Insolvency: Public examinations may well be the best method of dissecting an insolvent party, write Susan Carter CPA and Michael Peldan.
Public examinations are a very useful tool for liquidators and bankruptcy trustees. They have many benefits, few drawbacks and can be the most effective way for an insolvency practitioner to obtain information about the affairs of an insolvent entity.
A wide range of people may be called to give evidence and produce documents. Included among these are external accountants, who are often called to give evidence on transactions, solvency and about any advice that may have been given to the insolvent parties. Yet many accountants have never been summoned to a public examination and have little knowledge of what they are or why they are held.
Why hold public examinations?
Some bankrupts and directors are economical with the truth when dealing with insolvency practitioners. They lie about the existence and ownership of assets, the location of the books and records, what their income is, the reasons for and their knowledge of insolvency, the extent of their liabilities, and other issues where they think they may be exposed. Often public examinations are the best forum to find the truth.
Some background
Both bankruptcy trustees and liquidators have a duty to investigate insolvent entities, but that duty varies greatly between the Bankruptcy Act and the Corporations Act.
Trustees must comply with sections 19 and 19A of the Bankruptcy Act. Liquidators have more limited statutory duties to investigate, and voluntary administrators must only do so in the context of the voluntary administration appointment.
Generally, there is a practical need to investigate to find assets, verify claims, discover offences, and to provide some sense of resolution to creditors. Some part of the investigation process involves obtaining information from someone.
There are a few alternatives to holding a public examination. Insolvency practitioners can simply rely on the records available, hold formal interviews, issue 77A notices and hold 77C interviews (both limited to bankruptcies), obtain search warrants, or obtain orders for the provision of affidavits on certain issues (section 597A of the Corporations Act). Each of these has its uses, but all have limitations in scope, effect and enforceability, and often they are not worth the effort.
It is clear that liquidators and bankruptcy trustees often must try to find a hidden truth, and some of the methods available to them do not provide the necessary force to get to that truth. Public examinations, on the other hand, have some significant advantages.
First, they are held in a court. Witnesses are therefore in a room designed to find the truth. Witnesses sit in a court of law, with a judge, magistrate or registrar, a bailiff, a witness box and most of the rules and protocols of the legal system.
They are then placed under oath and warned of the consequences of perjury. Very few witnesses fail to be intimidated by this setting, and this gives an immediate tactical advantage to the insolvency practitioner. Witnesses are then asked a series of questions, and they must provide answers. The immediacy of the answers gives little time to concoct a believable lie.
Witnesses must answer all questions put to them, even if the answer is incriminatory. They may, however, claim a type of privilege that protects them from the answer being used against them in a prosecution.
One of the benefits of the public examination process is that it is inquisitorial, not adversarial. The insolvency practitioner is not trying to prove a case against another party trying to disprove it. They do not use the usual rules of evidence or cross-examination. They have nothing to lose. It is purely a fact-finding process.
Who can be examined?
Both the Bankruptcy Act and the Corporations Act allow examinations in a court. The Bankruptcy Act has section 81 providing for an examination of the bankrupt and 'examinable persons'.
Examinable persons include directors of associated entities, spouses of the bankrupt, people in possession of records, creditors of the bankrupt and debtors of the bankrupt, and accountants and solicitors. Essentially, anyone who has advised or dealt with the bankrupt may be examined.
Bankruptcy Act 1966 Section 81
Discovery of bankrupt's property, etc. Where a person (in this section called the relevant person) becomes a bankrupt, the Court or a Registrar may at any time (whether before or after the end of the bankruptcy), on the application of:
a person (in this section called a creditor) who has or had a debt provable in the bankruptcy
the trustee of the relevant person's estate
the Official Receiver
summon the relevant person, or an examinable person in relation to the relevant person, for examination in relation to the bankruptcy.
The Corporations Act has two relevant sections. Section 596A provides for the mandatory examinations of past and present officers of a company. Officers include directors and secretaries, people who make decisions that affect the business or financial standing of a company, and those whose directions are acted upon by the directors. 'Mandatory' means that an application for an examination must, in theory at least, be granted.
Corporations Act 2001 Section 596A Mandatory examination The Court is to summon a person for examination about a corporation's examinable affairs if:
an eligible applicant applies for the summons
the Court is satisfied that the person is an officer or provisional liquidator of the corporation or was such an officer or provisional liquidator during or after the two years ending:
if the corporation is under administration on the section 513C day in relation to the administration
if the corporation has executed a deed of company arrangement that has not yet terminated on the section 513C day in relation to the administration that ended when the deed was executed
if the corporation is being, or has been, wound up when the winding up began
otherwise when the application is made
Section 596B provides for discretionary examinations of those who have taken part in the examinable affairs of a company and, more widely, those who may be able to provide information about these examinable affairs. Essentially, to obtain such an order, the applicant needs only convince the court that the proposed witness would be able to provide some relevant information. Subsection (1)(b)(ii) is the usual section used to obtain examination orders against accountants.
Corporations Act 2001 Section 596B Discretionary examination The Court may summon a person for examination about a corporation's examinable affairs if:
an eligible applicant applies for the summons
the Court is satisfied that the person:
has taken part or been concerned in examinable affairs of the corporation and has been, or may have been, guilty of misconduct in relation to the corporation
may be able to give information about examinable affairs of the corporation
The requirement is knowledge. Due to their involvement in their client's affairs, accountants are often on the list of witnesses. They usually prepare the financial statements and various tax returns, and commonly give advice on business matters and transactions. They may also have given advice on the question of solvency, and this may be the insolvency practitioner's major area of inquiry.
Accountants, solicitors and bankers are usually 'friendly' witnesses simply providing an insight into the financial affairs of the insolvent, but not always. Sometimes they have been party to transactions under investig-ation and find themselves on the receiving end of recovery actions, or directors and bankrupts have blamed their advice for all of their problems.
Who can apply for an order for an examination?
Under the Bankruptcy Act, the official receiver, the trustee, or any creditor with a provable debt may make an application. That means that any creditor may apply to the Federal Court to examine the bankrupt, solicitor, accountant and other parties, and they do not need the approval of the trustee. In theory, the trustee cannot even intervene in their examination.
The Corporations Act restricts the applicants to the liquidator or administrator, ASIC, or someone authorised by ASIC. Creditors may still be able to make an application, as long as they have been authorised by ASIC to do so. ASIC has granted authority to receivers, managers, creditors, regulatory authorities and trustees of related trusts.
Who may take part?
Those who may apply for the examination also have the right under the Bankruptcy Act to take part in an examination. But it does not limit involvement to the party that actually made the application.
Any creditor can 'take part' in any examination, even when the trustee or another creditor made the application. So any creditor can turn up to court and put questions to any witness. The court would likely take a dim view of a trustee who refuses to allow a creditor to exercise this right.
Section 81 goes even further to allow a creditor to authorise someone else to represent them at the examination. This will usually be a solicitor or barrister who can ask questions about the property, income, related trusts or companies and property held by spouses, and any other relevant topic.
81 (8) Where a person is summoned for examination under this section, a creditor, the trustee or the Official Receiver may take part in the examination and, for that purpose, may be represented by counsel or a solicitor or by an agent authorised in writing for the purpose.
The Corporations Act does not go into the same detail as the Bankruptcy Act, and there are no corresponding provisions that allow creditors to automatically take part in the examination. In practice, whoever applies for the examination will have the conduct of it, and that will usually be the liquidator.
Witness representation
Witnesses have the right to be represented by counsel or a solicitor, but their role is very limited compared to their role in a trial. The Bankruptcy Act allows for counsel or a solicitor to re-examine the witness.
81(7) A person summoned to attend before the Court, the Registrar or a magistrate for examination under this section is entitled to be represented, on his or her examination, by counsel or a solicitor, who may re-examine him or her after his or her examination.
The position is probably better explained in the Corporations Act. It provides that questions may be asked to explain or qualify any answers or evidence given by the witness.
Corporations Act 2001 section 597 Conduct of examination (16) A person ordered to attend before the Court or another court for examination under this Division may, at his or her own expense, employ a solicitor, or a solicitor and counsel, and the solicitor or counsel, as the case may be, may put to the person such questions as the Court, or the other court, as the case may be, considers just for the purpose of enabling the person to explain or qualify any answers or evidence given by the person.
Having counsel present and re-examining the witness usually proves to be useful. Witnesses tend to answer their own counsel's questions more fully and provide more information.
A lot of information can be obtained from the re-examination of witnesses.
Should people be represented at a public examination? Some people feel comfortable without representation when they know that they have nothing to hide. Some people feel more comfortable with their lawyer in the room, even if they expect not to need them.
It is a personal question and most insolvency practitioners would not try to influence an examinee's decision to be represented.
Who asks the questions? The trustee or liquidator or anyone else running or taking part in the examination will usually have legal representation present on the day. A solicitor will be involved to make sure that all of the legal protocol is observed and, when needed, to give legal advice. Usually the trustee or liquidator will engage a barrister or a solicitor experienced in cross-examination to ask the questions. But there are pros and cons to this approach.
On one hand, barristers make their living by asking questions, listening to the answers and exploring the detail with follow-up questions. This is what they do, and they generally do it very well.
On the other hand, no one is more conversant with the background of the matter than the trustee or liquidator, no matter how detailed the brief. Also, the lawyers may not be as conversant with the financial details and accounting statements, ledgers and the like as the accountant, trustee or liquidator.
Generally the best results are achieved with an experienced solicitor or barrister asking the questions, while the trustee or liquidator sits beside them at the bar table providing details and direction as required. It is generally worth the investment of this extra legal cost. Standing up in court and firing questions at a witness may sound great in theory, but it is considerably more difficult than it looks. It is a skill that is acquired only by practice.
Questions of privilege
Accountants and solicitors are often called to give evidence when their client becomes an insolvent under some form of administration, usually liquidation (company clients) or bankruptcy (for individuals).
Sometimes the accountant or solicitor has some sensitive information usually the information that the liquidator or trustee wants and is hesitant to disclose it. Accountants may have had these clients for some time and feel some personal responsibility to protect them in some manner. To do so they sometimes claim professional or other privilege on some documents or information to avoid answering questions.
Privilege is one of those widely argued points of law, a subject that could be the sole topic of a book. But there are a few points that should be considered before trying to make such a claim.
Usually in a liquidation a company (rather than a director) is the client. The liquidator, having taken control of a company by resolution or court order, now controls the client. Effectively the witness is simply providing evidence to their own client, and no claim for privilege can be made.
In most cases, the same situation will apply in bankruptcies, with the trustee being the client, standing in the shoes of the bankrupt.
In cases where transactions or files involve or advice has been given to the bankrupt or liquidated company and another party, the witness will have to provide all of the information except the part that relates solely to the other party.
Even if the advice or document relates to the other party, if it is part of a file in which the insolvent is involved and in normal circumstances the bankrupt or insolvent company would be entitled to access to it it must be provided to the insolvency practitioner.
Why public examinations may be useful
an examination in a court is generally a better fact-finding tool than the alternatives available under the Acts
a trustee or liquidator will use examinations when fact, detail or documentation are not forthcoming from parties
the two Acts differ in the detail of who may apply and take part in examinations, but generally achieve the same result
anyone with information on the affairs of the bankrupt or company may be examined and may have to provide their files to the court
any question may be asked about information relevant to the affairs of the bankrupt or company, and the witness must answer the questions
accountants are often called as examinees on the basis that they are familiar with transactions of financial affairs of the insolvent party
About the authors Susan Carter is a partner at the Gold Coast office of Worrells Solvency & Forensic Accountants, an official liquidator and an active member of CPA Australia's Queensland Public Practice Committee. Michael Peldan is a partner at the Brisbane office of Worrells Solvency & Forensic Accountants, and is an official liquidator and registered trustee in bankruptcy.
Reference: November 2007, volume 77:11, p. 54 - 57
