Preserving the status quo: How provisional liquidators can save a deadlocked company

Introduction

A provisional liquidator may be appointed to a company between the time an application is made to wind up that company and the winding up of the relevant company. The purpose of the appointment of a provisional liquidator is to ‘preserve the status quo’ and remaining assets of a company prior to determination of the winding up of a company. Outside of this specific purpose, a provisional liquidator has a similar function to a Court-appointed receiver.

The Federal Court of Australia (in Hema Maps Pty Ltd v HemaX Digital Pty Ltd [2024] FCA 1127) recently set out the relevant principles that a Court will consider in determining whether it is appropriate to order the appointment of a provisional liquidator.

Key Takeaways:

Situations where it may be prudent to make an application for the appointment of a provisional liquidator include:

• where management is misappropriating company property or not acting in the best interests of the company; or
• where there is a deadlock in management, to the extent that the company is suffering harm from the lack of decisions able to be made.

Facts:

In the recent case, the company which was the subject of the winding up application, HemaX Digital Pty Ltd (HXD), was a joint venture company whose shareholding was made up of two groups, being Hema Maps Pty Ltd (Hema) and the Derry Trust, the owner of CJ Global Tech Pty Ltd. Each party provided a different service to create an offroad GPS technology product.

Hema brought the winding up application against HXD, as a result of a breakdown in relationship between the shareholders and the appointed directors, which resulted in a deadlock where the Board of the company was unable to make decisions.

Legal Principles:

It has been noted that the principles governing the grant of this relief are analogous to the considerations relevant to other grants of interlocutory relief to protect assets, such as freezing orders.

There are two key matters that a Court will address in making a determination to appoint a provisional liquidator, being:

• that a winding up application has been filed, and taking into consideration the strength of the applicants case there is a reasonable prospect that a winding up order will be made; and
• there is urgency and a sufficient reason for intervention prior to the final hearing, including consideration of the public interest, the protection of the company’s assets, or to protect the status quo in respect of the company’s affairs. This enquiry also accounts for the practical consequences that may flow from the appointment of a provisional liquidator.

In relation to the reasonable prospect of a winding up order being given and the strength of the applicants case, regard must be given to principles surrounding when a winding up order would be given in circumstances where it is ‘just and equitable’ as per section 461(1)(k) of the Corporations Act 2001 (Cth). Although the term ‘just and equitable’ is too broad to be defined precisely, it is often called upon in situations where there is no other practical alternative to winding up, and has included situations such as:

• where there is a justified lack of confidence in the management of the company;
• where there has been a deadlock in management, or a dispute between directors and shareholders; or
• where the company was established on the basis of a personal relationship involving trust and mutual confidence, which has deteriorated and no longer functions to the extent that continuation of the business would be futile.

The appointment of a provisional liquidator is not a decision that the Court will make lightly, being described as a “drastic intrusion into the affairs of the company and is not to be contemplated if other measures would be adequate to preserve the status quo”, as it has the effect of displacing the directors and having the provisional liquidators take control of the company, effectively commercially paralysing the company.

Application in Hema Maps:

As mentioned, HXD suffered from a total breakdown between its two controlling shareholders, which created the situation where the board is deadlocked and no longer able to make decisions.

The decision made by the Court was to appoint a provisional liquidator, relying upon the following in making the decision:

• there was a total breakdown in the relationship between the two controlling shareholders;
• there seemed to be no goodwill or trust between the two shareholders;
• one of the shareholders ceased to provide critical services; and
• harm was being caused to HDX’s business, which began threatening its solvency.

The Court also imposed limits on the power of the provisional liquidators, being to exclude them from selling or disposing of the property of the company, or to obtain credit on behalf of the company.

If you are considering provisional liquidation as a potential solution to an issue you may be facing, please do not hesitate to contact our Directors, Aaron McDonald or Nick Malone, on their emails directly: aaron@pragma.law or nick@pragma.law.