The court finds that the legal obligations have been violated by the de facto administrator – Insolvency/Bankruptcy

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This week’s TGIF looks at a recent decision from the NSW Supreme Court which illustrates the circumstances in which a person will be considered a ‘de facto administrator’ and the duties owed to creditors in the face of insolvency.

Key points to remember

  • Whether a person is a “de facto director” is a question of fact and requires consideration of the powers exercised by that person and the perception of third parties who deal with the company.

  • A director’s duties to act in good faith and for a legitimate purpose may, in times of financial difficulty, extend to taking into account the interests of a company’s creditors.

  • Failure to respond to notices of production and failure to conduct public questioning may result in the risk of adverse inferences being drawn in subsequent proceedings on these matters.

What happened?

Hemisphere Technologies Pty Ltd (the Company) was in the business of distributing antivirus and cybersecurity software. A distribution agreement with Kaspersky Lab UK Ltd (Kaspersky) represented a significant portion of the Company’s revenue.

On August 25, 2016, Kaspersky terminated the agreement due to unpaid royalties allegedly owed under the distribution agreement and subsequently commenced proceedings to collect the debt owed to it. On December 22, 2016, the Company sold its trade debtors and shares to Hemisphere Technologies AUS Pty Ltd and appointed liquidators on January 17, 2017.

On June 29, 2018, the Supreme Court of NSW appointed a special liquidator (SPL) to investigate whether the director of the Company has failed in his duties and, if so, to pursue any claims that may be available.

Following public reviews in accordance with Part 5.9 of the
Companies Act 2001 (Cth) (the Law), the SPL sued the former director of the Company and maintained, despite a resignation dated October 14, 2014, that he remained a director until the dissolution of the Company in 2017.

Two corporations were also added as defendants to the claim and the orders sought against them for allegedly unreasonable dealings related to the directors.

The proof

The evidence presented at the hearing revealed that:

  • the administrator had authorized the Company to make installment payments for property to be purchased by two separate entities of which he was also a director and beneficiary under the relevant trusts; and

  • payments totaling $1.7 million had been made by the Company to companies whose director was also a director and shareholder, in circumstances where the Company had ceased operations, was defending proceedings initiated by Kaspersky and had a large debt towards the ATO.

No documents were produced in previous public examinations to explain the use of company funds for these purposes and the SPL presented transcripts of these examinations in which the director did not provide a convincing explanation for support payments.

Determination

The court finally concluded that the director had continued to act as a director from his “resignation” until the date of the liquidation of the company and, following this finding, that his legal obligations had been violated and that the payments made during the months preceding the liquidation were voidable.

In reaching this decision, His Honor noted that:

  • the director’s conduct, as well as his admissions during his examination, led to the conclusion that he met the definition of “director” in the Act (despite his previous resignation). This conduct included signing resolutions as a director, executing a lease as a director, and filing as such in an affidavit under Kaspersky proceedings. In light of this, His Honor concluded that he had acted as the “de facto” administrator during the relevant period;

  • given the Company’s financial situation, the statutory duties of the director included an obligation to take into account the interests of creditors. His Honor found that, based on the evidence, the $1.7 million appeared to have been paid to entities that provided no services to the Society and to which the Society had no pre-existing liability. Further, His Honor noted the vague and speculative answers the Director gave during his public questioning and inferred that no Company debt had to be discharged; and

  • there was no evidence that the Company benefited, directly or indirectly, from payments made as a deposit for a property. His Honor determined that the funds benefited the monies beneficiaries who acquired the properties (of which the administrator was also the administrator and beneficiary of the underlying trusts) and that the requirements of an unreasonable administrator-related transaction were met .

As a result of the above findings, orders were issued requiring the payment of compensation by the Director to the Company in the amount of $1.7 million and the reimbursement of the deposit amount by the beneficiaries.

Comment

This case is a useful reminder to insolvency practitioners and their advisers of the potential for claims against persons who, although no longer registered as administrators, perform the duties attached to the office. If the evidentiary threshold can be met, breach of duty relief claims may be available.

The decision also demonstrates the risks of not fulfilling production orders and not engaging meaningfully in matters under public scrutiny. Such actions may lead to adverse inferences being drawn in subsequent proceedings on matters that may have a compelling explanation.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.





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