As the childcare empire was cratering in 2008, the bankers to ABC Learning deftly snatched an “oral” charge over the company’s assets, leapfrogging to the front of the creditors’ queue and clawing back a cool $100 million or so before ABC bit the dust a few months later.

Sadly for Commonwealth Bank, Westpac, National Australia, ANZ, BankWest, Bank of America, Mizuho and Citibank, however, they now face a legal challenge from ABC’s liquidator Ferrier Hodgson. Ferrier is backed by litigation funder IMF Australia.

It might be chump change for the banking syndicate if they lose the case, or more likely capitulate to a settlement, yet the $100 million action should put insolvency types and bankers – a cosy crew who tend to work in tandem – on notice that they can’t jump the creditors’ queue quite as breezily in the future when they sniff a corporate wreck in the offing.

The action hinges on the “six months rule” which has it that a charge is not valid if a company collapses within six months of the charge being struck.

On June 25, 2008, Eddy Groves’s ABC granted an oral charge to its banking syndicate. That’s correct, an oral charge, quite possibly along the lines of Eddy himself saying “sweet” to a syndicate lawyer over the phone. The effect of the deal was to improve the bankers’ security over ABC’s assets in the event of a wind-up.

Two weeks later the oral charge was transferred to a written and registered charge.

ABC fell over five months later, appointing Ferrier as administrator in November. Now Ferrier is trying to retrieve the money paid under the charge, which is no small feat (from a “food-chain” perspective rather than a theoretical perspective that is).

Taking on the Big Four on behalf of small unsecured creditors is quite the act of courage and integrity for a major insolvency firm. They make most of their money from the banks and don’t usually act against them.

This is a case of an insolvency practitioner doing the right thing. A cynic might even say it merits applause.

In Federal Court proceedings in 2010 brought by the Commonwealth Bank, which was trying to have PPB appointed as external controller in Willmott Forest over the incumbent, Justice Ray Finkelstein was asked “how many times PPB have been appointed by the Commonwealth Bank or voted in by the Commonwealth bank in administrations of one type or another?”

His response:

“I have had for some years a growing sense of unease about the power and influence that large creditors have over insolvency administrations.  It is not beyond a large creditor – it doesn’t have to be a secured creditor, it’s got nothing to with holding security; in fact, it’s irrelevant that it might be a secured creditor – for a large creditor to, if he has got an insolvency administrator – insolvency practitioners not playing ball to say, I’ll vote you out.  I can vote you out.”

We can translate Finkelstein’s “large creditors” as “banks”. This issue is absolutely critical to the legal system and insolvency administration. Yet there is a dearth of regulatory oversight.

And so it is that the “six month rule” is – to the detriment of all smaller and unsecured creditors in corporate collapses – going entirely unpoliced.

But we digress. IMF is likely to argue that the charge is only effective to the extent of ABC’s fixed assets, relying on section 588fj of the Corps Act which says the charge is void (the floating charge that is and this was a fixed and floating charge) if there is no new money raised.

The banks were never going to lend Groves any new money. They were merely improving their security over ABC on expectations that it would soon be rendered a smoking ruin.

IMF has to prove that the banks received money after June 25 when the floating charge was taken. The banks have to prove that ABC was solvent, which might be difficult if the evidence arising from the liquidators examinations in the Federal Court earlier this month is any guide.

IMF treads the simpler path. Shortly after striking the charge, Eddy Groves struck a $300 million joint venture deal with Morgan Stanley in relation to ABC’s assets in the United States.

Some of that money reverted to the syndicate. All up, more than $100 million was clawed back under the charge, some of it by McGrath Nicol who was appointed receiver when ABC crashed. McGrath Nicol will also be joined along with the banks.

The interesting part will come, if the case ever goes to trial, when the banks set about proving that ABC was solvent at the time the charge was taken.

The plaintiffs are likely to argue, and quite plausibly, that ABC had not been solvent for years, perhaps ever. It is doubtful that it could ever have paid its debts at any point in time had it been required.

Groves’s high-octane property play imploded owing roughly $2 billion to creditors. It had borrowed $2 billion in debt and raised $1 billion in equity but the funds had all been gained without full disclosure of Eddy’s business model.

The market foolishly deemed this to be a childcare business whose fortunes rose and fell with the number of ankle-biters who were enrolled in ABC’s centres.

Rather, this was something of a property development and accounting play which fell apart when Ernst & Young took over the audit form Pitcher Partners in the year of the 2008 accounts. That Pitcher Partners Queensland division has since melted away.

The lurk was this: Groves was essentially running a “round robin” of cheques with the property developer associates who built his childcare centres.

ABC would overpay the developer to build the childcare centre. While it was being constructed and while ABC was waiting for the kids to fill the new centres, the developer would pay back some of that money to ABC and ABC would book it as revenue.

There was never any breakdown or disclosure in the accounts as to the split between the fees from the property developers and the actual childcare fees.

It all looked fabulously profitable – the developer fees looked like childcare income that is – until Ernst & Young bobbed along and insisted upon a proper accounting treatment of ABC’s assets. The music stopped when the income was unearthed as fees from property developers rather than paying parents.

The asset values in the balance sheet were illusory.

As the market clued into what was really happening from February 2008, coinciding with the global financial crisis, the stock price plummeted from $7 to $1.50. Groves desperately tried to raise equity and copped margin calls on his personal stake.

He is a lucky man: a wild ride, $3 billion of other people’s money blown up and no reprisals from the authorities.