High Court confirms liquidator has first pick of the fruits of litigation

In brief

The High Court recently considered the competing entitlements of a liquidator and a secured creditor to the proceeds of a claim brought by the liquidator which was against the secured creditor's interests. Partner Chris Prestwich and Law Graduate Kaelah Ford report on the High Court's decision that the liquidator has an equitable charge over the proceeds securing the realisation costs, that will take priority over the secured creditor's charge.

Facts and background

Background

Atco Controls Pty Ltd (the secured creditor) held a fixed and floating charge over the assets of its subsidiary, Newtronics Pty Ltd (the company). The secured creditor gave letters of support to the company, promising to provide the company with funds to meet its trading obligations and provided assurance that it would not call upon the debt owed to it within a relevant period.

The secured creditor appointed receivers to the company after the company was ordered to pay damages of $8.9 million to an unsecured creditor, Seeley International Pty Ltd, in a separate proceeding. The receivers sold the company's business and shortly after, Seeley International Pty Ltd applied to have the company wound up and a liquidator was appointed.

As the company had no assets which could be realised in order to pay the liquidator's costs, the liquidator sought funding from its creditors. Seeley International Pty Ltd (the funding creditor) agreed to indemnify the liquidator for his costs and expenses in pursuing an action against the secured creditor on the basis of the letters of support.

Initial action against the secured creditor and the receivers

The company alleged that by reason of the promises made in the letters of support, the secured creditor was not entitled to enforce its security and that the receivers were wrongfully appointed. The claim against the secured creditor was unsuccessful, but the receivers settled the liquidator's claim against them for $1.25 million (the settlement sum).

The secured creditor demanded payment of the settlement sum pursuant to its charge. The liquidator declined to pay the settlement sum to the secured creditor on the basis that it had an equitable lien over that sum that secured its realisation costs (which were in excess of the settlement sum). In response, the secured creditor brought proceedings challenging the liquidator's decision.

The Supreme Court and appeal

The Supreme Court of Victoria found in favour of the liquidator. The secured creditor then appealed this decision and was successful in the Court of Appeal. The liquidator was subsequently granted special leave to appeal to the High Court.

The High Court decision

The High Court unanimously upheld the liquidator's appeal. The decision turned largely on the application of the principle in Universal Distributing Co Ltd (In Liq)² which provides that a secured creditor may not have the benefit of a fund created by a liquidator's efforts in the winding up, without the liquidator's costs and expenses first being met. To that end, equity will create an equitable charge over the fund which ranks ahead of the secured creditor's charge (the Universal Distributing principle).

Although the Universal Distributing principle is well established, the secured creditor contended that it should not be applied in circumstances where it argued that the proceeding was, in substance, between the funding creditor (which had indemnified the liquidator) and Atco; the secured creditor had not willingly allowed the litigation to be run; and it did not stand to benefit from the claim (which was against it and its receivers). The High Court rejected each of the secured creditor's arguments, observing as follows:

• The fact that the secured creditor had not willingly participated in the realisation of the settlement sum did not preclude the creation of an equitable charge.
• There is no requirement that the liquidator's work had to be done for the exclusive purpose of raising the fund for an equitable charge to be created. The liquidator's subjective purpose (which the secured creditor contended was to remove its status as a creditor) was irrelevant.
• The liquidator has not acted unconscientiously by acting in the funding creditor's interests. The liquidator's duty is owed to the body of creditors as a whole and to the court. The liquidator had acted with propriety and in the course of his statutory duties in bringing the proceeding.

The High Court held that there were no particular facts or circumstances in the Atco matter that rendered the Universal Distributing principle inapplicable. The result of the decision is that the fund produced by the litigation should bear the cost of its realisation, with the settlement sum being applied to meet the costs incurred in running the proceeding.

Comment

While a secured creditor's fixed charge will ordinarily have priority over all other claims, there are some circumstances in which the costs incurred by an insolvency practitioner will be required to be paid ahead of the secured creditor. Under the 'salvage principle', the administrators' or liquidators' expenses reasonably incurred in the care, preservation and realization of the secured property are required to be paid ahead of any return to the secured creditor. The High Court's decision in Atco demonstrates that, where a liquidator causes a company to pursue a cause of action that is subject to the secured creditor's charge, and the liquidator acts with propriety and in the interests of the general body of creditors, the liquidator will have an equitable charge or lien over the proceeds of that claim. That charge or lien will secure the costs and expenses incurred by the liquidator in pursuing the claim.