Advisors are often the first point of call for directors when a business begins to experience financial distress. Cashflow tightens, the ATO engagement escalates, debts mount, and suddenly, the conversations shift from growth to survival. These conversations typically occur at a time when directors are stressed, creditors are pressing, and time is of the essence.
The Federal Court’s decision in Connelly (Liquidator) v Papadopoulos [2024] FCA 888 provides a useful reminder of the importance of maintaining appropriate boundaries when advising distressed businesses. While the case involved extreme facts, the principles that emerged are relevant to accountants, lawyers and other advisors who assist clients navigating financial difficulty.
Background
TSK QLD Pty Ltd operated a labour hire and recruitment business, primarily servicing the mining and resources sector. Despite turnover exceeding $90m in previous years, the company’s financial position deteriorated rapidly in 2021 and by February 2024, insolvency was looming.
Rather than entering into a formal restructuring process, the director and senior management engaged an external advisor to assist with an informal restructure of the company. What followed was a series of transactions designed to move the business and its cashflow away from TSK and into related entities before an insolvency appointment occurred.
Over the course of 2021, more than $10m was transferred out of the company. By the time administrators, and later liquidators, were appointed, little remained for the benefit of creditors.
As part of the liquidators’ role, a detailed review of the company’s affairs was undertaken. That review identified a series of related party transactions and significant funds being redirected away from the company in the period leading up to its collapse, as well as the involvement of an external advisor in structuring and implementing those arrangements.
Given the scale of the losses and the advisor’s central role in the structure and execution of the transactions, proceedings were commenced against the advisor (and other parties) in the Federal Court to recover losses suffered by the company and its creditors. While a number of the defendants resolved the proceedings by settlement, the advisor contested aspects of the liability and quantum, which were ultimately determined by the Court.
How the Court Viewed the “Restructure”
The Court had little difficulty in characterising the arrangements as an “asset stripping scheme”. Justice Downes found that the advisor was not simply providing high level advice, but had designed the structure, prepared or arranged key documentation, approved payments and undertook the valuation of the business.
Importantly, the advisor argued that he should not be responsible for certain payments because he did not personally process or authorise them. The Court rejected this position, noting that liability does not depend on who executes a transaction, but on whether the advisor knowingly participated in the scheme that resulted in the dissipation of company assets.
For advisors, this is a critical point. Liability does not rely on who clicks “authorise” in the bank account, but whether you knowingly participate in a transaction that disadvantages creditors.
Valuations, Commerciality and Credibility
One of the more damaging aspects of the advisor’s position was the valuation of the business at nil, despite ongoing trading and significant receivables. That valuation underpinned the justification for transferring assets to related entities without proper consideration.
The Court was not convinced that this approach reflected commercial reality. In assessing the loss suffered by the company, the Court relied on the expert valuation evidence obtained by the liquidators, which was based on the company’s financial records and trading position at the relevant time. That evidence demonstrated that value remained in the business, notwithstanding its financial distress.
This highlights the importance of ensuring that valuations used in distressed scenarios are robust, defensible and where appropriate, independent. Where valuations appear to facilitate related party outcomes at the expense of creditors, they are likely to be closely scrutinised.
Courts Findings
The Court held that the advisor was personally liable because of his active involvement in causing loss to the company, not merely because he gave advice.
Specifically, the Court found that the adviser was knowingly involved in breaches of directors’ duties and in transactions that caused the company to suffer loss, exposing him to liability under s588M of the Corporations Act, s1317H (compensation for contraventions) and by way of equitable compensation. Importantly, this finding was made without the adviser being characterised as a shadow or de facto director. The adviser was not treated as a passive advisor; rather, the Court found that he had designed and implemented the asset stripping scheme. That level of involvement was sufficient to establish that his conduct caused, or was materially connected to, the loss suffered by the company. As a result, judgment was entered against the advisor for over $7.29 million, representing the loss suffered by the company.
An attempt was made by the advisor to limit the practical impact of the judgement, arguing that other parties had entered into settlements which resulted in the possibility of creditors being repaid overtime and seeking orders that would defer or condition enforcement against him.
The Court rejected this approach, stating that liquidators are entitled to pursue immediate recovery from any party responsible for the loss.
Why this Matters for Advisors
In this case, the Court’s focus was not on intention, but on outcome. Even if the aim was to preserve the business or protect jobs, the effect of the transaction was to strip assets and prejudice creditors.
Advisors who become too embedded in restructuring strategies, particularly where they draft documents, direct cash flow or undertake valuations, are at risk of being viewed as more than advisors. In such a case, personal liability is enlivened.
Final Thoughts
Decisions like this highlight the importance of involving experienced insolvency practitioners at an early stage in order to assist advisors and their clients to properly assess all available options. This includes an assessment of whether a formal insolvency process may achieve the same or a better outcome, while also reducing the risk of future claims against advisors and their clients.
If advisors would like to discuss how these issues may arise in practice or would benefit from a sounding board when working through restructuring options for a client, a Worrells Principal can assist in considering the range of available options and associated risks.
