Use of s 1324 to restrain a director from appointing an administrator

Section 1324 of the Corporations Act 2001 (Cth) is cast in very broad terms and, in my opinion, is a provision which is sometimes overlooked. As a separate issue, I am sure other practitioners working in the insolvency and commercial law space, will have come across cases of deadlock or shareholder oppression in an SME, where the threat is made – or even acted upon – to appoint a voluntary administrator to a company, in what is suspected to be a scorched-earth strategy.

While we cannot know and I do not suggest any such strategy was at play in this particular case, that aspect aside, these two issues otherwise came together in March of this year in an interesting ex tempore judgment of Black J of the NSW Supreme Court. In that case, s 1324 was used to seek an injunction restraining a director from appointing an administrator for what was claimed by the applicant to be an improper purpose – In the matter of O’Neill v Advantage Hearing Pty Ltd [2013] NSWSC 175.

I will set out here in full just three of the sub-sections of the provision. Sub-sections (1) and 4) are relevant to the case now discussed. Sub-section (10) is not, but it is the sub-section of 1324 which in my view tends to be over-looked, although last year there was an interesting s 1324(10) decision in Queensland by the Full Court of the Queensland Supreme Court in May (McCracken v Phoenix Constructions (Qld) Pty Ltd [2012] QCA 129, see in particular [21]-[40]). So while it is not relevant here, I also reproduce sub-section (10) below, merely to draw attention to it.

Sub-sections 1324(1) and (4) provide as follows –

“(1) Where a person has engaged, is engaging or is proposing to engage in conduct that constituted, constitutes or would constitute:

(a) a contravention of this Act; or

(b) attempting to contravene this Act; or

(c) aiding, abetting, conselling or procuring a person to contarvene this Act; or

(d) inducing or attempting to induce, whether by threats, promises or otherwise, a person to contravene this Act; or

(e) being in any way, directly or indirectly, knowingly concerned in, or party to, the contravention by a person of this Act; or

(f) conspiring with others to contravene this Act;

the Court may, on the application of ASIC, or of a person whose interests have been, are or would be affected by the conduct, grant an injunction, on such terms as the Court thinks appropriate, restraining the first-mentioned person from engaging in the conduct and, if in the opinion of the Court it is desirable to do so, requiring that person to do any act or thing.

“….(4)  Where in the opinion of the Court it is desirable to do so, the Court may grant an interim injunction pending determination of an application under subsection (1).”

I recommend readers also pay attention to the other sub-sections, most notably sub-sections 1324(6) and (7), to fully appreciate just how wide the powers under this section were cast, by the legislature.

Skipping ahead, sub-section 1324(10) goes on to provide the Court with an additional, potentially far-reaching power –

(10)  Where the Court has power under this section to grant an injunction restraining a person from engaging in particular conduct, or requiring a person to do a particular act or thing, the Court may, either in addition to or in substitution for the grant of the injunction, order that person to pay damages to any other person.” 

In this case a recently-removed director of a company called Advantage Hearing Pty Ltd, Mr Matthew O’Neill, issued proceedings seeking interlocutory and substantive relief against the company itself, a director Ms Rhonda Hughes, and another person with an interest in the company, Mr Soeren Iversen, and associated entities. The company was trustee of the Advantage Hearing Trust, which appeared to conduct a hearing assessment business. While there was controversy as to the circumstances, Mr O’Neill’s employment had been purportedly terminated and he had been removed as a director. However there were problems with the application, including as to service of the affidavits in support, the defendants did not appear, and the evidence did not properly establish all that was needed to found the claim for interlocutory relief.

The plaintiff Mr O’Neill sought an order under s 1324 that, until final hearing or further order, Ms Hughes be restrained from appointing an administrator under Pt 5.3A of the Act. Black J observed (at [3]) that the steps necessary to establish such relief “would seem to be” –

1. That there is at least a serious question that the company is not in fact insolvent or likely to become insolvent, so that the appointment of an administrator is inappropriate;

2. Implicitly, that the appointment of an administrator for an improper purpose would not only be invalid but also a contravention of the Act, for example, of Ms Hughes’ duties as a director; and

3. That a basis for interim relief under s 1324 of the Act is established, in that the balance of convenience favours interim relief.

The threat of appointment of a voluntary administrator was said to emerge from a letter from the defendants’ solicitors to Mr O’Neill’s solicitors. The letter discussed proposals to resolve the dispute between the parties. It noted that if no resolution was reached, the third defendant Mr Iversen was likely to call in a loan he had made to the company, which would render the company insolvent, and Ms Hughes would then have no alternative but to appoint an administrator. Mr O’Neill’s solicitor responded, contending that the appointment of an administrator would not be for a proper purpose, and that there was no basis for the threat of that appointment because the loan was not repayable until February 2016 under the terms of the loan deed.

His Honour considered the first letter to be inadmissible, as subject to the “without prejudice” privilege, and that it would follow that the response from Mr O’Neill’s solicitor would also be subject to the privilege.

However, even if he was wrong on that and the letters were admissible to establish a threat of the appointment of a voluntary administrator, his Honour found that the basis for the interlocutory relief sought was not established, because –

(1) The evidence did not establish, as Mr O’Neill contended, that the loan could not be called on. Mr O’Neill sought to rely upon the loan being treated as non-current in the balance sheets. The deed he relied upon was unsigned, undated and unstamped, and Mr O’Neill could give no evidence either that it was executed or that the parties had conducted themselves on the basis set out in it.

(2) There was no affirmative evidence as to the company’s solvency, which his Honour observed would at least require some scrutiny of its cash flow position, and no basis for a finding that the company was neither insolvent nor likely to become insolvent, such that a voluntary administrator could not properly be appointed. His Honour emphasised that he was not finding that the company was insolvent or likely to become insolvent. Rather, he was noting there was no evidence one way or the other, as to the company’s solvency.

As Black J astutely observed (at [8]), there may be a real question as to whether a Court would, without clear evidence of solvency, restrain the appointment of an administrator under s 436A, where the provision for such appointment is important to the mechanism for reconstruction of potentially insolvent companies, and also allows directors to avoid potential liability or insolvent trading. A potential consequence of restraining the appointment of an administrator would be that directors would in fact be exposed to potential liability for insolvent trading, if a company then continued to trade in circumstances where it had been unable to appoint an administrator when it was in fact insolvent. However, I pause here to note that the defence to insolvent trading in s 588H(5), as further described in s 588H(6), does not require that a director succeed in appointing an administrator. It requires that the person “took all reasonable steps to prevent the company from incurring the debt” which, per s 588H(6) means the Court must have regard to matters which include, but are not limited to… “any action the person took with a view to appointment an administrator of the company”. If there was clear evidence that a director took steps or evinced a clear intention to have an administrator appointed to an insolvent company, but was prevented by injunction, it is difficult to see a Court rejecting the contention that the person met these requirements of the defence, subject to other relevant circumstances. As an example of another relevant circumstance – if there were other steps the director could have taken to prevent the company incurring the debt, and he or she did not take them either, I suggest the defence may be more likely to fail.

In any event his Honour found it was possible to resolve that aspect of the application on a narrower basis: a serious question had not been established that it would be an improper step to appoint an administrator, as it had not been established that the company was plainly not insolvent and unlikely to become insolvent (at [9]).

Black J pointed out that there were other avenues available to Mr O’Neil to address the position, if an administrator is in fact appointed for an improper purpose. Those protections being –

1. The administrator himself or herself has an obligation to at least take some steps to satisfy himself or herself as to the validity of his or her appointment, and in particular to review the terms of the resolution of the board by which he or she is appointed: Deputy Commissioner of Taxation v Portinex Pty Ltd [2000] NSWSC 557; (2000) 34 ACSR 422.

2. More fundamentally, the Court has jurisdiction to scrutinise the reasons given by directors for the appointment of an administrator and, if they are not objectively established, the administrator will be removed and the appointment of an administrator for a collateral purpose is potentially a breach of directors’ statutory duties: see the authorities cited at Austin and Black’s Annotations to the Corporations Act at [5.436A]. Accordingly, if an appointment of an administrator is made in circumstances where it was not objectively justified, the Court has ample powers available to invalidate the appointment. Black J expressed the view that that course seemed to be preferable, as a matter of balance of convenience, than an interlocutory injunction, in that it does not expose directors to potential liability for insolvent trading if an injunction is wrongly granted. I suggest respectfully, however, that in some cases waiting for a threatened appointment before challenging it may not be seen as preferable for a company, depending upon what effect an appointment may have upon its significant contracts or banking facilities (see below).

Mr O’Neill also pointed to the appearance of recent changes to the company’s balance sheet, recording additional liabilities to Ms Hughes and Mr O’Neill. Those could be open to challenge, but Black J took the view that that challenge could properly be brought in an application to set aside the administrator’s appointment, or at a final hearing of the proceedings.

On the issue of balance of convenience, Mr O’Neill had also contended that there would be detriment to the company if an administrator was appointed, by reason of risk to a contract with a government agency, the Office of Hearing Services. However that contract was not in evidence, such that there was no evidence of the impact of such an appointment under the terms of the contract.

I pause here to note, as mentioned above, that in some cases the appointment of an administrator will place at risk if not a significant contract or contracts vital to the business’s revenue stream, but also  a company’s banking facility. Indeed, it is possible that an appointment of itself can render a company insolvent, when it previously was able to pay its debts as and when they fell due. The difficulty for the director who has been ousted from the company in these cases in terms of an ability to pre-empt and restrain threatened conduct, is that he or she is often unable to produce the necessary evidence to obtain the orders sought, because the other directors have shut him or her out of the company and are preventing access to the company’s books and records.

Here, Mr O’Neill sought further interlocutory relief, restraining the defendants from preventing Mr O’Neill having access to certain offices of the company, access to its books and records, taking certain actions in respect of its bank accounts, and having access to its computer server. However Mr O’Neill relied upon an affidavit of some months prior, following which the defendants had given certain undertakings (not detailed in the judgment). There were assertions and counter-assertions in the correspondence between the solicitors as to whether those undertakings had been honoured or breached. There was no further evidence to establish any breach, or to establish any occasion when access had been denied to Mr O’Neill.

Black J also declined to grant an injunction restraining the defendants from preventing Mr O’Neill from engaging in his duties as an officer and employee of the company, which relief was positive in substance (although s 1324(1) expressly provides for this), and one as to ASIC recognising Mr O’Neill as a director.

An interesting case and, as is often the case with injunction applications of any sort, one which in the end came down to the quality and sufficiency of the evidence.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s