Selecting the right liquidator for an insolvent business

In article:

Rather than aiming for loyalty, directors should aim to appoint a competent and ethical liquidator.

This means directors need to avoid anyone who is inexperienced or who over-promises. In particular, directors should be wary of any ‘bait and switch’ sales tactics, that is, potential liquidators who promise not to ‘dig too deep’ in their investigations in order to secure appointment. 

Here we look at the key things to expect in a competent liquidator and how you can best avoid appointing an incompetent one. 

What are the duties of liquidators?

A competent liquidator is one that, first and foremost, performs all the tasks prescribed to them by law. The key tasks of a liquidator are to:

• Collect and realise the company’s assets.
• Investigate and report to creditors about the affairs of the debtor company. This includes reporting on any voidable transactions (such as unfair preference claims), as well as other claims against the officers of the company.
• Investigate the failure of the company and any possible offences by people involved in the company. These matters then need to be reported to the Australian Securities and Investments Commission (ASIC).
• Distribute the proceeds of liquidated assets in line with the priority rules set out in the Corporations Act 2001 (Cth), ie. first to secured creditors and then to unsecured creditors in accordance with prescribed regulations.
• Apply to deregister the company following the liquidation. 

In carrying out these tasks, a range of overarching legal duties apply to liquidators.  

First, liquidators are classified as ‘officers’ of the company being wound up (see section 9 of the Corporations Act 2001 (Cth)). This means that they have all the duties of officers under that Act, including the obligation to ‘exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise’ (section 180), as well as an obligation to act in good faith, in the best interests of the company (section 181). 

Where there is recklessness or dishonesty involved, breach of an officer’s duties can also be a criminal offence under the Corporations Act 2001 (Cth), as well as attracting civil penalties. 

Second, in addition to legal duties specified in the Corporations Act 2001 (Cth), liquidators have other obligations such as equitable obligations (eg. the obligation to disclose conflicts of interest and to act impartially) and the obligations set out in industry codes, such as the Code of Ethics of the Accounting Professional & Ethical Standards Board (APESB). 

It is worth noting that none of these duties refer to the interests of directors. This is no accident. Liquidators do not have any duties to directors (only creditors and the company itself). Therefore, directors should not see liquidators as their ‘friend’. This means directors who ‘ghost’ or obstruct liquidators in any way will probably get rough treatment. 

As a matter of practice (though not law), liquidators charge on an hourly basis. Therefore, one would expect that more experienced liquidators would execute their required tasks more quickly, thus reducing the number of billable hours needed for the liquidation. Though as we shall explain below, directors should seek out scrupulous liquidators who will not be inclined to ‘pad’ their billing unnecessarily. 

What counts as liquidator incompetence? 

The legal obligations of liquidators set out above do not specify how the liquidation is to occur. Furthermore in the case of the liquidation of a small or medium-sized enterprise (SME), where few assets may be available, liquidators exercise considerable discretion when it comes to commercial decisions (eg. the sale of assets) and investigation decisions. 

Naturally, when appointing a liquidator, many liquidators will be concerned about the outcome of any investigation into their own conduct. A common concern of directors is that they will be found in breach of their duty to prevent insolvent trading (see section 588G of the Corporations Act 2001 (Cth)). 

However, there is no empirical evidence available suggesting that engaging an incompetent liquidator will either increase or decrease the chance of an in-depth investigation. It is worth noting that, perhaps due to the financial constraints on liquidators, it is very rare for directors to be pursued for allowing insolvent trading anyway. 

Common liquidator competence issues can be observed in the decisions of the Companies, Auditors and Liquidators Disciplinary Board (the Board), which determines whether a liquidator gets struck off or not. 

For example, in the case of Fiorentino, failings were found in the liquidator’s: 

• failure to provide required reports and notice of meeting to all employee creditors; 
• pre-filling of proxy forms (including the details of the potential proxy) with a view to influencing the vote on his own liquidator remuneration;
• acceptance of proxy vote forms that were clearly not signed by the employee creditors to whom they applied; and
• a failure to properly investigate the affairs of the company, especially any possible voidable transactions. 

The Board found that the liquidator was negligent, reckless or dishonest in the various failings identified, and was therefore in breach of his obligations under the Corporations Act 2001 (Cth) and the Code of Ethics that applied. 

It is worth also noting in this case that the liquidator informed directors prior to the liquidation that a transfer of assets to another company prior to liquidation (which the Board described as having the appearance of a phoenix transaction) was legally acceptable, when in fact it was not. This is a stark warning on the risks of listening to ‘over-promising’ potential liquidators. 

A potential conflict of interest?

As company directors can pick the insolvency practitioner who will become liquidator, this can lead to a misconception of the liquidator’s role. Like a US President, they expect loyalty/compliance from their appointee, Fiorentino shows the folly of this belief. 

The reality is often more of a ‘Dr Jekyll and Mr Hyde’ scenario — a liquidator can appear, from the director’s perspective, demanding and arbitrary after appointment. From the liquidator’s perspective, the winding up in question is one of many appointments, they will not sacrifice their professional integrity for a single pre-appointment representation.

This is formalised in the law in the liquidator’s duty of independence (see the decision of the High Court of Australia in Ebner v Official Trustee in Bankruptcy (2000) 205 CLR 337 for the classic statement of this position). 

This duty of independence is captured in the various legal protections for creditors. For example, the requirement of the liquidator to declare interests, the creditors’ ability to replace the liquidator and the creditors’ ability to appoint a reviewing liquidator. 

Read more about the duty of independence and creditor protections relating to that duty in Ultimate Guide to Liquidation Part 3: Responding to liquidation. 

What to look for in a competent liquidator?

Given that directors don’t have a crystal ball, what is the best way of determining whether a proposed liquidator looks competent? There is no magic answer here. There aren’t many liquidators in Australia, and as a general rule, they seem to see themselves as ‘undertakers’ rather than ‘rescuers’ so choice is relatively limited. Nevertheless, there are some considerations that may prove useful in making your decision. Some key factors to consider include: 

• Firm size. On the one hand, a larger liquidation firm may have rigorous and established processes in place to quickly identify relevant issues in a liquidation. On the other hand, in a smaller firm it may be less likely that important work gets handed off to junior staffers.
• Culture. Is the liquidation firm known for in-depth investigations, or does it adopt a ‘box ticking’ approach? 
• Price. Are the liquidator’s fees market-appropriate?
• Ethics. Is the firm known for scrupulous dealings?
• Experience. Does the liquidator have extensive experience with SME liquidation?
• Commercial nous. The best liquidators have the commercial nous to maximise returns from the liquidation. 

Conclusion 

It is a common misconception of directors that, because they generally appoint liquidators, the liquidators work for them. The legal reality is that the duties of the liquidator are to the creditors and the company itself, not to the directors. More important for directors in choosing their liquidator is to choose them based on competence, rather than perceived loyalty.