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By Stephen Mullette, Principal, Hayley Hitch and Bonnie McMahon, Solicitors of Matthews Folbigg, in our Insolvency, Restructuring and Debt Recovery Group

Rocky road, got my assignment

Rise above, ride my dreams

— The B-52s “Eyes Wide Open”, 2008

From 1 March 2017, insolvency practitioners will be participants in a brand new market created by the Insolvency Law Reform Act 2016 (Cth) (“ILRA”), and in particular section 100-5 of the Insolvency Practice Schedules (both Corporations and Bankruptcy Schedules). This section allows the sale of voidable transaction claims previously only able to be conducted by an insolvency practitioner. The creation of this brand new market, and the involvement of the insolvency practitioners in it, have far reaching implications well beyond any considered in the explanatory memorandum or any discussion surrounding the introduction of this reform.

The Amendment

The Amendment is simple. Section 100-5 of the Insolvency Practice Schedule (Bankruptcy) provides:

100 5 Trustee may assign right to sue under this Act

  1. Subject to subsections (2) and (3), the trustee of a regulated debtor’s estate may assign any right to sue that is conferred on the trustee by this Act.
  2. If the trustee’s action has already begun, the trustee cannot assign the right to sue unless the trustee has the approval of the Court
  3. Before assigning any right under subsection (1), the trustee must give written notice to the creditors of the proposed assignment.
  4. If a right is assigned under this section, a reference in this Act to the trustee in relation to the action is taken to be a reference to the person to whom the right has been assigned.

Essentially the only obvious restraint on assignment of statutory causes of action is that:

  • If the action has already been commenced, approval of the Court is required ; and
  • Prior to making an assignment, the Trustee must give written notice to creditors of the proposed assignment.

Otherwise, there are no provisions dealing with the mechanics of a transaction, and assignment of a statutory cause of action, nor, with one exception, how the assignee is to conduct the assigned proceedings. The only provision in section 100-5(4) is that if a right is assigned, then a reference to the Trustee or Liquidator becomes a reference to the person to whom the right is assigned.

Policy

The idea for the assignment of statutory causes of action was first set out in a government proposals paper of December 2011 . It noted that many claims in personal and corporate insolvency are not brought because there are no funds to do so; or, if money is on hand, creditors would prefer to have that paid as dividends than fund what may be risky litigation.

The proposals paper stated that:

216. Reforms are proposed to allow practitioners to assign causes of action. This would increase the level of deterrence against corporate breaches, reduce losses suffered by stakeholders as a result of those breaches and increase the overall efficiency in insolvency administrations.

It went on to say:

218. The inability to obtain funding is a major obstacle to the commencement of these actions. The taking of these actions may also delay the finalisation of administrations as a whole, ultimately to the detriment of creditors. The sale of rights of action may enable the value in such rights to be realised in the absence of funding being available and may result in the pursuit of matters which would not otherwise have been able to be pursued”.

It can be seen then that the main objectives of the amendment are:

  • To obtain funding for actions which are not otherwise going to be conducted;
  • To speed up finalisation of administrations;
  • To make actions more liquid;
  • To enable more actions to be conducted.

Whether these lofty goals are achieved by such a simple section remains to be seen.

So what is the big deal?

Whilst on its face, the amendments are straight forward, the transformation to the processes and procedures in an insolvency administration, as well as the commercial implications, are considerable.

It has always been possible for Trustees and Liquidators to sell causes of action which belong to the bankrupt or the company. This is part of the ordinary realisation of property that vests in the Trustee, or which belongs to the company:

“If the trustee gets a right of action, why is he not to realise it? The proper office of the trustee is to realise the property for the sake of distributing the proceeds amongst the creditors. Why should we hold as a matter of policy that it is necessary for him to sue in his own name? He may have no funds, or he may be disinclined to run the risk of having to pay costs, or he may consider it undesirable to delay the winding-up of the bankruptcy till the end of the litigation. Considering these things, it seems to me to be à priori probable that he would be entitled to sell it, but I prefer to rest my decision upon the plain words of the statute.”

However, what is significantly different is that for the first time, insolvency practitioners will be entitled to assign statutory causes of action that could previously only be conducted by the insolvency practitioner.

There are a number of significant implications of this, in particular having regard to the broad powers of review of an insolvency practitioner’s conduct, such as decisions related to selling property. Trustees in bankruptcy are familiar with these applications under the former s 178 of the Bankruptcy Act, which has now been reworded and reworked in section 90-15 of the Insolvency Practice Schedule (Bankruptcy) to the Bankruptcy Act. External Administrators in corporations matters will need to catch up quickly as a similar provision now appears in section 90-15 of the Insolvency Practice Schedule (Corporations) to the Corporations Act.

Some initial comments on some of the relevant issues are set out below.

Issues for Insolvency Practitioners to consider

1. The buyers

The most likely buyers for statutory causes of action in an insolvency are what makes the development most intriguing. Arguably not many of them make the outcomes more beneficial to creditors or the economy generally, however. The probable purchasers would include:

  • Potential defendants

Even if it is insurance against the possibility of a claim being made it should lead to greater realisations from statutory claims. It might be suggested that a potential defendant willing to pay for a cause of action would have been willing to settle the claim anyway, so selling it doesn’t make any difference. However this ignores the threat of the liquidator selling the cause of action to person or persons unknown.

  • Competitors?

Imagine a preference action being bought by a major competitor, perhaps caught up in existing litigation with the potential defendant and seeking to press home an advantage?

  • Guarantors?

It is not too hard to contemplate directors buying up preference actions in order to set-off against personal guarantee claims.

  • Litigation funders.

Whether litigation funders will back themselves to conduct the action, rather than simply fund others to conduct a claim, only time will tell.

  • Ex-Spouses

Why not throw into the Family Law mix an insolvent trading debt? Perhaps unlikely, but not inconceivable.

  • Disgruntled directors, shareholders and related parties.

What better way to vent one’s frustration at the perceived mismanagement of fellow directors, or majority shareholders (or holding companies) than by seeking to recover insolvent trading losses, or unfair preferences or uncommercial transactions.

Each proposed assignment will be substantially different depending upon a number of factors including the makeup of creditor claims. For instance in Unal v Cetinkaya , the Court had to consider whether a potential assignee of a cause of action could be someone who was in significant breach of the Bankruptcy Act. It held there was no principle against such an assignment , although it is a discretionary factor to be taken into account.

And in due course the hypothetically disgruntled assignee may run actions against the insolvency practitioner for misrepresentation as to the value or merits of the claims assigned.

2. The Claims

It is important to understand the context in which these assignments will occur. The claims which will now be assigned are claims traditionally conducted by insolvency practitioners with the benefit of statutory powers of investigation to inquire into those claims and gather the evidence required.

These powers are normally not available to assignees. In the Bankruptcy Act it is possible for creditors to conduct public examinations . However if the assignee is not a creditor, public examination will be unavailable. This may lead to third parties needing or seeking to also gain status as a creditor, in order gain access to this right. In the Corporations Act the assignee may seek to be authorised as an ‘eligible applicant’ under section 9 for the purpose of conducting an examination under section 596A and 596B. Whether ASIC will impose any restrictions on assignees obtaining this right remains to be seen.

Other possible implications include:

  • Insolvency practitioners having to consider conducting some of this investigative work in order to make the statutory actions more saleable.  Think of it like lodging a DA or spending money on a property in order to sell it for a better price;
  • Attempts by purchasers of statutory actions to impose conditions, either in the sale, or to seek to require the insolvency practitioner later on, to require the help of the insolvency practitioner undertake some of these investigations.

All of which leads to several questions – one of which is: at what point does all of this become an abuse of process? Yes the statutory causes of actions have become more liquid, but once market forces have been let loose upon those processes, at what point does the legislature, (or the courts in the absence of legislative constraint) call off the hounds? It has been held that “public policy is relevant to the exercise of discretion by a trustee in relation to an assignment” , and so it is simplistic to assume that simply unlocking the statutory actions will lead to more efficient realisation of such claims.

Further practical implications arise from transferring the investigations of the insolvency practitioner – any legal advice will be privileged, and should not be assigned without considering the implications of this step. The insolvency practitioner will also need to retain his own books and records, and there are copyright issues associated with transcripts of public examinations.

3. The Assignment

The assignment will become the focus of attention in at least 2 ways from those unhappy about the assignment:

  • attacking the decision to assign;
  • attacking the method of assignment.

The decision to assign can be attacked, particularly in bankruptcy, using the equivalent of section 178 as modified by the ILRA. There is a reasonable body of case law regarding the way in which a court will review a trustee’s decisions, although it remains to be seen whether this law will remain applicable in full to decisions under the review provisions as amended by the ILRA. In general, it should be expected that the court will generally approach the assignment decision in the same or a similar way, which is to say that the court’s power is extremely broad to make orders which are just and equitable (or in the language of the amended act – “such orders as it thinks fit”) regardless of whether the Trustee’s original conduct is wrong or objectionable, but will generally not unduly interfere with the day to day administration of a bankrupt’s estate by a trustee in bankruptcy .

Such broad discretions can lead to broad areas for disagreement, and there are a number of cases in bankruptcy where this has occurred with significant ramifications for the bankrupt, the trustee and the estate – regardless of who is right or wrong about the challenge to the Trustee’s decision.

In 2015, in Unal v Cetinkaya , Beach J (sitting on behalf of the Full Court of the Federal Court) dismissed an appeal from a Federal Circuit Court judge to refuse to interfere with the Official Trustee’s assignment of a chose in action. This seems simple enough, until it is realised that the Official Trustee first sought offers from interested parties in relation to the assignment in 2009, leading to section 178 proceedings to review the trustee’s decision, by first one side and then the other, of a protracted dispute between bankrupts and an accountant. Ultimately an assignment of the cause of action occurred in 2013 leading to yet more litigation. Whilst perhaps extreme, this outcome is hardly exceptional given the combination of vested interests, conflict and dispute arising out of speculative and uncertain litigation.

More commonly, however, the decision to assign is attacked on the basis of the absence of prospects for success. There is considerable authority that a claim with no reasonable prospect for success ought not to be assigned and no doubt prospective defendants seeking to avoid litigation may seek to attack the assignment on this ground also. Importantly, this will be an attack on the practitioner who decided to assign, and the practitioner will need to consider how best to protect himself or herself against the possibility of such an attack, including indemnities in relation to costs, and protections against possible adverse costs. Will assignees be willing to put up security for the insolvency practitioner’s protection? Does the insolvency practitioner gain more protection from retaining the action and using a litigation funder? Can the practitioner justify disposing of 30-50% of the action to gain such protection where an assignee might be offering better terms. These, and many more question remain to be answered.

The method of assignment, can be attacked in various ways.

  • The focus may be upon the approach taken by the trustee to realise the cause of action – whether the court should intervene if there appears to have been a sale campaign which has prejudiced one or other party. Insolvency Practitioners would do well to develop systems for properly conducting a sale campaign in respect of the assignment of statutory causes of action. They should be treated similarly to most other assets of an insolvent – namely consideration should be given to the particular market or markets available for the asset, and the means of obtaining the best price in those markets, as well as ensuring transparency, and accountability in respect of any sale programme, so that this can be laid before any reviewing authority.
  • Alternatively it may be that the attack is upon the implementation of the assignment, and a number of cases have been fought over whether the deed or other instrument which effected the assignment did in fact achieve all that was intended; whether it had the correct parties; was correctly executed and stamped; etc.

Whilst some of these potential problems can be limited by having proper procedures in place, such cases can’t be categorically ruled out. They are problematic for the insolvency practitioner looking to finalise an administration – if his or her conduct in an assignment is still under a review, he or she may nevertheless be dragged into litigation which could destroy any value recovered for the action, and worse, still expose the practitioner to costs consequences, without the benefit of the action (or even control of it). Again, practitioners need to consider what steps they can take to mitigate this exposure, for instance indemnity from the assignee against these costs – with the dangers and difficulties this entails.

4. The Consideration?

And whilst in many ways the selling of an action is no different to other assets of an insolvent, there is one significant difference. With an action, the insolvency practitioner must also consider not just the price obtained in the open market, but the outcome which could have been achieved had the practitioner conducted the action himself or herself. Where there are no funds this will be an important qualification, but if there are funds, even limited funds, is the price (and terms) on offer from a potential assignee is better than could be achieved by the insolvency practitioner?

To complicate matters, invariably it will not be the case that large amounts of money are offered for these causes of action, but rather a small amount with a percentage of the upside, should the proceedings be successful, and after payment of the assignees costs.

This adds further layers of complication. Such an arrangement produces no advantage in the finalisation of the administration. The insolvency practitioner must keep the administration open until any recovery is determined, which could be years away. In fact administrations may take longer, as jobs which would have been shut down previously (because there is no funding to pursue actions) will need to remain open until a recovery is determined. And this in the context of actions which are no longer under the practitioner’s control.

Which leads to the concern that the practitioner will need to consider to what extent he or she should have regard to the conduct of the litigation and address creditors on its progress, together with the costs which are being incurred. Practitioners should consider this issue early and as part of the assignment process so that creditors are properly informed as to what role the practitioner will play.

This additional administration may need to be factored into the price for any assignment, so that creditors are not worse off by reason of the assignment which involves a percentage of recoveries.

It should also be remembered that most courts have the right to award costs against third parties – which could in theory at least still include insolvency practitioners who have assigned causes of action. This risk would be increased if the insolvency practitioner (in terms of remuneration) or the estate (in terms of recoveries) stand to benefit from the action.

In an English case, the trustee invited sealed bids for the asset from the parties to the action. The Official Receiver declined a right to the share of the proceeds because it did not want to be exposed to a potential adverse costs liability as a result of having an interest in the outcome of the litigation.

Conclusions

It is a brave new world from 1 March 2017 and the possibilities are exciting. Insolvency practitioners are at the centre of a brand new market full of opportunities, excitement and adventures.
However it is also insolvency practitioners who are at the centre of the cyclone of various interested parties regarding any assignment (or refusal to assign) who stand considerably exposed to the scrutiny and attack of creditors, potential defendants, regulators and the Court regarding each and every statutory cause of action, in each and every administration…

…Fasten your seatbelts, it’s going to be a bumpy night.

If you would like more information or advice in relation to insolvency, restructuring or debt recovery law, contact Hayley Hitch at hayleyh@matthewsfolbigg.com.au or Bonnie McMahon at bonniem@matthewsfolbigg.com.au or a Principal of the Matthews Folbigg Insolvency, Restructuring & Debt Recovery Group:
Jeffrey Brown on (02) 9806 7446 or jeffreyb@matthewsfolbigg.com.au
Stephen Mullette on (02) 9806 7459 or stephenm@matthewsfolbigg.com.au.