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Legal costs in insolvency proceedings – the risks you need to consider

A major risk factor in instituting legal proceedings, for any claimant, is the risk of unrecovered legal fees.  Unfortunately the cogs of the law tend to grind slowly and expensively and often even the winning party rarely recovers all it has been spent on a matter.  In the insolvency context the interests of creditors and insolvency practitioners, amongst others, must also be considered in addition to solely the interests of the applicant creditor.  It is accordingly key that all participants, be they solicitors, claimants, creditors, debtors or insolvency practitioners are aware of the risks that insolvency related proceedings may expose them to, particularly regarding recovery of legal costs, so they can take appropriate steps to minimise such risks.

Winding Up Applications

In successful winding up applications, the Court will generally order, in accordance with the Corporations Act (Cth) (Act) that applicant’s have their costs paid by the company being wound up.  Two factors affect what the applicant actually recovers from the costs of winding up the company.  Firstly, the costs will normally not cover the total legal costs and expenses that the applicant has spent due to the method the court uses to calculate costs.  Secondly, the costs order forms a claim in the winding up as an unsecured debt and is therefore subject to the priority rules in the Corporations Act.

Calculating Costs

The calculation of costs by the court will be done according to the court’s rules on costs assessment.  These are called assessed costs or taxed costs.  Generally this will result in the total being lower than what the applicant actually spent on his legal fees.

Priority Claims

Secured creditors may realise their security in priority to the unsecured creditors.  Then section 556 of the Act provides a list of priority in paying out unsecured claims in the winding up.  In this priority list the cost of the winding up application comes after the costs and expenses of the liquidation.  If the company has no assets left, then the applicant may recover none of the costs of the application.  Therefore the amounts paid to both secured creditors and the liquidators will affect whether the applicant’s costs get paid.

Investigations

Under s 596A of the Act liquidators may conduct examinations in court in order to examine parties involved with a company in liquidation.  This can include both creditors and the applicant in the winding up application.  The court normally will not make costs orders, unless it determines that the examinations were improper.  Therefore the person who is being examined will normally have to cover his own costs, which may include legal costs if the person chose to have a lawyer represent him at the examination.

Company Claims

The company may seek to recover debts or damages through legal proceedings.  The general rule in legal proceedings is that the costs follow the event; ie the successful party’s costs are paid by the unsuccessful party.  This is subject to some exceptions, including that if the unsuccessful party made an offer earlier that was the same or better than what was ultimately recovered, the successful party may be ordered to pay costs to the unsuccessful party.

There is a risk that court orders for costs will not be complied with, especially when the party who is ordered to pay is in liquidation.  For example, a company in liquidation may sue to recover a debt.  The defendant may successfully defend the action and be awarded costs, but the company may have no assets and therefore the defendant ultimately receives nothing despite the order.

Additionally Courts have powers to order persons who are not parties to the proceedings to pay costs.  This would be targeted at those behind the litigation such as creditors of the company.  The other party can apply for orders that they provide security for costs.

Issues for Liquidators

A liquidator may be vulnerable when he is not a party to the proceeding due to the court’s power to order costs against non-parties.  However as discussed in Macks v Hedley [1999] FCA 1208, liquidators are given special protection and such orders are only made when the proceedings were without merit or were brought with an improper purpose.

Liquidators may wish to recover preference payments from creditors, but these proceedings must be brought by the liquidator, not the company.  This means the liquidator is vulnerable to costs orders just as any party would be.  The liquidator will generally institute proceedings in his capacity as liquidator in order to limit liability to costs orders, but the court may be unwilling to limit the orders.  Liquidators can be at risk of having their professional fees and expenses deferred behind costs orders.  The liquidators should agree to the costs orders forming part of the winding up expenses and will be paid by the company.

Take Home Message

Parties involved with a company in liquidation need to be aware of their risks associated with the proceedings.  The Chamberlains Law Firm Dispute Resolution, Insolvency and Reconstruction team can assist and advise anyone with these issues.

Article by Sayward Brest – Law Graduate – Dispute Resolution, Insolvency and Reconstruction

P 02 6215 9100

E sayward.brest@chamberlains.com.au

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