Chief Justice Hammerschlag, sitting in the New South Wales Supreme Court (the Court), has delivered a judgement of importance to secured creditor and insolvency practitioners alike in Volkswagen Financial Services Australia Pty Ltd v Atlas CTL Pty Ltd (Recs and Mngrs Apptd) (In liq) [2022] NSWSC 573 (Atlas).
The Atlas case involved the administrators trading on a vehicle rental business, in circumstances where the main assets (the vehicles themselves) were secured to a range of vehicle manufacturers.
When the administrators failed to secure a going concern sale, the Court refused to allow the administrators to recover their costs and remuneration in respect of the administration via an equitable lien on the vehicles.
This lien was asserted on the basis of the “salvage” or Universal Distributing principle (named after Re Universal Distributing Co Ltd (in liq) (1933) 48 CLR 171).
The Court held that the Universal Distributing principle did not apply to the administrators’ claims because:
- the administrators’ claims for costs and remuneration during the administration did not have any connection with the proceeds of the vehicles;
- the administrators’ decision to trade on was not reasonable in the circumstances;
- the efforts of the administrators were not directed to the preservation of the vehicles (but rather to the preservation of the goodwill of the broader business); and
- the administrators did not prove that the amount of costs and remuneration was incurred exclusively in connected with the care, preservation or realisation of any particular asset.
The Atlas case is a cautionary tale of the risks of administrators trading on a loss making business where the assets of the business are encumbered and they have no indemnity. If a sale of the business is not achieved in such circumstances the administrators will find it difficult to recover the costs they have incurred in, or their remuneration relating to, the general trading of the business.
Background
In late 2019, two related companies, PJM Fleet Management Pty Limited (PJM) and Atlas CTL Pty Ltd (Atlas) entered voluntary administration.
PJM operated a vehicle fleet leasing business. It purchased or leased vehicles with the assistance of financing provided by vehicle manufacturers including BMW, Nissan, Volkswagen and Toyota. PJM then made these vehicles available to Atlas under a master leasing agreement. Atlas utilised the vehicles in its retail short-term car and rental business and for leasing to ride-share operators (the Atlas business).
As part of PJM’s acquisition of vehicles, it agreed security arrangements with each manufacturer such that each manufacturer had security over vehicles the acquisition or leasing of which they had financed. The manufacturers also had general security interests granted by PJM (and in some cases general security interests granted by Atlas), granting each of them subsequent ranking security over each other’s vehicles.
The administration period
On 22 October 2019, administrators (the Administrators) were appointed to each of PJM and Atlas. On the same day, Toyota appointed receivers and managers to PJM who immediately ceased trading of PJM’s business.
The Administrators determined that they would continue to operate the Atlas business, with a view to selling it on a going concern basis. Prior to the Administrator’s appointment, a potential purchaser, the Spanoan Group, had expressed an interest in acquiring the business. However, 3 days after the Administrator’s appointment, the Spanoan Group informed the Administrators that, while it was still “committed to completing a transaction”, it would not proceed with funding a deed of company arrangement or provide ongoing funding for the administration.
Notwithstanding the lack of funding, the Administrators continued to trade in the hope of realising a sale on a going concern basis. This was notwithstanding a number of negative developments, including:
- a draft cashflow analysis (which became available by 28 October 2019) predicting a trading loss of over $300,000 for the period from 22 October 2019 to 16 December 2019; and
- BMW appointing receivers and managers to PJM on 20 October 2019, and then starting to take steps to recover the BMW vehicles from Atlas.
An offer of $1.5 million was received on 15 November 2019 from Adapt A Lift for the Atlas business. However this was not supported by BMW or Nissan.
The Administrators provided their report to creditors on 19 November 2019 revealing a trading loss of $422,213. The report disclosed that the administrators did not expect any return, but they nonetheless recommended that Atlas be placed into liquidation.
The Administrators’ sale process was ultimately unsuccessful, and the Atlas business was shutdown. Both Atlas and PJM were placed into liquidation on 26 November 2019 (with the Administrators appointed as liquidators of those entitles).
The receivers and managers appointed by the various manufacturers successfully realised the vehicles they had financed. At the time of the case, the Volkswagen receiver had realised 490 vehicles giving rise to net proceeds of $5,220,832.27 (the Volkswagen fund). The funds realised by the receivers appointed by the other manufacturers were already distributed by the time of the case.
The Administrators’ equitable lien claim
Little or nothing was realised from the other assets of Atlas or JPM, but the Administrators had incurred significant expenses in the course of the administration (and to a lesser extent in the liquidation). They therefore sought to argue that their costs and expenses were secured by an equitable lien over the Volkswagen fund.
The amounts for which the Administrators sought to claim an equitable lien were as follows:
- $1,032,9110.48 in costs and expenses incurred as a result of a net trading loss during the administration period, being the net loss they made trading the Atlas business;
- $1,007,359.86 for remuneration during the administration period which they contended related exclusively to their actions in preserving, securing or attempting to realise the Atlas assets; and
- $427,399.63 for costs, expenses and remuneration for actions as liquidators of PJM and Atlas, which they contended related exclusively to their actions in preserving or securing vehicles in the Atlas fleet.
The Administrators based their claim for an equitable lien on the “salvage” or Universal Distributing principle. The principle was summarised by the High Court in Stewart v Atco Controls Pty Ltd (in liq) (2014) 252 CLR 307 at [22] as follows:
a secured creditor may not have the benefit of a fund created by a liquidator’s efforts in the winding up without the liquidator’s costs and expenses, including remuneration, of creating that fund being first met. To that end, equity will create a charge over the fund in priority to that of the secured creditor.
The Administrators submitted that such a lien arises when:
- the external administrator acts reasonably;
- the external administrator attempts to preserve, secure or realise assets;
- there is a sufficient nexus between the work done and the salvage objective;
- there is a fund (or assets) which may properly be the subject of the lien; and
- it would be unconscientious for the creditors who stand to take the benefit of the fund (or assets) to do so without recognising the administrator’s work.
In this regard, they argued that the Administrators’ trading activities were undertaken:
- exclusively in the securing, preservation and realisation of assets of Atlas, including the Atlas vehicles;
- in the discharge of their duties as Administrators of Atlas, for the purpose of securing, preserving and realising the assets of Atlas, including the vehicles in the Atlas fleet; and
- for the benefit of the creditors of Atlas, including the secured creditors.
The Court observed that the lien claim focused on the goodwill of Atlas during the administration period as the asset they cared for and protected, and on the vehicles as the assets after the winding up.
The Administrators further argued that:
- they acted reasonably in trading the business with a view to selling it as a going concern. They noted that at the time of their appointment, they had a promise of funding for their trading and that it was appropriate to pursue the Spanoan offer;
- the secured creditors consented to or acquiesced in them trading the business and undertaking the sale campaign. In particular, the secured creditors did not appoint receivers and managers to the Atlas business but instead allowed the sale campaign to continue, knowing that the business was trading at a loss and that the administrators were spending time trading it; and
- the sale campaign realised an offer for the purchase of the Atlas business and that the bulk of the price represented goodwill, and that the majority of their work was an attempt to preserve the Atlas business.
The Administrators sought recovery of their claimed amounts from the Volkswagen fund, on the basis that it was an existing fund (indeed it appeared to be the only remaining fund) and it represented the proceeds of sale of assets of Atlas and PJM over which BMW, Nissan and Volkswagen had general security interests. In this regard they did not apportion their ‘globular’ claimed amount between the secured creditors, but left it to the secured creditors to sort out between themselves.
The decision of the Court
His Honour Hammerschlag CJ found that the Universal Distributing principle did not apply to Administrators’ claim for each of the following reasons:
- the claims for trading losses and remuneration for the tasks completed during the Administration did not give rise to a lien over the Volkswagen fund as those claims did not have any connection with the Volkswagen fund as required by the Universal Distributing principle;
- the Administrators’ decision to continue trading was not reasonable in the way that the Universal Distributing principle requires it to be;
- the efforts of the Administrators were not directed to the preservation of vehicles (as opposed to preservation of the goodwill of the broader business); and
- the Administrators did not prove that the amount of costs, expenses and remuneration were exclusively connected with the care, preservation or realisation of any particular asset so as to be able to ‘sheet home’ liability in any sufficiently certain amount to any of the secured creditors.
The required connection between the claims and the fund
The Administrators placed reliance on Primary Securities Limited v Willmott Forests Limited (Receivers and Managers Appointed) (In Liq) (2016) 50 VR 752 (Primary Securities) to support their view that the Volkswagen fund was susceptible to a lien to secure their trading losses and remuneration.
His Honour considered that Primary Securities was only authority for the ‘narrow’ proposition that the existence of a fund which was realised or produced by the lien claimant is not a prerequisite for the application of the Universal Distributing principle.[1]
However, in his Honour’s view, Primary Securities did not stand for the proposition that equity will create a charge over property (or its proceeds) other than the property (or its proceeds) which was the subject of care, protection or realisation at the claimant’s expense. His Honour considered that ‘to do so would be inimical to the Universal principle’, and that:
the concept that the expenses and benefit must be directly related is reflected in the requirement that the costs and expenses [are] incurred for the exclusive purpose of caring for, preserving and/or realising property.
Accordingly, his Honour held that, in this case, the only asset that the equitable lien could or would attach to was the goodwill of Atlas, being the asset that the Administrators’ actions were aimed at protecting or realising.[2] However, this was of no avail to the Administrators as the goodwill of Atlas no longer existed (given Atlas had ceased trading and entered liquidation).
Reasonableness of trading on
Hammerschlag CJ did not consider that the Administrators had acted reasonably when they decided to trade the business during the administration.
He noted that:
- the starting point is that an administrator who decides to trade is personally liable for debts incurred in doing so under section 443A of the Corporations Act (and the Administrators were aware of this);
- it was readily apparent from the cashflows that further trading loss was predicted (and by 19 November 2019 it was apparent that the trading losses were 40% higher than predicted);
- the Administrators did not seek any assurances from secured creditors as to possible trading losses (and were not given any);
- the secured creditors were entitled to take a ‘wait and see approach’ to the ongoing trading by the Administrators;
- none of the secured, priority or unsecured creditors would have received any dividend if the Adapt A Lift offer proceeded;
- there was no evidence that the administrators obtained any valuation of the Atlas business; and
- there were no public policy considerations which supported the Administrators trading on.
Hammerschlag CJ accepted the following characterisation of the situation:
Counsel for Nissan described the trading on as a gamble that did not pay off. He put that equity does not come to the rescue of administrators who trade on unreasonably without valuations, without indemnity for their trading costs, and in the circumstances which are described above. I agree.
Did the Administrators care for, preserve or realise the vehicles?
His Honour considered that the activities of the Administrators were directed towards the continued use of the vehicles (which were needed to trade the Atlas business) rather than to their care, preservation or realisation. Indeed, he considered the use of the vehicles placed them at risk and exposed them to wear, tear and deterioration.
Evidentiary issues with the ‘global approach’
Furthermore, there was an inadequacy of evidence linking claims and expenses of the Administrators to the preservation of vehicles of particular manufacturers.
The Administrators had taken a ‘globular’ approach to their claims without seeking to establish any particular amounts that “conscience would require” each individual secured creditor to pay in respect of the preservation, securing or realisation of its own security.[3]
Hammerschlag CJ emphasised the importance of demonstrating that the costs incurred are for the exclusive benefit of the secured creditor:
The Universal principle allows an amount of money spent by the claimant to be charged against the creditor’s security and thus borne exclusively by the creditor. The principle leaves no room to charge against that security expenses incurred for the benefit of someone else. The principle leaves no room for the application of speculation or guesswork as to what was spent for the creditor’s exclusive benefit, and justice does not dictate that a figure be plucked out of the air…
He considered that an individual secured creditor should not be required to establish its proportion of a global costs claim, but rather that it was the responsibility of the claimant to quantify the claim applicable to each secured creditor.
Accordingly, the Court determined that it could not make a finding that any specific amount was secured by a lien against any of the secured creditors individually (even if the Universal Distributing principle was otherwise applicable).
Comment
As previously noted, the Atlas decision demonstrates the risk that administrators take where they choose to continue trading a loss making business where the main assets are encumbered (and they do not have an indemnity).
If a sale of the company’s business as a going concern cannot be achieved, then there may be no (unencumbered) assets left in the company for the administrators to recover their costs and remuneration. The decision demonstrates that in such circumstances the costs incurred by an administrator (or liquidator) in operating the business or seeking to preserve or realise its going concern value will generally not be recoverable through an equitable lien against specific secured assets (or their proceeds) on the basis of the Universal Distributing princple.
This is because the Universal Distributing principles requires that only those costs reasonably incurred in the care, preservation or realisation of that secured asset will be recoverable from the fund generated on realisation of the secured asset.
Using the secured asset in the going concern operations of the business will not generally be considered caring for or preserving the asset (especially where (as in this case) such use puts those assets at risk). Furthermore, the onus is on the administrator (or liquidator) to prove the costs were incurred in respect of the care and preservation of that asset.
This general principle has been established at least since the 19th century English case of Re Regent’s Canal Ironworks Company (1875) 3 Ch D 411. In that case a third party financier reached an agreement with a liquidator, whereby the financier would pay the operating costs of an iron manufacturer (rent, wages and taxes) in order to allow the company to continue operating. The court held that the operating costs borne by the financier were not payable out of a fund which the liquidators produced by the sale of the company’s fixed assets (leaseholds, machinery and plant), though they would have had priority over any realisations from the floating charge.
Asset-based financing
In the Atlas case each manufacturer (bar one) was granted security over the whole of PJM / Atlas’ enterprise via general security agreements. However, in substance, the manufacturers were specific asset financiers, focused on the security value of the specific vehicles they were financing.
In this context, it is not surprising that the manufacturers were not supportive of the Administrators’ attempts to continue trading in the hope of achieving a going-concern sale of the Atlas / PJM enterprise. Though a whole enterprise sale may have presented the only path to achieving a return for unsecured creditors, this is not the basis asset financiers make their credit assessments in an insolvency scenario – asset financiers focus instead on rapid realisation of their secured asset pool. This of course assumes there is a ready market for sale of the relevant assets– this is not always the case, as was demonstrated in the Virgin Australia administration, where aircraft lessors faced difficulty deploying those assets and were therefore more open to consensual ).
Prolonging the period of trading on in an insolvency potentially puts the assets at risk, and can result in a deteoriation of recovery for a secured lender. However, this creates inherent tension where the business cannot operate on a going concern basis without access to the secured equipment.
For this reason, the moratorium under section 440B of the Corporations Act prevents lessors and secured creditors from repossessing assets or enforcing their security during the period of the administration (other than with the consent of the administrator or the court). However asset financiers will frequently require general security over all of the assets of the company so as to allow them to take advantage of the moratorium exception for creditors with security over the whole or substantially the whole of the company’s assets under section 441A of the Corporations Act (as was the case here).
Whilst the asset financiers in this case were willing to ‘wait and see’ for a period of time whether the Administrators could achieve a sale, they were clearly sceptical as to the prospects of this being achieved and whether it would be beneficial to them.
Business cashflow based financiers
In contrast to an asset-based lender’s focus on fixed asset recovery, a traditional business lender will consider the merits of the business as a whole when deciding whether to extend financial accommodation to a company, including its earnings and value as a whole when operating on a going concern basis.
Such business lenders may therefore be more likely to support or benefit from a trade on strategy when a company encounters financial difficulties, as they expect that the sale or restructuring on a going concern basis will realise more value, and therefore achieve a better recovery than on a break-up and realisation of assets.
Whole of business sales
The circumstances in the Atlas case should be distinguished from a whole of business sale. Coad v Wellness Pursuit Pty Ltd (in liq) [2009] WASCA 68 demonstrates that an administrator is entitled to assert an equitable lien against the proceeds of a whole of business sale ahead of a prior fixed charge, provided the relevant costs and remuneration has been incurred in achieving that sale.
In those circumstances, it would be inequitable for the secured lender to “sit back” while an administrator works to achieve a sale for their benefit, then refuse to meet the administrator’s reasonable costs and remuneration.]
Alternatively, if the business is restructured by way of a deed of company arrangement, an administrator will typically require that his or her costs and remuneration are payable as a first ranking distribution from the deed fund.
Unreasonableness
Throughout Chief Justice Hammerschlag’s judgment, significant emphasis is placed upon the conclusion that the Administrators’ decision to continue running the Atlas / PJM businesses was not a reasonable one. However it is important to place these comments within the context of the equitable lien being asserted in this case.
Under the Universal Distrbuting principle, the test of unreasonableness relates specifically to costs and expenses incurred in the care, preservation and realistion of the assets giving rise to the particular fund in respect of which a lien is being claimed. The proper question in this context is therefore not whether the Administrators acted reasonably from the perspective of the creditors or estate as a whole, but whether the costs they incurred were reasonably necessary to care for, preserve or realise the Volkswagen vehicles specifically (being the relevant assets in respect of which the lien is sought).
It is also important to note that whilst the Court in Atlas considered the decision to trade on unreasonable in the circumstances of this case, in many cases a period of trading while in administration is key to unlocking the value of a business for the benefit of its creditors (both secured and unsecured). Indeed, this is recognised by section 435A of the Corporations Act, which states that where possible, part 5.3A of the Corporations Act should be administered to maximise the chances of the company, or as much as possible of its business, continuing in existence. In other contexts, the courts have indicated reluctance to interfere with or second guess the business decisions made by an administrator (even where those decisions have legal aspects – see for example Re Pan Pharamceuticals Ltd [2003] FCA 855 at [51]) .However the deference shown by the courts is clearly not unconditional.
Furthermore, the Atlas case illustrates that on a practical level administrators need to take prudent steps to protect themselves in such situations given the potential for administrators to incur personal liability. Such steps may include:
- carefully monitoring available cash balances;
- obtaining interim funding or indemnification to cover the costs of trading on;
- obtaining a robust valuation of the business which justifies trading through temporary liquidity issues and incurring additional costs or losses; and
- engaging with key creditors and stakeholders (including in particular secured creditors) to determine support for trading on and a going concern sale or restructuring.
Taking into account these and other relevant factors, administrators should assess the realistic prospects of a successful going concern sale or restructuring, whether such a process is in the best interests of creditors and how the costs incurred by the administrators in undertaking such a process will be met if the process is ultimately unsuccessful.
[1] In Primary Securities, the liquidators were appointed to an insolvent company which was the responsible entity for a managed investment forestry scheme. The growers resolved to remove the responsible entity and replaced it. However before that occurred the liquidators devoted effort and spent money managing the scheme. The Court in that case considered the liquidators to be “interim custodians” of the scheme assets who should not go unrecompensed simply because no fund had been created. Hammerschlag CJ noted that there was still some degree of uncertainty as to whether a Universal Distributing lien could arise where there was no fund, but was willing to accept this position for the purposes of the case.
[2] Interestingly, he also noted in passing that there may be conceptual difficulties in a lien attaching to “bare goodwill”. In this regard he referenced Federal Commissioner of Taxation v Murry (1998) CLR 305, a High Court of Australia case indicating that goodwill has no existence independently of the conduct of a business and that goodwill cannot be severed from the business which created it.
[3] Whilst the Administrators had in their schedules divided each item of their costs between the categories of preservation, securing and realisation, this division was described as “somewhat random” by Hammerschlag CJ.
