HWL Ebsworth’s Perth Restructuring and Insolvency team recently obtained declaratory orders confirming the validity of the appointment of former voluntary administrators (who had been appointed as liquidators by the date of the hearing) under section 436A of the Corporations Act 2001 (Cth) (Act). Richard Johnson (Partner) and Tom Langdon (Senior Associate) acted for the successful practitioners and argued the application in the Supreme Court of Western Australia before Master Sanderson.
The resulting decision in Hughes, Traditional Therapy Clinics Ltd  WASC 139 (click here) provides some useful guidance to insolvency practitioners (and those that advise them) in relation to:
- The duties of directors in appointing administrators;
- The duty of inquiry to which an administrator is subject in accepting an appointment; and
- The use of pro-forma director appointment and information packages by prospective administrators.
The decision concerned the question of whether the appointment of the administrators (Administrators) was valid in circumstances where two of the five directors of Traditional Therapy Clinics Ltd (Company) did not did not have sufficient knowledge of the affairs of the Company to form an opinion as to whether the Company was insolvent or likely to become insolvent.
In the face of concern by ASIC as to the resulting validity of their appointment, the Administrators sought two alternative orders. The primary relief sought was a declaration pursuant to section 447C of the Act confirming the validity of the appointment of the Administrators under section 436A. In the alternative, the Administrators sought remedial orders pursuant to section 447A of the Act validating their appointment. ASIC, who applied for and obtained leave to appear at the hearing, opposed the making of the first order and offered no objection with respect to the alternate relief that was sought under section 447A.
The Administrators succeed with their primary claim, the Court declaring under section 447C that their appointment was valid despite two of the Company’s five directors not having sufficient knowledge of the affairs of the Company to form an opinion as to whether the Company was insolvent or likely to become insolvent.
At the time of the purported appointment of the Administrators, the Company had five directors, two of whom had been appointed immediately prior to the resolution to appoint the Administrators. The evidence disclosed that those additional directors had been appointed with a view to ensuring the Company’s compliance with section 201A of the Act. Prior to the appointment of those additional directors, none of the Company’s three directors were resident in Australia. All of the Company’s directors voted in favour of the appointment of the Administrators. That was so notwithstanding that the two most recently appointed directors did not have sufficient knowledge of the affairs of the Company to form an opinion to the Company’s solvency.1
ASIC maintained that section 436A(1)(a) of the Act required all of the directors that voted for the resolution appointing the Administrators to hold the opinion that the Company was either insolvent or was likely to become insolvent. ASIC contended that if a director had not formed that opinion and voted in favour of the resolution, the resulting resolution would be invalid and any appointment would not have been properly made.2 Curiously, ASIC conceded that if a director who had not formed an opinion in relation to insolvency had abstained from voting, the appointing resolution would nevertheless be valid if passed by a majority.
The Administrators’ position
The Administrators argued that ASIC’s preferred interpretation of section 436A(1) was too narrow and unworkable in practice. They submitted that so long as a majority of directors held the opinion the company was insolvent or likely to be insolvent, the resulting appointment would be valid.
The Court’s decision
The Court favoured the Administrators’ view, observing that Part 5.3A of the Act does not require, as a necessity, that each director voting upon a resolution under section 436A have a “fully formed carefully reasoned opinion”3 regarding the requisite elements of section 436A. The Court observed that:
“…there is nothing in pt 5.3A which compels a court to take a rigorous and technical view of the appointment process.The whole exercise must necessarily be a matter of commercial judgment. A company will be insolvent when it is unable to pay its debts as and when they fall due. A company might become insolvent if, at a future date, when debts fall due it might not be possible for the company to make payment of those debts. All of this anticipates commercial judgment. For instance a company may be expecting an outstanding account to be paid. It is a matter of commercial judgment whether that account is likely to be paid before debts are actually due for payment. Some directors may have a better understanding of the financial position of the company than others. Some directors may have expertise in marketing and sales and limited knowledge of the financial aspects of the company. That does not mean they are failing in their duties as directors. It simply recognises different qualities of different individuals. So some directors may, with the benefit of their financial expertise, be well across the question of a company’s solvency whereas others are dependent upon their fellow directors’ opinion or opinions offered by others both internal and external”.4
The Court held that the phrase “the opinion of the directors voting for the resolution”, within section 436A, means the opinion of the majority, observing that it would be a strange outcome if a decision of the majority acting on a fully informed basis could be vitiated by the actions of a minority. The Court sensibly noted that the alternate approach would leave open the possibility of sabotage by a director after the appointment of an administrator by taking the position that they had never formed an opinion regarding the solvency of the company and voted for the appointment mistakenly.5
Master Sanderson ultimately found that all that was required to appoint the Administrators in this case was that a majority of directors had formed the opinion the Company was insolvent or about to become insolvent voting in favour of the appointment, and that those requirements had been satisfied. The Master also observed that if he was wrong in that conclusion, he would nevertheless have made an order under section 447A deeming the appointment to be valid.
Other takeaways – Pre-appointment packs
An interesting aspect of the decision that is not readily apparent from the Master’s judgment is that ASIC, in the course of its oral submissions, offered the view that the provision of ‘pro-forma’ appointment packs by prospective administrators was an unusual or concerning practice and that the use of such documents potentially derogated from a director’s obligations when voting for a resolution under section 436A. Pleasingly, that argument did not develop any traction with the Court, the Master noting that:
“The circumstances in which administrators are appointed necessarily varies from case to case. But this case is by no means unusual. In broad terms the external accountant for the Company came to the view that the Company was insolvent and should appoint administrators. He put the directors in touch with the plaintiffs. The plaintiffs are experienced administrators and have been involved in any number of administrations. But there were equally competent alternatives. What any potential administrator must demonstrate to the directors is that they can conduct the administration in an efficient and cost effective manner. Part of that process is to provide the directors with proforma resolutions allowing for the appointment of administrators. It is, of course, always for the directors to make the ultimate decision. But there is nothing wrong with their adopting the pro forma resolutions once the decision has been made.”6
In confirming that the comments of Barrett AJA in Condor Blanco Mines Ltd  NSWSC 1196, at , represent the definitive statement as to an administrator’s duty of inquiry as to the circumstances of their appointment, the Master made some helpful suggestions as to the means by which issues of the sort raised in relation to the Company might be proactively avoided in the future, stating that it may be prudent for administrators, as part of the pre-apportionment packages that they provide to directors, to:
- Include a statement signed by each director to the effect they have formed a view the company is insolvent or about to become insolvent; and
- Warn directors if they have not reached the requisite opinion regarding solvency, they should either vote against the resolution or abstain from voting.
This article was written by Richard Johnson, Partner and Rozita Jahangirian, Law Graduate.
P: +61 8 9420 1539
1Hughes, Traditional Therapy Clinics Ltd  WASC 139 at .
2Hughes, Traditional Therapy Clinics Ltd  WASC 139 at .
3Hughes, Traditional Therapy Clinics Ltd  WASC 139 at .
4Hughes, Traditional Therapy Clinics Ltd  WASC 139 at .
5Hughes, Traditional Therapy Clinics Ltd  WASC 139 at .
6Hughes, Traditional Therapy Clinics Ltd  WASC 139 at .