The Insolvency Practice Schedule (IPS)[1] gives creditors greater rights to access information and to require external administrators to call meetings. A key caveat is that creditors’ requests must be ‘reasonable’ and external administrators are not obliged to respond to requests where, amongst other things, there is ‘substantial prejudice’ or the request is ‘vexatious’. Those terms are open to various interpretations, so when is an external administrator obliged to respond to such a request?

Key takeaways

The recent judgment in AXF Group Pty Ltd & Anor v AXF Holdings Pty Ltd & Ors [2020] VSC 375 (AXF) emphasises that external administrators must be careful in objectively satisfying themselves that a creditor’s request under the IPS is unreasonable. Although each case must be considered on its own facts, AXF outlines some considerations external administrators should take into account, including:

• an external administrator needs to be satisfied that there would be (not that there could or might be) substantial prejudice to creditors in complying with the request, and must be satisfied that a direction to convene a meeting is (not that it might or could be) vexatious;
• the fact that a creditor may be in the same camp as the officers or former employees of the company is not a relevant consideration and should not be taken into account;
• in the absence of evidence to suggest that the creditor’s alleged debt is bogus, the external administrator should decide how to respond based on what is currently known and cannot assume that the claims will be rejected or substantially reduced;
• although the early stage of the external administration may be a relevant factor to take into account, it can cut both ways and may be neutral. Earlier cases have found that the early stage of the liquidation was a factor that justified a liquidator refusing to convene a meeting on the grounds that it was vexatious.[2] However, AXF suggests that if the liquidation is at a very early stage the transfer to another liquidator may be less problematic in that it may involve less duplication and lower costs than if the liquidation is at a more advanced stage;
• the existence of factors such as any funding agreement entered into by the liquidator or undertakings given by the liquidator are relevant factors. However, they will be neutral if the funding would also be available to the replacement liquidator and the undertaking assumed by the new appointee;
• there is nothing untoward about the officers of a company in liquidation seeking advice from rival insolvency practitioners and then seeking to replace a liquidator. It cannot be assumed that the proposed substitute liquidators would act in any way other than consistently with their duties; and
• without some specific evidence, generic concerns that the proposed removal and replacement of a liquidator may be designed to obstruct the liquidation do not establish substantial prejudice or vexatiousness.

Increased creditor rights

The IPS was introduced in 2017 to achieve a number of aims. One of those aims was to enhance the transparency between creditors and external administrators and give creditors greater rights. Some of the rights which were afforded to creditors in the IPS are:

1. the right to request certain information, reports or documents from an external administrator (Information Requests);[4] and
2. the right to direct an external administrator to convene a meeting of creditors to vote on a resolution to remove and/or replace the external administrator (Meeting Requests).[3]

Creditors’ requests must be reasonable and an external administrator does not need to comply with any ‘unreasonable’ request. The Insolvency Practice Rules (IPR)[5] set out the relevant factors an external administrator must consider in determining whether both Information and Meeting Requests are unreasonable.

Factors for assessing reasonableness

Under the IPR,[6] an external administrator may decline to comply with a Meeting Request under the IPS if, acting in good faith, they are of the opinion that:

• complying with the direction would substantially prejudice the interests of one or more creditors or a third party and that prejudice outweighs the benefits of complying with the direction;
• there is not sufficient available property to comply with the direction;
• a meeting of the creditors dealing with the same matters covered by the direction has already been held, or would be held within 15 business days after the direction is made; or
• the direction for the meeting is vexatious.

In the AXF case, the Court found that unless at least one of the prescribed circumstances listed in the IPR applies, the Meeting Request is reasonable.

Prior to this, the first clear statement of practitioners’ obligations was in In the matter of 1st Fleet Pty Ltd (in liquidation) [2019] NSWSC 6 (First Fleet), where the Court considered the reasonableness of certain Information Requests made by the Commonwealth to an external administrator under the IPS. Relevantly, his Honour referred to the IPR[7] and held that the listed factors were a complete statement of the factors which needed to be considered. The relevant factors are as follows:

• whether complying with the request would substantially prejudice the interests of one or more creditors or a third party and that prejudice outweighs the benefits of complying with the request;
• whether the information, report or document would be privileged from production in legal proceedings on the ground of legal professional privilege;
• whether disclosure of the information, report or document would found an action by a person for breach of confidence;
• whether there is not sufficient available property to comply with the request;
• whether the information, report or document has already been provided;
• whether the information, report or document is required to be provided under the Act within 20 business days of the request being made; or
• whether the request is vexatious.

The IPS contains no list of matters which an external administrator may take into account in forming an opinion that a direction is unreasonable on the basis that there is ‘substantial prejudice’ to the interests of creditors or a third party or that the request is ‘vexatious’. What do these terms mean?

Substantial prejudice or be vexatious?

In AXF, the court appointed liquidator of AXF Group Pty Ltd (Company) sought directions from the Court about relevant factors to be taken into account in concluding that a Meeting Request was unreasonable. The background to the liquidation shows that it was acrimonious, in particular:

• the liquidator’s appointment was unsuccessfully appealed by the sole director of the Company and other associated entities to the Company;
• the liquidator had obtained freezing orders as against the appellants;
• shortly after the liquidator’s appointment, the director sought advice from a rival insolvency firm about the process for calling meetings of creditors and replacing liquidators;
• the director’s father and major creditor of the Company and a group other creditors directed the liquidator to call a meeting of creditors to consider his removal and replacement as liquidator of the Company;
• while the liquidation was still at an early stage, many months had passed since the liquidator’s appointment;
• the liquidation was funded under the terms of a funding agreement;
• the director’s father was offering $10,000 towards convening the meeting; and
• the liquidator approached the Court for directions that he was justified in forming the opinion that the Meeting Request was unreasonable on the basis that it:
  
  • would cause substantial prejudicial to creditors as, in short, his removal would cause his costs to be ‘sunk’ and duplicated by any replacement liquidator; and/or
  • was vexatious, as the Meeting Request was made by creditors who were allegedly:
    
    • sympathetic to the director, who had an established apathy to the liquidator; and
    • seeking to remove him as external administrator to delay further investigations being undertaken into the affairs of the Company and the director’s conduct.

In a recent case considered in AXF, ‘vexatious’ in the context of an Information Request has been held to mean that the request is made for an improper purpose, being a purpose that was unrelated to the creditor’s claims in, or the conduct of the external administration or was made for a purpose of harassing or annoying the external administrator or causing delay or detriment to the external administration. [8]

The Court in AXF ultimately found that the liquidator must have regard to the following factors in determining if the Meeting Request was unreasonable:

1. the stated purpose of the proposed meeting was to remove and replace the liquidator, not merely to remove him. The winding up would be continued regardless of the identity of the liquidator, meaning there was little prejudice to creditors in complying with the Meeting Request;
2. the liquidator’s costs and work would not all be wasted or duplicated if he was removed as external administrator. If a replacement liquidator was appointed, they would prudently make use of the liquidator’s work. This again meant there was little prejudice to creditors in complying with the Meeting Request;
3. notwithstanding that the moving creditors on the Meeting Request were relatives or potential sympathisers to the director, the IPS and IPR give related creditors equal voting rights to unrelated creditors. There was no reason why related creditors should be viewed any differently from unrelated creditors (unless they engage in vexatious conduct);
4. mere ‘concerns’ that the creditor’s actions were designed to obscure or delay investigations in the Company’s affairs did not, without more, provide a foundation for a finding of vexatiousness;
5. the liquidation was at an early stage, although this was a factor which cut both ways;
6. while there were no funds currently in the liquidation (other than pursuant to the funding agreement), the funding agreement appeared to bind a replacement liquidator, with the moving creditor also offering to provide funds towards the meetings; and
7. a replacement liquidator would have duties to the Court and to creditors, and would likely be required by the Court to give an undertaking as to damages whilst the freezing orders were in place.

The Court also stated that there was nothing untoward about officers of the Company seeking advice from rival insolvency practitioners about the process of the winding up and then seeking to have those practitioners appointed.

The AXF judgment does not explain what costs orders were made and the Court simply directed that the liquidator reach a concluded opinion within seven days. As the judgment was delivered on 25 June 2020 a further judgment on costs may follow.

Comment

Liquidators confronted by directions from creditors related to a company or its officers might be forgiven for thinking that those directions are likely to be made for purposes unrelated to the efficient conduct of the liquidation. In this context, the AXF judgment provides important guidance on the concepts of ‘substantial prejudice’ and ‘vexatiousness’.

The judgment demonstrates that Courts are interpreting these concepts with the aims of the IPS in mind (i.e. empowering creditors), and require there to be ‘substantial’ and real prejudice to creditors, and clear evidence of vexatious conduct in order for a request to be unreasonable. Seeking court directions may not be possible in all circumstances, but doing so will give liquidators comfort when confronted with challenging directions.

[1] Schedule 2 to the Corporations Act 2001 (Cth) (Act) and Schedule 2 to the Bankruptcy Act 1966 (Cth) (Bankruptcy Act).

[2] Re FW Projects Pty Ltd (in liq) [2019] NSWSC 892 (there the request was made only 4 weeks into the liquidation with limited funding).

[3] Insolvency Practice Rules (Corporations) 2016 and Insolvency Practice Rules (Bankruptcy) 2016.

[4] Sections 75-15 and 90-35 of the IPS.

[5] Sections 70-40 to 70-50 of the IPS.

[6] See for example rule 75-250 of the Insolvency Practice Rules (Corporations) 2016 and rule 75-250 of the Insolvency Practice Rules (Bankruptcy) 2016.

[7] See for example rule 70-15 Insolvency Practice Rules (Corporations) 2016 and rule 70-10 Insolvency Practice Rules (Bankruptcy) 2016.

[8] Secatore, in the matter of Last Lap Pty Ltd (in liq) [2020] FCA 627 and First Fleet.