Universal Distributing is no Silver Bullet

A recent case in the NSW Supreme Court gave a good remainder about the limitations of the Universal Distributing principle.

As a refresher, in Re Universal Distributing Co Ltd (in Liq) (1933) 48 CLR 171, the Court established the principle that an external administrator is entitled to recover costs and expenses related to the preservation and realisation of assets in priority to the interest of a secured creditor in those same assets, and that the external administrator has an equitable lien in respect of such costs and expenses over the assets.

This is obviously a principle that is very useful for external administrators and one that I have used on many occasions to ensure that we got paid for the work we did preserving and realising assets.

However, the Universal Distributing principle isn’t all encompassing and this case gives an example of when reliance upon it didn’t work out in the external administrator’s favour.

In this case, Administrators were appointed to two related entities, Atlas CTL and Pty Ltd (”Atlas”) and PJM Fleet Management Pty Limited (“PJM”). Atlas offered short-term car and truck rentals and leasing of vehicles to ride-share operators, while PJM leased vehicles from a variety of vehicle finance providers (such as Volkswagen, BMW, Nissan, and Toyota Finance) and provided these vehicles to Atlas for leasing. Each of the Finance Companies held purchase money security interests over the vehicles they financed, and Volkswagen and Nissan Finance held each also held a general security agreement with Atlas. It’s fair to say, everything of value was subject to at least one perfected security interest.

The Administrators decided to trade on the business of Atlas, with a view to selling the business as a going concern. However, following a sale campaign, no buyer was found, and the Administrators had accrued a significant trading loss.

At this point, the finance companies appointed receivers and mangers and tools steps to realise their secured property. After the sales were completed and the business of Atlas was shut down, the only significant pool of fund was approximately $5 million held by Volkswagen from the realisation of their secured property.

The Administrators then brought a claim that their remuneration and costs, totalling approximately $2.4 million, were secured by an equitable lien arising from the Universal Distribution principle. The application was made on the basis that the Administrators’ work to preserve and realise the assets of Atlas and PJM had been of benefit to Volkswagen Finance.

The Administrators submitted that an equitable lien would arise when:

* The external administrator acts reasonably.

* The administrator attempts to preserve, secure or realise assets.

* There is a sufficient nexus between the work done and the salvage objective.

* There is a fund (or assets) which may properly be the subject of the lien.

* That it would be unconscientious for the creditors who stand to take the benefit of the fund (or assets) to do so without recognising the administrator’s work.

The Administrator argued that it was reasonable for them to trade on the business with a view to a sale and that where the secured creditors adopted a ‘wait and see’ approach, it would be contrary to public policy to discourage Administrators from trading on businesses.

The Court dismissed the Administrator’s claim, finding that the claim failed both on the principle and on the facts.

The Universal Distributing principle only created an equitable lien over assets, or a pool of funds, if there was a sufficient nexus between the administrator’s activities and the preservation of assets or creation of the fund. In this case, the Court found that the Administrators did not have a role in preserving the assets or in the creation of the funds. In fact, rather than being directed to the preservation or realisation of the secured assets, the Administrators put them at risk by continuing to use them in the trading of the business.

This case gives a timely reminder that before deciding to trade on, and Administrator needs to be aware of both the costs associated with trading and how these will be funded. Further, when it is intended to rely upon the Universal Distributing principle, detailed records need to be retained as to both what work was done, and how that work was related to the preservation and realisation of specific secured property.

The Court Makes Interesting Use of s90–15 of the IPS

The Federal Court has made innovative use of its powers under Section 90–15 of the Insolvency Practice Schedule (“IPS”) to amend various provisions around calling for and adjudicating on Proofs of Debt in Woodhouse (Liquidator), in the matter of Forex Capital Trading Pty Ltd (in liq) [2022] FCA 600.

The innovative approach was in response to a fairly unique set of circumstances. The Company in Liquidation was a seller of over-the-counter derivatives and the Liquidation was faced by approximate 8,600 clients with potential claims against the Company totalling approximately $69.5 million.

The Company had been provided with a letter of comfort by its Ultimate Holding Company (“UHC”) whereby the UHC undertook that, upon request, it would provide financial support to meet any debts incurred by the Company. However, the undertaking was to be terminated on 30 June 2022. Accordingly, there was pressure on the Liquidators to urgently quantify the debts of the Company so that they could make a claim against the UHC before the undertaking expired.

The Liquidators approached the Court and sought Orders that would permit them to conduct an abridged process for the adjudication and admission of claims, that would allow “customers the option to accept a 15% discount on the value of their claims as calculated by the Liquidators by a certain deadline, in exchange for exempting them from providing further detailed evidence as to each element of their alleged claims.”

The expedited process would allow the Liquidators to quantify the Company’s debts and make a claim under the undertaking before it expired, maximising the potential return to creditors.

Given the obvious commercial logic behind the application, the Court sensibly made Orders, amending the process for calling for and adjudicating on proofs of debt set out in Corporations Regulations 5.6.48, 5.6.49, and 5.6.54. In particular, the Orders set out the form of the notices to be sent to creditors to satisfy the Liquidators’ obligations and the notices are well worth a read.

It’s great to see the Court sensibly utilise its powers under s90–15 of the IPS to assist Liquidators to maximise the likely outcome for creditors. It’s for situations like this one that these powers exist.

Link to the Judgement: https://www.judgments.fedcourt.gov.au/judgments/Judgments/fca/single/2022/2022fca0600

A First Decision on Creditor-Defeating Dispositions

The creditor-defeating dispositions provisions have had what is, to my knowledge, their first outing, with the Victorian Supreme Court handing down a decision in Re Intellicomms Pty Ltd (in liq) [2022] VSC 228 (11 May 2022), voiding a sale of the company’s business to a related entity.

The creditor-defeating dispositions provisions were introduced, as a new class of voidable transactions, in 2020 as part of a package of legislation to combat illegal phoenix activity. The provision is found in section 588FBD of the Corporations Act, and the key part for this case is found in subsection 1:

(1) A disposition of property of a company is a creditor-defeating disposition if:

(a) the consideration payable to the company for the disposition was less than the lesser of the following at the time the relevant agreement (as defined in section 9) for the disposition was made or, if there was no such agreement, at the time of the disposition:

(i) the market value of the property;

(ii) the best price that was reasonably obtainable for the property, having regard to the circumstances existing at that time; and

(b) the disposition has the effect of:

(i) preventing the property from becoming available for the benefit of the company’s creditors in the winding-up of the company; or

(ii) hindering, or significantly delaying, the process of making the property available for the benefit of the company’s creditors in the winding-up of the company.

On the face of it, the fact in this case are pretty suspicious. Intellicomms operated a business providing translation services to businesses in Australia and New Zealand. On 8 September 2021, the company transferred its business to a related entity that had been incorporated just two weeks before the transaction. Intellicomms was put into voluntary liquidation on the same day the transaction was completed.

The Liquidators sought to have the Sale Agreement set aside as a creditor-defeating disposition within the meaning of s 588FDB of the Act, and a voidable transaction within the meaning of s 588FE(6B) of the Act.

While the business had been sold following a valuation, its Director had obtained several valuations in the months before the sale, providing the valuers with increasingly pessimistic inputs as to future trading revenue. This caused the valuations to decrease from over $11 million in the first one obtained, to only $57,000 for the one relied upon to sell the business.

The Judge, not surprisingly, found the transaction to be a creditor defeating disposition, opining:

“I consider that the Sale Agreement has all the features of what has become known as a phoenix transaction; indeed, it is a brazen and audacious example. The effect of the Sale Agreement was to strip Intellicomms of what assets it had to satisfy the claims of its creditors and transfer them to an entity which was closely associated with its director”

With such a straightforward set of facts, we don’t get much in the way of interesting clarification of how the provisions will work in practice, however, there was one interesting point made. His Honour expressed the view that Liquidators are only required to establish that, on the balance of probabilities, the consideration payable under the Sale Agreement was less than the market value or the best price that was reasonably obtainable and that there was no onus on the Liquidators to evidence actual values.

It’s great to see these new provisions get a successful outing. They provide another useful tool in the Liquidators toolbox to combat phoenix activity.

Unfair Preferences and the High Court

It was a strangely busy day for the High Court today when it comes to considering cases related to unfair preferences, with movement on both the ‘Peak Indebtedness’ rule and 553C Set-off.

Peak Indebtedness

Submissions were published in the matter of Bryant & Ors v. Badenoch Integrated Logging Pty Ltd

As many of you will recall, on 10 May last year, the Full Court of the Federal Court of Australia (“FCFCA”) handed down a decision that the ‘peak indebtedness rule’ which has been a long-standing precedent in preference claims, was abolished with the introduction of section 588FA of the Corporations Act (“Act”). You can read about that decision at https://www.linkedin.com/pulse/peak-indebtedness-rule-preference-claims-abolished-brendan-giles/

The decision has been appealed to the High Court and we finally get a look at the submissions by the appellant.

The submissions are focused on two grounds:

(a) In enacting section 588FA of the Act, did Parliament intend to abrogate a liquidator’s right to choose any point during the statutory relation back period, including the point of peak indebtedness, in an endeavour to show that from that point there was an unfair preference (the peak indebtedness rule)?

(b) Will a continuing business relationship, within the meaning of section 588FA(3) of the Act, cease if the operative and mutual purpose of inducing further supply of goods or services is subordinated to a predominant purpose of recovering past indebtedness?

Clarity on both these points will go a long way to clearing up the lingering uncertainty in this space following the FCFCA decision.

As I’ve said previously, I found the decision by the FCFCA is a more equitable approach. I have never seen an equitable justification for allowing the Liquidator to choose a date that maximised the preference claim and nothing in the submissions in compelling enough to make me change my mind.

553C Set-off

The High Court also granted an application for special leave to appeal in the decision of the FCFCA in the matter of MJ Woodman Electrical Contractors Pty Ltd v Metal Manufactures Pty Ltd [2021] FCAFC 228.

In that case the FCFCA clarified the, until then, quite confused law around the availability of set-off as a defence to an unfair preference claim, confirming that set-off was not available as a complete or partial defence for a creditor facing an unfair preference claim.

While we won’t see submission on this one for a while, it will be interesting to see the basis upon which the appeal in being made. I personally think that the FCFCA got this one right as well and expect that the High Court will be more likely to remove any doubt around the issue, rather than to overturn the FCFCA’s decision.