The Federal Court has granted leave to a Trustee in Bankruptcy to disclaim a litigation funding contract – which provided the funder with a premium of 80-85% plus reimbursements of its costs.

Not all contracts that have been entered into by a bankrupt are going to be performed during the bankruptcy.  Some existing contracts can be ‘disclaimed’, freeing the Trustee in Bankruptcy from taking any further action with regard to the contract’s performance.

Under s. 133(1A) of the Bankruptcy Act 1966 (Cth), a Trustee can disclaim a contract.  Then, s. 133(5A) that a “Trustee is not entitled to disclaim a contract (other than an unprofitable contract) without the leave of the Court”.

Additionally, s. 133(5B) states “The Court may, in relation to an application for leave to disclaim a contract under this section: (a) impose such terms as a condition of granting the leave; and (b) make such orders with respect to matters arising out of the contract; as the Court considers just and equitable.”

Essentially, this gives the Trustee two (2) options: to disclaim an unprofitable contract, or if there is doubt, to approach the Court to have the Court order that the contract be disclaimed.

A notice of disclaimer must identify the contract being disclaimed and set out the facts showing that the contract is an unprofitable one.  The disclaimer does not affect the rights and liabilities of any aggrieved contracting party, for example, to lodge a proof of debt in respect of any liquidated damages arising from the breach of contract by the bankrupt.

The Bankruptcy Act does not contain a definition of the term ‘unprofitable contract’ and the question of whether a contract is unprofitable or not is a question of fact.  Case law precedents taken from bankruptcy law’s close equivalent – the statutory provisions in corporate statutes – have added marginally to defining the term and the concept.  Examples are that the unprofitable contract must be one that gives rise to prospective liabilities, that the burdens of the contract exceed the benefits, and that it does not become an ‘unprofitable contract’ merely because it is financially disadvantageous.

When the Court is asked to exercise its discretion to grant leave it will address the effect of disclaiming, weighing up the prejudice to unsecured creditors of the bankrupt’s estate with the opposing view, most likely form the contracting party, that a grant of leave to disclaim should not be granted.  The Court will also be minded of the Trustee’s duty to facilitate the timely finalisation of the administration of the bankrupt estate.

The Federal Court, in a case involving the author as Trustee in Bankruptcy, recently considered the matter.

Cooper (Trustee) v GT Capital Partners Pty Ltd, in the matter of Tonner [2019] FCA 2174 involved a contract (a litigation funding agreement) that the bankrupt had entered into shortly prior to bankruptcy.  The Trustee was granted leave to disclaim the funding agreement.

On the facts, under this contract the contracting party (a litigation funder) would have received a total premium of 80% (or 85% if there was an appeal) from a successful litigation that involved parties including the bankrupt.  In addition, the litigation would be reimbursed its costs paid to fund the litigation, in addition to its 80% (or 85%) premium.

The Trustee told the court that he had not previously seen such a high funding premium and that, in his opinion, the contract was “uncommercial and would not result in any, or any meaningful return, to creditors” if the litigation was pursued successfully.

In the judgment, Besanko J stated he was unaware of any authorities that dealt with funding agreements as unprofitable contracts either under personal or corporate insolvency law.  He reached the conclusion though that, in all the circumstances, this contract was of doubtful profitability to the bankrupt estate though he did not find that the contract was an unprofitable one.

Therefore, the Trustee could not disclaim under s. 133(1A).  However, in reaching such a point of not satisfying s. 133(1A), Besanko J then went on to consider whether leave to disclaim should be granted by the Court.

His Honour, in light of the fact that there were no authorities from bankruptcy law addressing the principles that governed the exercise of the Court’s power to grant leave to disclaim under s. 133(5A), considered several corporate cases.  He noted that the decision to grant leave is a discretionary one and that any effects of granting leave were relevant.

Besanko J agreed that as a general proposition, leave to disclaim in bankruptcy is more readily granted because the Trustee has property vested in them and if not for an effective disclaimer they would be personally liable under the contract.  His Honour noted that this contract had the ‘tendency to interfere’ with the Trustee’s control of the litigation and the ‘potential to interfere’ with his duties as the appointed Trustee of the bankrupt estate.

The judge also saw that the contract was extremely favourable to the contracting party but not to the bankrupt.

In summary, it is most helpful that Trustees have the ability to rid themselves of property and unburden themselves from unprofitable (or overly restrictive) contracts as provided by the Bankrupt Act and now given certainty by Cooper (Trustee) v GT Capital Partners Pty Ltd, in the matter of Tonner [2019] FCA 2174.