Company in liquidation to sue its liquidators as court grants leave to bring derivative action

The Court’s decision in Barokes Pty Ltd (in liq) [2022] VSC 642 is important because, for the first time in Australia, a Court has granted a creditor leave to bring a derivative action in the name of a company in liquidation against its liquidators. This case opens another significant gateway for creditors to seek redress for their losses.

Recent Australian case law has established that an administrator and liquidator of a company can be publicly examined by a former director, shareholder and creditor (subject to obtaining eligible applicant status from ASIC), and public examinations can be for a purpose which does not ultimately confer a benefit to creditors of the insolvent company. In the UK, a duty owed by directors to creditors has been firmly established – with its likely application in Australia.

This trend in case law is likely to give rise to an increase in shareholder and creditor litigation against directors, accountants and insolvency practitioners – especially given the personal liability of insolvency practitioners and the potential availability of an insurance policy, such as D&O policy.

Facts

Barokes, an Australian company, sold wine-in-a-can products. The plaintiff, Daiwa, is a Japanese corporation which holds 60.05% of the shares in Barokes. Daiwa was also a creditor of Barokes.

Between September 2012 to May 2014, Daiwa lent money to Barokes under various loan agreements.

Barokes brought various patent infringement proceedings against Daiwa and a number of its subsidiaries, and a separate claim against Daiwa’s trading partner in China (together, Foreign Patent Proceedings). Neither of these claims were successful.

In December 2018, Barokes went into liquidation. In early 2019, the liquidators conducted a process for the sale of Barokes’ business. Daiwa submitted four offers to the liquidators (respectively, Daiwa’s First, Second, Third and Fourth Offer) but all were ultimately rejected in favour of a joint offer from a past employee of Barokes (who was the wife of a director of Barokes and associated with one of the minority shareholders) (Joint Venture Offer).

Daiwa made an application to Court seeking leave to bring proceedings on behalf Barokes, a company in liquidation, to sue its liquidators for failing to consider a further offer.

The question before the Court was whether Daiwa should be granted leave to bring proceedings on behalf of Barokes against the liquidators. The Statement of Claim included three main claims – these claims were based on:

1. The liquidators’ failure to consider and or accept Daiwa’s First Offer, which was materially superior to the Joint Venture Offer.

2. The liquidators’ failure to take into account the value of the extra payment Daiwa was willing and able to make for the claims in the Foreign Patent Proceedings in accepting the Joint Venture Offer, despite possessing knowledge that Daiwa had a special interest in acquiring the rights associated with those proceedings.

3. The liquidators’ failure to consider and or accept Daiwa’s Fourth Offer, which was materially superior to the Joint Venture Offer.

Applicable law

Attiwill J summarised the principles surrounding how a member of a company has standing to bring a derivative action in the name of a company in liquidation. As to the jurisdiction of the Court to allow such a derivative action to be brought, it was clear from El-Saafin v Franek (No 2) [2018] VSC 683 that:

1. the Court has inherent jurisdiction to grant leave for an “appropriate person” to bring proceedings on behalf of a company in liquidation. Those persons include creditors and contributories of a company, but also any party who is entitled to derive benefits from the assets of the company in the winding up (eg guarantors);

2. the Court has power as custodian of the interests of every class affected to ensure that all assets of the company are brought into the winding up; but

3. this said, the bar for exercising the Court’s discretion is high (analogous to equity in allowing a beneficiary to sue on behalf of a trust). In the trust scenario, a suit can only be commenced in ‘special circumstances’ which would embrace a failure by the trustees to protect the trust property or to protect the interests of the beneficiaries of the trust.

To satisfy this high bar, the Court will have regard to three main considerations, which were first laid out in Carpenter v Pioneer Park Pty Ltd [2008] NSWSC 551 and adopted in El-Saafin v Franek (No 4) [2020] VSC 389 (not disturbed on appeal). Those considerations are as follows:

1. Whether the proceedings proposed to be pursued have some solid foundation – neither vexatious nor oppressive – with reasonable prospects of success:

• • This is so regardless of an apparent contradiction with s 237(2)(c) of the Corporations Act 2001 (Cth) which requires the Court to be satisfied that the proposed derivative action is in the best interests of the company.

• • There is no requirement that the Court base its decision solely on a draft pleading. Rather, consideration will be given to whether the cause of action asserted, and the evidence led, betray a solid foundation for the proposed proceeding.

2. The attitude of the liquidator as to whether proceedings should be pursued, and the basis of such attitude. Usually, this will involve a liquidator believing that the action is worth pursuing but he or she cannot pursue the proceeding due to a lack of funds.

3. Whether “practical considerations support the initiation of the proceedings” with reference to the financial protection of the liquidator and the estate:

• • The Court is to ensure that the assets of the company in liquidation are not put at risk by the proceeding and that the liquidator is not exposed to personal liability.

• • The Court may require that the person who conducts the litigation give an indemnity to the company in liquidation and or the liquidator in order to facilitate this.

It was further observed that the above three factors are non-exhaustive, and that the Court retains a general discretion.

Decision in this case

1. Whether “solid foundation” existed 

In finding for the applicants, Attiwill J considered the three-limbed test above, starting with whether the proceedings “have some solid foundation in that they exhibit such a degree of merit as to be neither vexatious nor oppressive and present a reasonable prospect of success” in respect of the three claims asserted in Daiwa’s proposed Statement of Claim. His Honour’s findings were as follows:

a. Daiwa’s First Offer

First, His Honour was not satisfied that the liquidators breached their duty of care to the company on the basis that they did not, or did not adequately, compare Daiwa’s First Offer to the Joint Venture Offer before accepting the Joint Venture Offer. Daiwa itself conceded that the offer was “a fairly cryptic offer” and “too uncertain to be accepted”, and that some conditions in Daiwa’s First Offer constituted “problematic conditionality”. Further and in any event, this First Offer was superseded by Daiwa’s subsequent offers.

b. Foreign Patent Proceedings

Secondly, His Honour found that there was a solid foundation for the claim in relation to the Foreign Patent Proceedings.

The Court was satisfied that from 25 March 2019, the liquidators knew that Daiwa had a special interest in acquiring the rights associated with the Foreign Patent Proceedings. Despite this, it was not made out on the evidence that the liquidators had obtained any, or alternatively any adequate, independent legal advice that the Foreign Patent Proceedings had any reasonable prospects of success or would result in any monetary return to Barokes. There was also no basis upon which the liquidators could reasonably conclude that the rights associated with the Foreign Patent Proceedings had material value to Barokes beyond what Daiwa was willing to pay for them.

Therefore, the Court found that the evidence established that there was a solid foundation for the proposition that the liquidators’ actions constituted a breach of duty on the liquidators’ part “to act with due care and still to an extent that is reasonable in all the circumstances”, which would cause Barokes loss.

c. Fourth Offer

Thirdly, His Honour found that there was a solid foundation for the claim in relation to Daiwa’s Fourth Offer.

The Court found that by failing to make any inquiries as to Daiwa’s Fourth Offer, in particular by failing to compare it to the Joint Venture Offer (which was what was ultimately accepted), the liquidators prima facie breached their duty to act with due care and skill because Daiwa’s Fourth Offer was materially superior to the Joint Venture Offer. This failure on the part of the liquidators resulting in the acceptance of an inferior offer caused loss to Barokes and subsequently yielded a lower return to creditors than what they otherwise would have received.

2. Attitude of the liquidators

Having found that there were solid foundations for two of the three claims, His Honour proceeded to examine the second limb of the test, being the attitude of the liquidators.

Given the unique circumstances of this case, His Honour held that the attitude of the liquidators is of no real relevance in circumstances where the proposed claims are being made against the liquidators. This case may be distinguished from the ordinary and usual situation in which a liquidator brings proceedings on behalf of a company.

3. Practical considerations

The issue of whether there are practical considerations preventing grant of leave was mostly ameliorated by Daiwa’s proposal to indemnify Barokes from any liability for costs ordered against it in the putative proceedings. However, a point of contention was whether Daiwa should be required to give security for this indemnity. Daiwa asserted that the dividend that it would get from the winding-up of Barokes by reason of its admitted debt would be more than sufficient to meet these costs, obviating the need for security.

In considering this issue, His Honour first held that the indemnity should not be limited to that which follows a final determination of the derivative proceedings. For example, if Barokes is ordered to pay the liquidators’ costs for an interlocutory application, the indemnity should also cover those costs. His Honour also rejected Daiwa’s submissions in relation to the security point and held that any grant of leave should also be conditional on Daiwa providing security for its indemnity. This is because there was no evidence that it had any assets in this jurisdiction and that the final quantum of the dividend to be received by it was uncertain.

In conclusion, having considered the relevant legal test and evidence, leave was granted for Daiwa to bring proceedings in Barokes’ name. This was so regardless of the delay which would be caused to creditors in receiving their dividend in the liquidation – the potentially substantial damages that Barokes could be entitled to under the derivative proceedings would outweigh the prejudice suffered by creditors from this delay.

Practical takeaways

1. When selling assets, or otherwise realising assets of an insolvent company, insolvency practitioners should be careful to review all competing offers and conduct a robust return-to-creditors analysis of the offers.

2. Insolvency practitioners should always carefully document the process by which they evaluate any competing offer, and the steps taken to consider whether a particular action is in the best interests of the creditors.

3. Administrators should be slow to discount a competing deed of company arrangement – especially when making a recommendation to creditors – without fully evaluating the ultimate benefit to creditors.

4. Creditors and shareholders may wish to consider whether any claims could be made against directors and insolvency practitioners to recover any loss, rather than just accepting the dividend which could ultimately flow with the liquidator running its own course.

5. It is critical that sufficient evidence is adduced to make out a strong case in respect of the application for a grant of leave for a contributory to sue in the name of a company to succeed. Since any such evidence adduced will also be useful in the substantive proceeding, it is prudent to be diligent with such evidence-gathering from the very start – therefore consideration should be given to the use of public examinations, which can also help test recoverability.

6. The prospects of leave being granted for a derivative suit appears to increase if the indemnity given by the contributory is fortified by security. Bearing in mind that such litigation may be extremely time-consuming and expensive, contributories must weigh up the opportunity cost between the potential benefits of the action against the alternative use of capital.