Those familiar with the circulars issued by insolvency practitioners will be aware that it is commonplace in administrations with limited assets for liquidators, to provide creditors with an opportunity to fund investigations (or pursue claims) which may otherwise be abandoned due to a lack of resources. These are typically expressed in our reports as “requests for indemnity funding”. In our view the ability to indemnify a liquidator provides creditors with a valuable tool to influence the level of investigations or actions taken in relation to certain matters in a liquidation.
Where a creditor provides an indemnity to a liquidator and other creditors do not, and when funds are recovered as a result of the actions or investigations that the funding allowed, the indemnifying creditor may claim an entitlement to a greater proportion of the funds recovered than may have otherwise been available to them. This is provided for by section 564 of the Corporations Act and further discussion on this issue can be found in our Indemnity Funding fact sheet.
A recent matter which sought to challenge the validity of indemnity funding in circumstances where the funds are provided by multiple parties was that of HP Mercantile Pty Ltd v Tumut River Orchard Management (In Liquidation)  FCA 200. In that matter proceedings were brought against a Liquidator claiming an indemnity funding arrangement should be disallowed as it was operating as an unregistered managed investment scheme in contravention the Corporations Act.
A summary of the facts in the case are as follows:
Tamut River, a horticultural project operator with a large number of investors, was placed into liquidation in July 2008. The majority of the company’s investors procured loans to subscribe for the interest in the projects through Tamut River directly, by way of “investor loans”. During Tamut River’s trading history, these investor loans were purportedly assigned to various unconnected entities. At the date of liquidation the rights to the investor loans were allegedly held by HP Mercantile.
HP Mercantile commenced various proceedings for the recovery of investor loans however were faced with disputes from the investors. A principal (although not the sole) issue in dispute in the proceedings between HP Mercantile and the investors was the validity and efficacy of the investor loan assignments.
In various circulars, the liquidators of Tamut River sought indemnity funding from both investors and creditors in order to investigate, inter alia, the investor loan assignments. It was observed by the liquidators that if the assignments were found to be invalid, then the ownership of the investor loans may revert to the company.
Funding was ultimately provided by a number of pooled investors to allow the liquidators to conduct public examinations of the HP Mercantile executives. As noted above, HP Mercantile challenged the liquidators purpose of raising and receiving the indemnity funds as being a managed investment scheme which was not registered in accordance with the Corporations Act.
A managed investment scheme is broadly defined in the Corporations Act as a scheme in which parties contribute monies to acquire an interest to benefits produced by the scheme. These contributions are pooled or used in a common enterprise and members of the scheme do not have day to day control over the operation of the scheme (section 9). The Corporations Act provides that such schemes are required to be registered if they have 20 or more members (section 601ED). HP Mercantile contended that the liquidators were operating such a scheme for reasons which included the following:
– Funding was pooled together by more than 20 members (in this case, investors);
– The members had no day to day control of the scheme operations; and
– The scheme provided the member with a series of potential benefits, including but not limited to, the opportunity to obtain declarations that the assignments of the investor debts were null and void and thereby avoid liability to HP Mercantile
In a decision handed down on 10 March 2011, the Federal Court found against HP Mercantile and dismissed the application (with costs). It was held that the funding scheme did not satisfy the definition of a managed investment scheme, with the decision appearing to hinge on the following two (2) points:
– No member to the scheme acquired any right to the benefit of avoiding liability because such benefits would flow to any investor, whether they contributed money or not; and
– There was no “pooling” because any benefit to a contributing investor would not change depending on the size of the pool.
Whilst it was in our view a peculiar position put forward by HP Mercantile, the above provides some comfort that multiple creditors (or multiple third parties) can pool funds together to indemnify a Liquidator for investigations or actions deemed warranted.
It is an unfortunate fact that in many cases the funds available to a Liquidator are insufficient to properly investigate and pursue claims. This leaves the liquidator with little choice other than to ask creditors for an indemnity to fund the costs of the investigations/actions.
Whilst understandably creditors who have already lost money to a debtor may be hesitant in readily agreeing to take further financial risks in funding a liquidator’s action to recover assets, the potential of priority afforded in section 564 of the Corporations Act (discussed above) may offer some incentive. As we have seen in cases such as DCT v Vintage Gold Investments Pty Ltd (In Liquidation)  FCA 967, the Courts appear to look favourably on creditors who provide an indemnity in cases where no action can otherwise be taken to pursue a recovery of monies.
Irrespective of whether the party has evinced an intention to fund the action, all our offices support open dialogue with creditors and we encourage any creditor who believes they may have information on potential action(s) in a liquidation we are administering to contact us to discuss the matter.