A man walks into a bar…and appoints an administrator – more on validity of administrator appointments

The facts

The facts of the case were reasonably complex but in summary were as follows:

• Condor Blanco Mines Ltd (Company) was an ASX-listed company involved in mining exploration;
• A general meeting of shareholders of the Company was scheduled for 5 July 2016. One of the resolutions proposed for that meeting was for the removal of one of the directors. The second director was due to cease to hold office after the meeting in accordance with the Company’s constitution;
• It became clear on 4 July 2016 from the proxies received in relation to the general meeting that the incumbent director would be removed at the general meeting the next day;
• Soon afterwards, the directors met with the proposed administrator (and others) at a public bar of a hotel in Kings Cross in Sydney, where the directors of the Company passed a resolution that the Company was insolvent or likely to become insolvent and appointed the administrator to the Company pursuant to section 436A of the Corporations Act 2001 (Act);
• At the general meeting of the Company’s shareholders on 5 July 2016, the resolution to remove one of the directors was passed; and
• The Company, through its newly constituted board, applied to the Court seeking a declaration that the appointment of the administrator to the Company was invalid, void and of no effect or, alternatively, that the administration should end.

The Company relied upon five grounds in support of the relief it claimed. This note will focus on the following grounds argued by the Company:

1. The directors did not hold the opinion as to insolvency required by section 436A(1)(a) of the Act; and
2. The resolution to appoint an administrator to the Company was passed for an improper purpose.

Opinion as to insolvency

The authorities make it clear that in order for a valid appointment of administrators to occur, directors voting for a resolution to appoint administrators must have a ‘bona fide and genuinely formed’ opinion that the company is insolvent or likely to become insolvent.

The Court examined the evidence in relation to each of the directors who voted in favour of the resolution to determine whether they held the requisite bona fide and genuinely formed opinion of insolvency. This required the Court to consider what each of the directors voting in favour of the resolution did to inquire into and form an opinion about the financial position of the Company.

The Court found that the Company had not established that the first director did not hold the required opinion as to insolvency.

In relation to the second director, the evidence was as follows:

• When asked during cross-examination what he did to inform himself about the financial position of the Company, he stated that he was not aware of an obligation to seek out that information;
• The director stated in his affidavit that he was never given access to the Company’s books and had never spoken to the secretary of the Company about getting access;
• The director stated in his affidavit that he knew about the Company’s position from discussions with the other director and that he ‘always relied on [the other director] as regards the financial position and solvency of the Company’; and
• During a discussion shortly prior to the purported appointment being made, the other director stated that they had no choice about appointing an administrator because the Company was insolvent, to which the director responded ‘OK, I believe you’.

The Court found that the director did not inquire about the Company’s financial state and did not address his mind independently to the question whether the Company was insolvent or likely to become insolvent. It was not open to him to take unquestioningly and at face value the opinion communicated by the other director as he had a responsibility to think and assess the situation for himself and, for the purpose of doing so, to familiarise himself with relevant financial facts. As he did not form an opinion of his own as to insolvency, the Court held that the statutory precondition to the appointment of an administrator under section 436A(1)(a) did not exist and that justified the declaration that the purported appointment of an administrator was void, invalid and of no effect.

Improper purpose

Given the Court’s finding in relation to the second director’s opinion as to insolvency, there was strictly speaking no need for the Court to consider the Company’s argument that the resolution to appoint an administrator was passed for an improper purpose.

The cases recognise that the appointment of an administrator must be in furtherance of the object of Part 5.3A of the Act and that the Court may intervene to terminate an administration where the power of appointment had been exercised for an ulterior or extraneous purpose to Part 5.3A.

The Company argued that the appointment of the administrator was a defensive tactic used by the director against the virtual certainty that he would be removed as a director the following day. That argument consisted of two parts; first, that the director sought to initiate administration so he could make a deed of company arrangement (DOCA) proposal to protect his interests; and, second, that the administration was commenced with undue haste to defeat the legitimate expectations of the proposed new directors and the shareholders seeking to appoint them.

The Court rejected the argument that the DOCA proposal was designed to protect the director’s interests.

In relation to the haste in which the administrator was appointed, the Court stated that the following conclusions were irresistible:

• The first director acted with extreme haste when he realised that the general meeting scheduled for 5 July 2016 was not going to be postponed; and
• The first director took this action to cause the Company to be in the hands of an administrator before the new directors were appointed.

The Court found that the first director was motivated by the improper purpose of negativing the power and influence of the incoming directors and defeating the will of the members who were about to put those directors into office. As the second director followed blindly and unquestioningly in the first director’s footsteps, his participation was tainted by the same improper purpose.

Had it been necessary, the Court would have made on order terminating the administration on this ground.

What does an administrator need to do to assess the validity of an appointment?

In considering submissions on costs, the Court had to consider the parties’ submissions on whether the administrator should have commenced proceedings seeking orders to clarify the status of his appointment. This required the Court to consider the nature of the responsibility of administrators in assessing the validity of their appointment.

After reviewing some of the authorities on the issue, Barrett AJA stated the applicable principles as follows:

• At the time of appointment and subsequently, an administrator must be attentive to any matter coming to his or her notice that may call into question whether the directors genuinely held the required opinion concerning solvency and validly and regularly passed a resolution pursuant to section 436A;
• There are two matters to be tested:

1. The formal validity of the resolution. Publicly available information (including bankruptcy records) will be examined to determine who the directors are and whether any of them are disqualified from acting because they are a bankrupt. The administrator must be satisfied that the board consisting of those directors has adopted due process to pass, by a majority of votes, a resolution in appropriate terms.
2. To the extent possible on available materials, the administrator should consider whether the directors voting held the stated opinion of insolvency at the time. His Honour stated that it may be expected that an administrator would make enquiry with those who have approached them and subjected the opinion of the directors to a ‘rough check’.

• Barrett AJA stated that in all but very exceptional cases, the responsibility to assess the validity of an appointment ends once the above steps are taken;
• His Honour also expressed the view that in general, it is not part of an administrator’s responsibility to delve into the purpose or motive of the directors beyond that of resort to administration as a response to actual or impending insolvency. In this regard, Barrett AJA stated that any suggestion to the contrary in ASIC v Planet Platinum [2016] VSC 120 (in which it was stated that the actual purpose of the appointment is ‘an important factor’ for the administrator to consider in discharging their responsibility to assess the validity of the resolution) should not be accepted; and
• His Honour went on to say that if it were ‘as plain as a pikestaff’, without any inquiry, that directors were resorting to administration for an extraneous purpose, the practitioner would fail to discharge their responsibility by accepting the appointment. Barrett AJA provided examples of where it might be ‘plain as a pikestaff’ that an extraneous purpose is involved, such as:
  • the directors actually refer to the extraneous purpose; and
  • where there are immediately obvious or observable circumstances that leave no alternative explanation.

Beyond such ‘patently obvious’ cases, Barrett AJA stated that an administrator’s responsibility at the time of appointment extends to considering possibilities of improper purpose and abuse of process.

For various reasons, the Court found that the administrator had reviewed the validity of his appointment in accordance with his responsibility.

Should the administrator have resigned or applied to Court seeking clarification on the validity of his appointment?

The issue then arose as to whether the administrator had an obligation to resign or initiate Court proceedings in relation to the validity of his appointment in response to matters raised by the Company. The Court found that:

• Having properly reviewed the validity of his appointment, the question of whether the appointment was made for an ulterior or extraneous purpose was not a judgment for the administrator to make and could only be determined by Court proceedings. In those circumstances, it would have been a clear breach of duty for the administrator to abandon his appointment by resigning in response to the Company’s demand to do so; and
• Whilst it was open to the administrator to commence Court proceedings seeking declaratory relief in relation to the status of the administration, he was not required to do so. It appears that the main factor relied upon by the Court in deciding this was that the administrator did not himself suspect any improper purpose in the appointment and was responding to allegations made by others. In circumstances where there was no positive duty to take such a step, the Court held that the absence of funds in the administration represented a good reason not to take the step.

The Condor Blanco case is the latest in what appears to be an increasing number of decisions about the validity of appointments and serves as a useful reminder to practitioners about the matters they should consider to ensure that any appointment they accept is valid.

This article was written by Polat Siva, Partner.