Litigation funding of liquidators – the ALRC inquiry

The current law reform inquiry into class actions and their funding may also need to look at the funding of another type of collective litigation action, claims by liquidators in insolvency proceedings.

The Australian Law Reform Commission is conducting its litigation funding inquiry with an emphasis on class action proceedings and the important role they play in securing access to justice. It has issued its Discussion Paper 85 – Inquiry into Class Action Proceedings and Third-Party Litigation Funders.

While class actions are one focus, the terms of reference also require the ALRC to look at the role of third party funding in enabling the commencement of other types of legal proceedings.  As to those other types, litigation funding of insolvency proceedings is significant.

Collective litigation

As to class-actions, while a company liquidator is not involved in a class action as such, there are parallels between the collective interests of creditors in a company external administration, on whose behalf a liquidator may bring a proceeding, and the collective plaintiffs in a class action.

In the same way that a funded class action assists individual claimants who do not have the resources or capacity for risk to pursue their justice, a funded liquidator’s claim assists creditors collectively to bring a claim in their interests, which they cannot in law bring individually, and where, collectively, they have insufficient funds.  In both cases, the claim could not be brought but for the litigation funding provided.

“Whilst entering into the proposed funding agreement necessarily involves a potential cost of the Company in the form of a premium and other amounts, this potential outcome must, as I have said, be compared against the likely alternative, namely, that no litigation will be pursued because of the lack of funds”: Pascoe; in the matter of Matrix Group Ltd (in liq) [2011] FCA 1117.

Whether or not those parallels can be taken further, the ALRC terms of reference do ask about litigation funding generally.

Liquidation claims

In the context of insolvency, a liquidator with a potential legal claim, for example, to bring voidable transaction proceedings, will often be in the position where there are inadequate or no funds to bring the legal claim. A clear case of a transfer of company assets to a third party for nil consideration days before a winding up order may go unactioned. Even if funds are available, the liquidator has to weigh up the use of remaining company funds to bring the proceedings, which are in one sense, ‘creditors’ moneys’, being moneys that might otherwise be simply paid to the creditors, rather than spent on litigation.

The liquidator has a number of options for funding of the litigation claim:

  • bringing the proceedings on a speculative basis, with recompense in the event of a successful outcome;
  • seeking funds from one or more creditors to litigate the claim. Insolvency policy encourages this option through provisions in the law that allow the court to give a priority dividend over other creditors in the event that moneys are recovered: s 564 Corporations Act;
  • contributories may sometimes wish to fund: In the matter of 77738930144 Pty Limited (in liq) (formerly Commercial Indemnity Pty Ltd) [2017] NSWSC 452;
  • seeking government funding. That can be available if the government is a creditor, or if the government chooses to fund for other reasons, or if it provides a fund for such purposes; or
  • seeking litigation funding from a private funder.

Although not really in the nature of litigation funding, the liquidator may sell the company’s claim to an external party; and sell the liquidator’s own claim (typically voidable transaction proceedings) under new s 100-5 of the IPSC.

Litigation funding in insolvency

If litigation funding is sought, the liquidator will invariably need to seek court approval, not because it is a funding agreement, but because it is usually an agreement that extends beyond 3 months and needs court approval: s 477(2B) Corporations Act.

The Court then gives consideration not only to the terms of the funding agreement, and why it is being sought, but to issues concerning the interests of creditors and the responsibilities of the liquidator.  Conditions on the funding arrangement may be imposed.

The courts in the last decade or more have developed settled principles in their various decisions approving litigation funding agreements entered into by liquidators.  As recently stated in Hird (Liquidator), in the matter of Allmine Group Limited (in liq) [2018] FCA 781, the factors taken into account include:

(1) the prospects of success of the proposed litigation;
(2) the interests of creditors other than the proposed defendant;
(3) possible oppression;
(4) the nature and complexity of the cause of action;
(5) the extent to which the liquidator has canvassed other funding options;
(6) the level of the funder’s premium;
(7) consultations with creditors; and
(8) the risks involved in the claim.

Liquidators and their funders are aware of these requirements and applications for approval are invariably approved.

The funder’s premium always receives attention:

“The additional sum is, in effect, the funder’s premium. It is 25% of the Final Amount (essentially, the proceeds of recovery) if recovery is within 6 months, rising to 30% if recovery is within 12 months, and 37% if recovery is more than 12 months after the date of the agreement. The fee is limited to 15% if the proceedings are concluded before any drawdown”: Leigh re King Bros [2006] NSWSC 315.

Bankruptcy

Much of this also applies to litigation funding in bankruptcy, but the law does not require a trustee who wishes to enter into a funding agreement, of whatever term, to seek court approval.

Some particular issues with funded insolvency litigation

Litigation claims in insolvency, including those funded, can be brought in situations where, in other circumstances of funded or class action claims, they may be criticised or prohibited.

For example, a liquidator, or trustee, may bring funded recovery proceedings without any or any assured return for creditors but to:

  • recoup their own unpaid fees; or
  • to enforce compliance with insolvency law, for example, in issuing an examination summons to obtain information;
  • pursue a matter in the public interest, for example, to sue to recover an asset fraudulently disposed of by a director or bankrupt.

“ … the fact that the most likely outcome of the litigation will benefit only the professionals involved in the winding up is not necessarily a reason to stifle the litigation; that there is also some chance of a benefit for the unsecured creditors without any detriment to them, to some degree, reinforces the case for bringing proceedings”: Re Imobridge Pty Ltd (in liq) (No 2) [2000] 2 Qd R 280 at 296 [39].

While a liquidator might properly obtain the views of creditors before taking any such proceedings, the decision is the liquidator’s.

Creditors’ influence

Creditors also have particular rights in the litigation process, which they increasingly exercise. In deciding whether to fund a liquidator, creditors may prompt a removal of the incumbent on the basis that they will only fund another nominated liquidator: In the matter of ACN 159 605 188 Pty Limited (in liq) (formerly Securimax Pty Limited) [2018] NSWSC 356, or only fund a special purpose liquidator: DCT v Italian Prestige Jewellery Pty Ltd [2018] FCA 983.

Questions of independence of the SPL from the funder can be raised: GDK Projects Pty Ltd, in the matter of Umberto Pty Ltd (in liq) v Umberto Pty Ltd (in liq) [2018] FCA 541. Funders are also able to have their own lawyers involved in the proceedings.

ALRC

Whether the policy issues raised by the ALRC about the need for regulation of litigation funding are addressed by the courts when approving such agreements is open to its further review.  Whether the criteria adopted by the courts in approving litigation funding of liquidators should be considered more generally by the ALRC is also open to review.

It may be that the ALRC is yet to look at litigation funding in insolvency; or that it considers that it should be left to the courts.

Submissions to the ALRC close on 30 July 2018.

 

 

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