In brief - "Double might" test crucial in determining liquidator's independence
Might a fair-minded observer reasonably conclude that the liquidators might not discharge their responsibilities with independence and impartiality?
ASIC v Franklin (liquidator), in the matter of Walton Constructions
In the case Australian Securities and Investments Commission v Franklin (liquidator), in the matter of Walton Constructions Pty Ltd  FCAFC 85, the Federal Court on appeal by ASIC removed the liquidators because of perceptions of lack of independence and impartiality. The judgment highlighted a test for independence.
However, the court did not agree with ASIC's contentions that the Declaration of Independence, Relevant Relationships and Indemnities (DIRRI) was inadequate.
The court was asked to attach weight to the Australian Restructuring, Insolvency & Turnaround Association (ARITA) Code of Professional Practice (COPP), but concluded that this was extrinsic material which was neither appropriate nor permitted to be taken into account when considering the adequacy of the DIRRI.
ASIC appeals primary judge's decision that liquidators made adequate disclosure
The liquidator had an ongoing "referral relationship" with the Mawson Group. The Mawson Group referred the Walton Constructions Group Companies to the liquidators after the Mawson Group had undertaken a restructuring of those companies, including the transfer of their business to new companies.
The liquidators (then acting as administrators) disclosed in the DIRRI that Mawson Group had referred work to them, but expressed the view that this did not give rise to a conflict.
The primary judge concluded that the liquidators had made adequate disclosure in the DIRRI and there was no conflict in them continuing to act as liquidators.
ASIC appealed the decision.
The appeal judgments were delivered on 18 July 2014 by White J and Robertson J with Jessup J concurring.
Independence, impartiality and integrity in a competitive commercial environment
Section 503 of the Corporations Act provides that the court may "on a cause shown" remove a liquidator appointed in a voluntary winding up. The guiding principle is that a liquidator must be independent and be seen to be independent.
The court emphasised the "double might" test stated by the majority in a High Court decision dealing with the judiciary - Ebner v the Official Trustee in Bankruptcy  HCA 63. The test was whether "a fair-minded lay observer might reasonably apprehend that the Judge might not bring an impartial mind to the resolution the Judge is required to decide" (my emphasis).
The court noted that liquidators are officers of the court and are expected to conduct themselves with independence, impartiality and integrity. However, liquidators are engaged in business in a competitive environment, they have to attract work, they need to develop contacts and relationships with actual or prospective sources of referrals and the success or otherwise of the practice will depend in part on them maintaining a good professional reputation.
Reasonable, fair-minded observer's view of liquidators
The court accepted that knowledge of these circumstances pertaining to liquidators can be imputed to the hypothetical reasonable, fair-minded observer (FMO).
The primary judge concluded that the FMO may "reasonably conclude" that the liquidators would discharge their duties impartially. However, the court said that the question the primary judge should have considered was "whether that same fair-minded observer 'might' reasonably apprehend that the (liquidators) 'might not' discharge their responsibilities with independence and impartiality" [paragraph 75] (my emphasis).
Referrals from Mawson Group a significant contributor to liquidators' income
The court then considered the relationship of the liquidators with Mawson.
In 2012, Mawson Group referrals were about $500,000, or just under 10% of the insolvency division's revenue at the liquidator's firm.
In 2013, the revenue from the referrals was $250,000, or just over 5% of the insolvency division's revenue.
The court considered that the FMO as a creditor would regard amounts such as $250,000 and $500,000 as significant and "might apprehend that (the liquidators) may not wish to put their continued receipt of income of these proportions in jeopardy".
The court did not see any difficulty with the liquidators meeting with Mawson Group and a representative of the company before their appointment. However, in view of the Mawson Group's significant involvement in the pre-administration transaction:
...it would be natural for the FMO in these circumstances to think that, by reason of the Mawson Group's relationship with (the liquidators) it regarded (the liquidators) as being possibly more amenable to its interests than others might be. [paragraph 102].
Creditors' meetings and voting on possible removal of liquidators
The court looked at the creditors' meetings where there were a number of questions asked about the liquidators' relationship with the Mawson Group and also considered the fact that a proposal for appointment of administrators other than the liquidators (then administrators) was defeated in circumstances where 40 creditors with debts totalling $5.9 million voted in favour of removing the liquidators and 23 creditors with debts totalling $27.1 million voted against removing the liquidators.
Those voting against included a company associated with Mawson Group with a debt of $18.9 million. One of the liquidators, as chairman, chose not to use his casting vote, which meant the proposal to appoint another firm as administrators failed.
Fair-minded observer's view of potential for conflict
The court was of the view that the questioning of the liquidators in relation to their relationship with Mawson and the transactions which required investigations, along with the attempts to remove the administrators, demonstrated that the FMO would have "a reasonable apprehension that the Respondents might not discharge their duties independently and impartially".
The court was satisfied that the reasonable FMO might perceive the potential for conflict and the potential that they might not discharge their duties with independence and impartiality.
The court ordered the removal of the liquidators and the appointment of new liquidators, regardless of the substantial investigations and work already undertaken up to that point by the liquidators.
Declaration of Independence, Relevant Relationships and Indemnities (DIRRI)
ASIC contended that the DIRRI was deficient because creditors were not alerted to the fact that there may be a need for the administrators to investigate the firm that referred work to them, nor why the relationship with Mawsons, which on its face may give rise to a conflict, did not actually give rise to a conflict.
The court noted that section 60 requires the administrators to disclose relationships "between the administrator and the company" and relationships between "the administrator and an associate of the company". It is only where one of these relationships arises that there is an obligation imposed on the administrator to state why the relevant relationship does not result in the administrator having a conflict of interest.
The Mawson Group was not an "associate of the company" and therefore it was not necessary to discuss the potential for investigations.
ARITA Code of Practice
Robertson J said at paragraph 38:
... I do not regard the Insolvency Practitioners Association of Australia’s guide entitled Code of Practice for Insolvency Practitioners, on which ASIC relied, as extrinsic material appropriate or permitted to be taken into account in construing ss 60 and 436DA of the Corporations Act. To my mind, the general law would not permit that guide to be taken into account in construing those provisions and that guide is outside the scope of s 15AB of the Acts Interpretation Act 1901 (Cth). For example, the relevant parts of the guide are not reproduced or referred to in the explanatory memorandum to the Corporations Amendment (Insolvency) Bill 2007 (Cth).
White J noted that the COPP reflected the principles:
...which have already been canvassed in these reasons and appear to be drawn from the summary of authorities to which reference has already been made. That being so, it is unnecessary, in my opinion, to address separately the parties submissions concerning the Code.
ASIC therefore failed to secure senior judicial approval for the COPP.
Liquidators need to avoid perception of conflict of interest
The emphasis placed by the court on the "double might" test and the fair-minded observer highlight the need for a potential appointee to consider carefully whether or not a fair-minded observer might reasonably apprehend that the practitioner might not be impartial in considering the issues the practitioner is required to investigate.
The judgment significantly highlights the risks faced by appointees who work closely with consultants who undertake restructuring or "pre-packs" shortly before the proposed appointment.