Litigation Funding in Recovery Proceedings

Can liquidators pursue preference claims which, in isolation, may do no more than pay for the cost of the litigation?

In the recent case of Marsden v Screenmasters Australia Pty Ltd, in the matter of Cardinal Group Pty Ltd (in liq) [2015] FCA 1256 the Liquidators of Cardinal Group Pty Ltd (“Cardinal Group”) commenced proceedings against Screenmasters for the recovery of uncommercial transactions or unfair preference payments in the sum of $49,600 plus interest. This was one of many preference claims the Liquidators were pursuing, which collectively had a value of around $8m.

Screenmasters filed a running account defence and made an application under section 536 of the Corporations Act 2001 (Cth) (“the Act”) seeking an order that an inquiry be made into the conduct of the Liquidators on the basis that:

1. the Liquidators were pursuing the proceedings without any reasonable prospect that any amount recovered would benefit the creditors of Cardinal Group or benefit anyone other than the liquidation; and
2. the Liquidators were influenced to reject Screenmasters’ offer because, having negotiated terms with a litigation funder, the plaintiffs’ costs of the proceedings were not a material concern for the plaintiff in resolving them.

Section 536 – “Sufficient Basis” and the Court's Discretion

Before a Court will exercise its discretion under section 536 of the Act to order an inquiry into the conduct of Liquidators, it must be satisfied that there is a “sufficient basis" for making such an order, that is, that there is something relating to the conduct of the Liquidators which requires inquiry.

If satisfied that there is a "sufficient basis" for inquiry, many factors will be relevant to the exercise of the Court’s discretion including (inter alia):

• the strength and nature of the allegations;
• any answers offered by the Liquidator;
• other available remedies;
• the progress of the liquidation;
• the likely amounts of money involved;
• the availability of funds to pay for an inquiry;
• the likely benefit to be derived from it; and
• the legitimate interest of the applicant in the outcome.^[1]

“Make Work Scheme”

Screenmasters submitted, inter alia, that the proceedings were a "make work scheme" for the benefit of the Liquidators and lawyers (it was unlikely there would be any return to creditors) and, further, that the existence of the litigation funding agreement and the insulation from costs it provided the Liquidators were the primary reasons the proceedings were being continued. In particular, Screenmasters identified the quantum of the claim, relative to the costs of running the proceedings as a “key issue” in circumstances where Screenmasters would likely incur costs in defending the proceedings greater than the maximum amount recoverable by the Liquidators if they succeeded with their claim.

In deciding the judgment, Markovic J considered the case of Hall v Poolman^[2] and noted that there is no per se objection to Liquidators entering into litigation funding agreements.  In fact, in certain circumstances, Liquidators may enter into litigation funding agreements where there is little or no prospect of recovery beyond their own expenses and those of the funder. Accordingly, Markovic J considered that the fact that any recovery from the proceedings may not add to the pool of funds available to unsecured creditors or may only add negligible amounts, was not of itself a sufficient reason to order an inquiry. However, Markovic J emphasised that it is important that Liquidators do not pursue litigation simply in order to generate fees without any regard for the interests of creditors or the public interest.

Further, despite Markovic J accepting that the quantum of the claim was low relative to the costs of running the proceedings, Markovic J considered that the commencement and continuation of the proceedings could not be viewed in isolation and must be considered in the context of the whole of the liquidation, including the litigation strategy adopted by the Liquidators. Therefore, taking into account, inter alia, that the Liquidators had been thorough in their investigations, had provided regular and fulsome reporting and that any recovery from the proceedings would be added to the overall pool of assets available for creditors, Markovic J opined that the pursuit of the totality of the roughly $8m of preference claims was proper and the fact that some of the claims were for smaller amounts was not, of itself, a reason to abandon those claims.

Comment/Conclusion

While the totality of the liquidation must be considered, taking into account the overall strategy and concern for creditors, a liquidator can pursue a claim even if that individual claim is unlikely to provide any return to creditors.