the examination cannot be used as a ‘rehearsal’ for cross-examination, to overcome failures in litigation or to destroy the credibility of the witness in other proceedings. Though, note, this does not stop liquidators with a strong claim using the examination in aid of injunction proceedings.
The examination power plays an important role for liquidators primarily as a tool to encourage directors to be upfront with liquidators in the first place. Ultimately, liquidators are aware that many directors will have asset protection schemes in place anyway. This means that even though they can ask about personal assets, this may not get them any closer to actually recovering from those assets.
Nevertheless, in those rare cases where there is a third party willing to fund the process, liquidators may apply for an examination purely with the goal of thoroughly covering all bases in the winding up. If a lawyer is acting for a client who admits that they committed a criminal act the examination process presents them with a difficult situation to deal with.