Rejection of a proof of debt – an illustration of the court’s general power to overturn liquidator decisions

The court’s power to overturn the decisions of insolvency practitioners in a company’s external administration was highlighted in the recent case of Tuscan Capital Partners Pty Ltd v Trading Australia Pty Ltd (in liq), in the matter of Trading Australia Pty Ltd (in liq) (Proof of Debt) [2021] FCA 1061 (Tuscan). This case serves as a reminder that liquidators and administrators should always exercise caution and diligence in assessing proofs of debt and remain cognizant that they may be subject to an adverse costs order if they fail to do so.

The Tuscan Case

A proof of debt was lodged by Fishbank Development Corporation Pty Ltd (Fishbank) claiming a contribution from Trading Australia Pty Ltd (Trading Australia) for fees arising from an alleged joint retainer for legal services. The liquidator accepted Fishbank’s proof of debt, which was promptly challenged by a director of Trading Australia on the basis that no retainer had in fact been entered into. The director’s argument was supported by facts that suggested the initial costs agreement (engagement letter) was revoked by amended ‘counter-offers’ sent by Fishbank – which were never accepted – that correspondence between the parties did not treat Trading Australia as a client, and that Fishbank waited five years (until Trading Australia’s insolvency) before requesting a contribution. Reviewing these facts, the court concluded that no retainer was operative and that Fishbank’s proof of debt should be rejected. The liquidator was ordered to pay the director’s costs of bringing the action.

Impact of the Tuscan decision

Impact on insolvency practitioners

First, the Tuscan case highlights that the proof of debt process does not end with a liquidator’s determination as courts can overturn their decisions. Indeed, the court has the power to make any orders it sees fit relating to a company’s external administration under section 90-15 of the Insolvency Practice Schedule (Corporations), located in Schedule 2 of the Corporations Act 2001 (Cth) (Schedule).

Second, the case reinforces the importance of properly assessing all proofs of debt. A proof should not be admitted without proper scrutiny of the surrounding circumstances to ensure the company in liquidation actually owes the debt (and if it does not owe the debt, the proof should be rejected). If there is ambiguity, liquidators and administrators should interrogate the circumstances surrounding the claim, including reviewing any available documentation or evidence.

Third, insolvency practitioners should be aware that where a proof of debt is improperly admitted and a court challenge ensues, the insolvency practitioner may become personally liable for an adverse costs order. Significantly, such an order was imposed in Tuscan, despite the judge stating that the position of the liquidator was ‘reasonable’ and their defending of the admission ‘appropriate’. This suggests that acting otherwise reasonably, will not prevent a costs order where the underlying admission of a proof of debt was flawed.

Impact on other parties

More generally, the case illustrates the ability of interested parties to challenge an insolvency practitioner’s adjudication of a proof of debt. While the court may exercise its power to make any orders it sees fit in external administration by its own volition, section 90-20 of the Schedule also empowers specified parties to apply for court orders. Those parties include persons with a financial interest in the administration, a creditor on behalf of a committee of inspection, ASIC, and company officers. This means that a shareholder, company director or other creditors who are sceptical about the admission (or non-admission) of certain debts in an administration can seek to have those decisions set aside, which may be useful to improve their own position – both from a voting point of view and in relation to participation in any distribution in a winding-up.