How Do You Work Out if a Liquidator Is Funded?
If you receive a letter from a liquidator demanding tens or even hundreds of thousands of dollars as part of a liquidation process, what do you do next?
A key consideration will be how likely is it that the liquidator will actually commence action in court? And to answer this question, it is essential for you to consider whether, and to what extent, a liquidation is funded.
Here we explain exactly why it matters whether a liquidation is funded, as well as looking at the mechanisms for working out what funding is available to pay for litigation.
Why Does It Matter if a Liquidator Is Funded?
Liquidators don’t oversee liquidations out of the goodness of their heart, nor are they public servants like the Australian Securities & Investments Commission (ASIC) or the Australian Tax Office (ATO).
Liquidators run a for-profit business. And the way that they make that profit is through the fees that they can recover from the recovered assets of a company. While creditors are required to approve of their fees and disbursements, liquidators do receive priority for payment over all unsecured creditors (see section 556(1)(a) of the Corporations Act 2001 (Cth)).
Nevertheless, liquidators will only be able to recover if funds are available, and given that a large proportion of liquidations result in zero returns, it is not uncommon for liquidators to go unpaid.
The fear of going unpaid, combined with a lack of funding, substantially reduces the likelihood that the liquidator will aggressively pursue outstanding amounts. For example, a liquidator may suspect that a debtor company’s funds have been diluted by a voidable transaction (such as an unfair preference claim or an unreasonable director-related transaction). However, to pursue any legal action to that effect, they will need to properly investigate that suspicion and retain a solicitor and/or barrister. This usually requires substantial funds. They also are adverse to personal costs orders for ill conceived litigation and security for costs orders.
Of course many liquidators will refuse to take on liquidation in these circumstances. To do so would require them to fund filing fees from firm funds, get lawyers to act on contingency and run the risk of adverse cost orders. However, where the liquidator does take on such a liquidation, it is a fair bet that protracted liquidation will not occur. In summary liquidators are paid hourly for work and other than that they have no incentive to take adverse risks. They don’t have enough skin in the game.
Aside from the impact on liquidators, there is also a broader economic impact of unfunded liquidations. The Senate Economic References Committee Report, ‘The regulation, registration and remuneration of insolvency practitioners in Australia’,examined the way in which liquidators charge extremely high hourly rates to compensate for ‘zero pay’ liquidations (see chapter 8).
An inquiry by the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) also examined why liquidators need to compensate for poor recovery prospects with high hourly rates:
Only once an investigation begins will they be able to determine the potential value of assets and total liabilities of the business. As a registered liquidator must complete an appointment once accepted, where there are no or limited assets, they will not recover their costs.
Arguably, the vested interests of the insolvency industry in consistent work (at a high rate) has meant a lack of appetite for broader change. One proposal from influential insolvency researchers, Professor Jason Harris and Michael Murray, is to introduce a ‘government liquidator’ to fill this gap and handle unfunded insolvencies.
Form 524: Liquidator’s Annual Return
The first place for an individual to check out the financial situation of a liquidation is the ‘presentation of accounts and statement’ or ‘Form 524’ (recently replaced with Form 5602 and Form 5603).
This is an official document that all external administrators (including liquidators) must fill out and file with ASIC to report on the progress of the liquidation. It covers such matters as:
- The debtor company’s assets and liabilities
- The estimated number and type of creditors
- The estimated amount owed to creditors
- A record of payments received throughout the insolvency
- A record of payments made during the insolvency
- The fees that have so far been charged by the liquidator
- The date by which the liquidator expects to complete the job
- The estimated return that the liquidator expects creditors to receive
Through an examination of payments received, and payments made, it is possible to discern what funding is available to the liquidator. Note, however, this form is only prepared and lodged annually, so it is unlikely to provide up-to-date information. It will also not include litigation funding arrangements that can be drawn upon in the future.
The Report to Creditors
A key liquidator obligation is to report to creditors on a range of matters, as it is ultimately the creditors who make crucial decisions about the progress of the liquidation (such as whether to accept a liquidator’s proposed fees and expenses).
The required information that must be provided to creditors is set out in clauses 70-30 to 70-50 of the Insolvency Practice Rules (Corporations) 2016.
These reports contain information on money available for the liquidation, as well as any expected future recoveries. For example, a report on dividends under clause 70-40 must report on the assets and liabilities of the company to date.
For more information on the information requirements in a liquidation check out Ultimate Guide to Liquidation Part 1: What is Liquidation?.
Third-Party Funding Agreements
If there are few funds available in the liquidation itself, and liquidators are disinclined to self-fund, what other options might be available to fund a liquidation?
It is increasingly common for liquidators to be funded by third parties, such as professional litigation funders retained by creditors. These arrangements will usually require creditor or court approval (see section 477(2B) of the Corporations Act 2001 (Cth) and Re Ascot Vale Self-Storage Centre Pty Ltd (In Liq) (2014) 98 ACSR 243 (VSCA)).
Note, however, that there has been very little use of this option in small business liquidations. For funders, such action only becomes worthwhile where the claim is in the millions, not the hundreds of thousands.
More commonly, third party funding comes from a disgruntled creditor, seeking ‘justice’ through the liquidation process. On some occasions, several larger creditors may band together to fund such action. Otherwise the ATO or FEG may fund liquidators where there are prospects of a return and/or a strong policy issue.
As with other funding information, this information about third-party funders may become available through Form 524 and the reporting to creditors.
Receiving a notice from a liquidator about possible legal action is not necessarily a cause for panic. It is sensible to consider the likelihood of any legal action by examining whether the liquidator has any assets available to pursue legal action.