ASIC v Franklin – Implications for Referrals in the Insolvency, Restructuring and Turnaround Industry

On 21 July 2014, the Full Court of the Federal Court of Australia delivered its judgment in ASIC v Franklin, in the matter of Walton Constructions Pty Ltd (in liq). The judgement is likely to have significant implications for solicitors, accountants and turnaround professionals operating in the complex network of insolvency and restructuring industry referrals.

Background and Decision at First Instance
Related companies Walton Construction Pty Ltd and Walton Construction (Qld) Pty Ltd entered voluntary administration and subsequently liquidation in late 2013. The three (3) liquidators (the Liquidators) of Lawler Draper Dillon (LDD) were appointed on the referral of the Mawson Group, a business advisory firm with which the Liquidators had an ongoing commercial relationship.

The proceeding below arose out of application by the Australian Securities and Investments Commission (ASIC) to remove the Liquidators pursuant to s 503 of the Corporations Act 2001 (the Act). The orders sought were based upon allegations that there was an apprehension that the Liquidators may lack independence and impartiality.

Davies J, the judge below, outlined the basis of ASIC’s allegations.  She noted:

“ASIC […] contends that a reasonable apprehension of lack of independence and impartiality exists because of the following matters:

1. The liquidators were appointed the administrators of the companies on the referral of the Mawson Group, which provides business advisory and restructuring services to companies in financial difficulty;
2. The Mawson Group, as advisors, had worked with the companies prior to their collapse;
3. The companies transacted asset sales and debt assignments shortly before they went into administration that the liquidators will need to investigate, where:
   1. It appears from company searches that the other parties to the transactions were companies connected with the Mawson Group; and
   2. The asset sales and debt assignments effectively resulted in the transfer of a significant part of the businesses of the companies;
4. There is a need to investigate whether those transactions can be challenged as uncommercial transactions or unreasonable director-related transactions, whether the directors have breached their duties and whether Mawson Group personnel were involved in such breaches, where:
   1. The Mawson Group was involved in the appointment of the insolvency practitioners who will ultimately investigate transactions to which entities connected with the Mawson Group are parties;
   2. The liquidators’ firm, Lawler Draper Dillon (LDD) has been referred six other voluntary administrations by the Mawson Group;
   3. The referrals from the Mawson Group have generated a material volume of work with significant fees for the firm; and
   4. In three of the other administrations, there were antecedent transfers of assets and debt assignments by the companies to entities connected with the Mawson Group”.

It was submitted on behalf of ASIC that these matters were significant because:

1. It was necessary for the Liquidators to scrutinise the Mawson Group’s involvement in the transactions, as well as the conduct of persons and entities connected with the Mawson Group relating to the transactions; and
2. The Mawson Group frequently referred work to LDD as part of a continuous commercial relationship, and any investigation by the liquidators would involve scrutinising the individuals responsible for the referral.

What ASIC was in effect asserting was (colloquially) that LDD would be unwilling to bite the hand that fed them, and that the Liquidators’ appointment was tainted by apprehended bias. This in turn, on ASIC’s view, led to the conclusion that, as his Honour put it “…the Liquidators would not bring an impartial and unprejudiced mind to the investigation of the pre-appointment transactions, and would favour interests associated with the Mawson Group at the expense of the interests of creditors”.

Davies J relied upon the Supreme Court of New South Wales decision of Accord Pacific Holdings Pty Ltd v Gleeson in holding that:

“The test for determining whether a hypothetical fair minded observer would apprehend a lack of independence and impartiality requires the articulation of a logical connection between the matters which, it is said, may impede or inhibit the liquidators from acting impartially in the interests of all creditors in the discharge of their duties and the feared deviation from discharging their duties and responsibilities impartially”.

Her Honour noted that ASIC had alleged the character of the Liquidators’ relationship with the Mawson Group was a ‘Logical connection’, which gave rise to a reasonable apprehension that the Liquidators may not act impartially in the discharge of their duties and responsibilities. ASIC placed particular emphasis on the significant volume of work and fees generated by the Liquidators through Mawson Group referrals along with the fact that some referrals involved antecedent transfers of Mawson Group assets. ASIC also submitted that it was inappropriate for the Liquidators to conduct investigations into the Mawson Group in circumstances where the lawfulness of the Mawson Group’s conduct was in question.

However, Davies J did not accept ASIC’s submissions. She held that an appropriately informed fair minded observer:

1. Would know that liquidators have statutory duties and responsibilities, including the investigation of whether any transactions are voidable and whether any conduct involved a breach of the Act;
2. Would be aware that LDD were commonly referred insolvency work by solicitors, accountants and turnaround professionals;
3. Would understand that the Mawson Group’s relationship with LDD was professional in nature;
4. Would know that there is nothing about the conduct of the other insolvencies referred by the Mawson Group to LDD that would bring the independence and impartiality of LDD into question having regard to the nature of their relationship with the Mawson Group.

Her Honour concluded that there was no substance to the claim of apprehended lack of independence, and consequently, dismissed the proceeding.

Full Court Decision
On appeal, White J delivered the principal judgment, with which Jessup and Robertson JJ concurred as to the orders that should be made. White J cited the High Court decision of Ebner v Official Trustee in Bankruptcy to clarify that the correct test for determining whether apprehended bias exists in a liquidator was the same as the test that applies to the judiciary and administrative decision makers. The test from the joint judgment of Gleeson CJ, McHugh, Gummow and Hayne JJ in Ebner is whether “…a fair-minded lay observer might reasonably apprehend that the judge might not bring an impartial mind to the resolution of the question the judge is required to decide”.

In apply the so called “Double might”, test and determining that the liquidators should be removed, the Full Court concluded that the following facts gave rise to an apprehension of bias:

1. There was a conflict that was more than theoretical between the interest of the liquidators in not jeopardising the prospect of further remunerative referrals from the Mawson Group on the one hand, and the proper discharge of their duties as liquidators of the Walton companies on the other;
2. Due to the liquidators’ interest in not jeopardising future income, they might not discharge their duties with independence and impartiality; and
3. The Mawson Group was influential in the appointment of the liquidators. The fact that the creditors of the Walton companies raised concerns about the referral relationship further added to the apprehension of bias.

Comment/Implication

The Full Court’s decision indicates that insolvency practitioners are held to a high standard of impartiality and independence, akin to the standard applied to judges.

The decision reinforces the importance of a liquidator’s independence and perceived independence.

Practitioners should be wary of accepting an appointment where there is significant referral relationship between the practitioner and the referrer, or where the referrer had been involved in pre-appointment transactions that the practitioner will need to investigate.

Irish Bentley Lawyers have experience in a range of insolvency matters, including acting for liquidators and voluntary administrators in a number of scenarios. The issues surrounding whether or not to accept an appointment are complex and often need to be addressed with haste. If you have an insolvency query or need legal advice on an insolvency, restructuring or turnaround issue then please contact the friendly team at Irish Bentley Lawyers on (07) 3229 4060.

Please note that the above does not constitute legal advice and Irish Bentley Lawyers make no representations or warranties as to the accuracy of any of the information contained herein. If you have an insolvency issue, then please do not hesitate to contact the team at Irish Bentley Lawyers – there is no substitute for proper legal advice based on your unique circumstances.