Court approval of settlements in liquidations

The Supreme Court has confirmed that declarations can be made approving settlement payments and the mere fact that a liquidator has acted on incorrect advice will not preclude a settlement payment being regarded as an expense “properly incurred” for the purposes of s 556(1)(a) of the Corporations Act.

Lewis & Templeton & Warehouse Sales Pty Ltd (in liq) v LG Electronics Australia Pty Ltd & Ors (No 2) [2016] VSC 63

Background

1. The Plaintiffs were appointed liquidators of two companies – Warehouse Sales Pty Ltd (“WHS”) and WHS2 Pty Ltd (“WHS2”). Both companies were involved in selling brown and white goods from a store in Wodonga. WHS was the owner of the store and leased it to WHS2.
2. WHS had supply agreements in place with various suppliers such as LG, Electrolux, Panasonic and SMEG. Those supply agreements included retention of title clauses and each supplier registered security interests on the Personal Property Securities Register accordingly. The arrangement between WHS and WHS2 was that WHS would purchase goods from suppliers, WHS would then sell those goods to WHS2, who then sold the goods to customers.
3. When the winding up of WHS and WHS2 commenced, the Plaintiffs, relying on legal advice they obtained, entered into agreements with certain suppliers (“Suppliers”) settling the Suppliers’ claims to stock, under which stock of a certain value would be returned to the Suppliers.
4. The advice received by the Plaintiffs was incorrect and, on realising that it may have been incorrect, they stopped the Suppliers from taking back further stock. The Plaintiffs then sought declarations under s 511 of the Corporations Act 2001 (Cth) (“Act”) from the Supreme Court to determine what, if any, security interests were held by the Suppliers. The Suppliers issued interlocutory processes in the proceeding commenced by the Plaintiffs, by which the Suppliers sought the recovery of stock or damages. The Plaintiffs’ application was the subject of an earlier judgment, in which Sifris J held that the Suppliers lost their security interests once goods were sold by WHS to WHS2 or a customer (apart from some layby sales) (see the judgment the subject of this note ([2016] VSC 63) at [53] and [60]).[1] The judgment confirmed, to the extent relevant, that the advice originally received by the liquidators was incorrect.
5. The Plaintiffs then sought to settle the Suppliers’ claims, and negotiated conditional settlements with the Suppliers, which involved WHS making a compromise payment to the relevant supplier. To that end, the Plaintiffs made a second application seeking further declarations from Sifris J that the settlement payments would be justified and, if paid, would be “properly incurred” expenditure (at [44]).

Can declarations approve settlement payments?

6. Sifris J concluded that ample authority existed for the proposition that a declaration that a settlement is “justified” can be made under s 511 of the Act (at [69]). However, his Honour held that directions should not be given retrospectively to approve settlements already entered into and should not deal with the reasonableness or otherwise of a liquidator’s conduct (at [86]).
7. His Honour also considered the circumstances that would support giving directions approving a settlement and concluded that the settlements in this case should be approved because each settlement (at [94], [102] and [108]):
   • avoided the risk involved in litigation;
   • avoided the Plaintiffs, as liquidators, incurring further expenses and remuneration;
   • avoided the risks of adverse costs orders;
   • was a commercial and arm’s-length dealing struck with the benefit of legal advice;
   • was the result of detailed consideration by the Plaintiffs and their advisers; and
   • was struck by the Plaintiffs after taking advice proportionate to the amount in dispute.
8. His Honour also considered it relevant that the Plaintiffs had acted in good faith in investigating, taking advice and negotiating with the Suppliers to reach the settlement agreements and that the complexities surrounding the liquidations justified the Court providing directions to clarify those matters (at [110]).

Can settlement payments made because of incorrect advice be expenses “properly incurred”?

9. The Plaintiffs also sought a declaration that the settlement payments would be expenses “properly incurred” for the purpose of preserving WHS and WHS2’s property. Sifris J had no difficulty in concluding that the payments would be expenses incurred in preserving WHS and WHS2’s property (at [129], [141] and [144]). The real issue was whether they would be expenses “properly incurred”, given that they would be a consequence of the original agreements to return stock to the Suppliers, which the Plaintiffs entered into in reliance on the incorrect advice.
10. His Honour noted a line of authority suggesting that expenses incurred because of “erroneous” advice could not be regarded as expenditure “properly incurred” (at [147]). However, his Honour did not accept that approach holding that the “mere” fact that the advice acted on was incorrect did not mean the expenses were not “properly incurred”. This was because, although the advice given was wrong, it was not unreasonable for the Plaintiffs to act on it having regard to the Personal Property Securities Act 2009 (Cth) being a “new regime” and without the benefit of a “developed body of explanatory case law” (at [150]). Further, his Honour expressly stated that reasonable allowance had to be made for the commercial realities and exercise of professional judgment by the Plaintiffs in a “complex” and “high pressure” situation when examining the Plaintiffs’ decisions with the benefit of hindsight (at [150]).

Conclusion

11. His Honour’s reasons make clear the following.
    • Declarations can be made approving a prospective settlement as long as a liquidator acts in good faith and the settlement is aimed at resolving a claim commercially and removing litigation risk.
    • Expenses incurred by liquidators as a result of incorrect advice may be “properly incurred” in certain circumstances.

[1] The earlier judgment is Warehouse Sales Pty Ltd v LG Electronics Australia Pty Ltd (2014) 291 FLR 407.