Legal limbo: Is creditor or court blessing now required for solicitors’ costs agreements?

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By Taline Chater, Partner and Matthew Bramich, Lawyer

Key insights

  • Traditionally, liquidators have not been required to seek creditor or Court approval pursuant to s477(2B) of the Corporations Act 2001 (Cth) to enter into costs agreements with solicitors on the basis that the agreement may end or be discharged by performance more than three months after the agreement is entered into.
  • There have however, been a limited number of single instance decisions in recent years, based on very particular factual circumstances in which the Court has either proceeded on the assumption that such creditor or court approval is required or expressed uncertainty as to whether approval is required.
  • In the recent decision of Naidenov, in the matter of AJW Interiors and Constructions Pty Ltd (in liq) [2024] FCA 25 (Naidenov, in the matter of AJW Interiors and Constructions) whilst the Court ultimately decided not to approve the costs agreement in question, it proceeded on the assumption (as did the liquidator applicant) that the costs agreement required approval. However, the specific circumstances of the costs agreement in question were as follows:
    • It was not a general costs agreement for advice in the liquidation as and when required. Rather, it was a costs agreement in respect of public examination proceedings brought by the liquidator.
    • It was akin to a litigation funding agreement and was conditional upon a successful outcome in the litigation and included a term providing a 25% uplift applied to all fees charged under the agreement if the liquidator were successful (including settlement).
  • Critically, the Court was not prepared to approve the costs agreement because it had been entered into at least 12 months before the liquidator approached the Court for retrospective approval of the costs agreement, this being a material delay and offending the underlying purpose of s477(2B) which is to act as a constraint on the power of liquidators and ensure a liquidation proceeds expeditiously.
  • We await a higher court’s decision as to whether ordinarily, creditor or Court approval is required by a liquidator (on behalf of the company in liquidation) who enters into a costs agreement with solicitors for general advice in connection with the conduct of the liquidation. In the authors’ view, requiring such approval would be impractical and would hinder the efficient conduct of a liquidation. It would also create potential implications for solicitors’ costs agreements entered into in other forms of external administrations.

Background facts

  • The liquidator was appointed to AJW Interiors and Constructions Pty Ltd (in liq) (the Company) in August 2019 and investigated possible recovery proceedings against the Company’s former director and his spouse (a former employee of the Company).
  • In April 2022 the liquidator on behalf of the Company, entered into a conditional costs agreement with his solicitors in relation to public examinations of the former director and his spouse and possible settlement negotiations for the recovery proceedings (Costs Agreement). Pursuant to its terms:
    • The solicitors were not entitled to receive payment of “Legal Costs” (as defined) unless a successful outcome, which included a settlement was obtained, in which case a 25% uplift applied to all fees charged under the agreement, including all paralegals and legal clerks.
    • The Costs Agreement was not conditioned on approval being sought under s 477(2B) of the Corporations Act 2001 (Cth) (the Act).
  • However, the terms of the Costs Agreement and the performance obligations under it were considered “clearly likely” to exceed the three month period prescribed by section 477(2B) of the Act.
  • The solicitors incurred costs pursuant over a 14 month period before the liquidator sought approval of the Costs Agreement from the Court.

Issues

  • Section 477(2B) of the Act requires liquidators to seek approval from the Court, Committee of Inspection (COI) or by creditor resolution, prior to entering into agreements on the company’s behalf where the agreement may end or be discharged by performance more than three months after the agreement is entered into.
  • This decision raises the issue of whether a solicitors costs agreement entered into by a liquidator on behalf of a company (in liquidation), in respect of legal proceedings and which is likely to exceed a three-month period, requires creditor, Committee of Inspection (COI) and/or Court approval pursuant to s 477(2B) of the Act. On the facts, both the liquidator and Court proceeded on the assumption that approval was required.
  • Whether the Court will grant approval to a liquidator to enter into a costs agreement nunc pro tunc (retrospectively) where the agreement in question was entered into over 12 months prior to the application.

Analysis re approval of costs agreement

  • Cheeseman J of the Federal Court of Australia refused to approve the Costs Agreement under s 477(2B) of the Act and made several observations relevant for liquidators seeking retrospective approval of solicitors’ costs agreements for purposes of advising and acting in a legal proceeding:

(A) Statutory Purpose of s 477(2B)

  • The purpose of s 477(2B) of the Act is to protect creditors against ill-advised or improper actions by requiring a liquidator to satisfy the Court, COI or creditors that entry into a long-term agreement will be in the interests of the administration, even though the agreement will prolong it.
  • This purpose may be frustrated where liquidators are delayed in seeking such approval, particularly where a delay in seeking that approval is not adequately explained.
  • Her Honour expressed concerns as to the magnitude of the delay, being 14 months and that the liquidator failed to provide any evidence or explanation for the delay and this factor weighed heavily against Her Honour granting approval.

(B) Good Faith, errors of law/principal etc.

  • When assessing whether to grant approval for a liquidator to enter into a long-term agreement, the Court must assess whether there are grounds for suspecting:
    • a lack of good faith;
    • an error of law or principal; or
    • some other good reason to refuse approval.
  • Her Honour did not find any lack of good faith or dishonesty, but did find that there were other reasons to refuse approval, namely:
    • the fact that the Costs Agreement was conditional on a “successful” outcome did not prevent the parties from assuming obligations that would prolong the administration;
    • the liquidator failed to provide any evidence as to how he could have believed that entering into the Costs Agreement and commencing recovery proceedings was in the interests of the administration; and
    • if the liquidator had proactively sought approval under s 477(2B) of the Act, there was no certainty that the Costs Agreement would have been approved, in circumstances where:
      • the liquidation had already been on foot for 2 years and 10 months;
      • there was a substantial deficit in the Company’s net asset position and any recovery proceedings would have been time consuming and expensive;
      • attempts at litigation funding had been unsuccessful; and
      • there were limited prospects of satisfying a judgment against the Company’s former director and his spouse.
    • Her Honour did however suggest that it would be acceptable for a liquidator to commence proceedings to preserve a cause of action whilst the prospects of those proceedings were investigated, which was not the case here.

(C) Prejudice to Creditors

  • Her Honour found that creditors suffered prejudice as a result of a materially delayed application because they lost the benefit of the ‘protective oversight‘ offered by s 477(2B) of the Act.
  • Significantly, as the liquidator did not raise it, Her Honour left open the issue of whether a costs agreement between a liquidator and a solicitor in general required approval under s 477(2B) of the Act:

93    Finally, I note that there is an unresolved issue raised in recent single judge decisions of this Court as to whether s 477(2B) applies to an agreement between a liquidator in that capacity and a firm of solicitors: Jahani, in the matter of Ralan Property Services Pty Ltd (receivers and managers appointed) (in liq) [2023] FCA 738 at [36] to [37] Stewart J referring to Frigger v Kitay (No 2) [2020] FCA 497; 143 ACSR 655 at [47] to [51], (Charlesworth J); cf Lewis (liquidator), in the matter of Concrete Supply Pty Ltd (in liq) [2020] FCA 841; 145 ACSR 459 at [20] (White J). The plaintiffs did not raise this issue on this application and proceeded on the basis that approval was required, and that it should be granted nunc pro tunc. I will approach this application with a view to framing any orders made under s 477(2B) with the qualification that such orders, if made, are made to the extent necessary. On the approach taken by the plaintiffs, it is not necessary to determine whether entry into the costs agreement requires approval under s 477(2B) of the Act.

  • In considering the prior decisions referred to by Her Honour, the authors note that firstly, in Frigger v Kitay (No 2) [2020] FCA 497, Charlesworth J of the Federal Court of Australia did not express any concluded view as to whether a written retainer between a company in liquidation and a solicitor would require approval under s 477(2B) of the Act. However, her Honour accepted that, to the extent that an agreement is between a liquidator (in their capacity as liquidator of a company) and a solicitor, approval under s 477(2B) would not be required.
  • Secondly, in Lewis (liquidator), in the matter of Concrete Supply Pty Ltd (in liq) [2020] FCA 841, White J of the Federal Court of Australia similarly expressed an inconclusive view, that a written retainer between a company in liquidation and a solicitor was subject to approval under s 477(2B) of the Act because:
    • it was reasonably arguable that the liquidators entered into the retainer as agents of the company (i.e. in their capacities as joint and several liquidators);
    • the services provided under the retainer would be, for the most part, for the benefit of the company, rather than the liquidators; and
    • the nature of the ex parte application necessitated the court to act out of an abundance of caution.
  • Third in Jahani, in the matter of Ralan Property Services Pty Ltd (receivers and managers appointed) (in liq) [2023] FCA 738, Stewart J of the Federal Court of Australia made orders approving three solicitor’s costs agreements in respect of separate legal proceedings, under s 477(2B) of the Act on the basis that the reasons specified in Lewis (liquidator), in the matter of Concrete Supply Pty Ltd (in liq) were applicable to the facts and also referred to Re Mudgee Dolomite & Lime Pty Ltd (No. 4). His Honour noted that his view was not conclusive.
  • Fourth, in the matter of Mudgee Dolomite & Lime Pty Ltd (No. 4) [2021] NSWSC 393 which is referred to in Jahani, in the matter of Ralan Property Services Pty Ltd (receivers and managers appointed) (in liq) [2023] FCA 738, Williams J of the New South Wales Supreme Court accepted that it was the better view that a costs agreement entered into by liquidators “in the name of and on behalf of” the company was an agreement to which s 477(2B) applied. The relevant costs agreement was in respect of defence to a court appeal and approval was sought under 477(2B) of the Act because the liquidators were of the view that it was likely to take more than three months for the appeal to be heard and determined.

Conclusion

  • The Court’s conclusion in Naidenov, in the matter of AJW Interiors and Constructions is in the authors’ views, limited to the specific circumstances of the case and is consistent with recent single instance decisions in the Supreme of New South Wales and the Federal Court of Australia.
  • The current state of play is therefore that in circumstances where a liquidator wishes to enter into a costs agreement with solicitors for the specific purpose of pursing litigation on behalf the company in liquidation, and the costs agreement is likely to extend beyond a three month term, a liquidator should seek creditor, COI or court approval. Such approval should ideally be sought prior to entry into the costs agreement or immediately following entry into the agreement, where prior approval is not practicable. This is consistent with the approach a liquidator would ordinarily take in respect of entry into a litigation funding agreement with a third party funder.
  • To the extent that the courts in recent decisions make a distinction between a liquidator entering into a costs agreement in their personal capacity as opposed to as agent of the company, whilst this accords with a strict reading of s477(2B) of the Act, it should not in the authors’ view, be the determining factor as to whether a costs agreement requires approval. This is because on any view, the purpose of a liquidator seeking legal advice (whether the costs agreement is executed in a personal capacity or as agent of the company) is ordinarily for the proper conduct of the liquidation and ultimately for the benefit of all creditors in the liquidation.
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