SOLVENCY AND ONLY SOLVENCY THE NEW WINDING UP REGIME

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1 SOLVENCY AND ONLY SOLVENCY THE NEW WINDING UP REGIME Introduction Notwithstanding that Part 5.4 of the Corporations Act was introduced in its present form on 1 January 1993, it took until 2003 for there to be a definitive determination of the practical application of the Part in so far as it applies to a winding up in insolvency. In three notable decisions the New South Wales Court Appeal recast the practical application of the Part and in doing so has for good reason restricted the scope of resistance that can be mounted by the Company. 1 Further, the principles laid down in the abovementioned authorities have been followed in this jurisdiction. 2 Disputed Debt and Abuse of Process The relevant facts in Braams Group Pty Ltd v Miric 3 was simple but unusual. Mr Miric, the creditor, had obtained a judgment and subsequently served a statutory demand. The Company failed to satisfy the demand or applied to have the demand set aside. The Creditor began winding up proceedings. The Company then appealed the judgment debt and sought to stay or adjourn the winding up proceedings. At a later date the judgement was set aside by the consent of both parties. Nevertheless, the winding up continued Switz Pty Ltd v Glowbind Pty Ltd (2000) NSWCA 37: (2000) 33 ASCR 723; Braams Group Pty Ltd v Miric (2002) NSWCA 417: (2002) 44 ACSR 124; Expile Limited v Jabb s Excavation Ltd (2003) NSWCA 163: (2003) 45 ACSR 711 Sindea Trading Co Pty Ltd v Asia Pacific Glass Pty Ltd (2003) QSC 406 (2002) NSWCA 417: (2002) 44 ACSR 124

2 2 A presumption of insolvency had arisen pursuant to Section 459C and, at the time of the winding up application was filed, the Applicant was a creditor holding a judgment. On the return date of the winding up proceedings the Company filed material showing that it was a trustee Company and that apart from its right of indemnity against the beneficiaries or trust assets, it had no assets and it had debts for legal fees in respect to earlier proceedings. No current accounts were produced and it had not traded in the current financial year. At first instance the Company was not given leave to dispute the debt because it could not satisfy the requirements of Section 459S in that disregarding any disputed debt it was nevertheless insolvent. Accordingly, the Company was wound up. Again while acknowledging the legislative scheme of Part 5.4 could have harsh consequences if a Company did not take advantage of Section 459G to set aside a statutory demand, the Court nevertheless found that there was no abuse of process in the creditor pursuing the winding up application. While the Court acknowledged that it was still possible for the pursuit of a winding up application to be an abuse of process such pursuit would have to be an abuse of process in the narrow and technical sense discussed in Williams v Spautz 4. In the present circumstances, once the Company had failed to comply with the statutory demand, the presumption of insolvency had arisen, the only proper manner for the Company to dispute the debt was seek leave under Section 459S. In the circumstances the Company could not demonstrate it should be given leave to dispute the debt as the Company was always insolvent. As the Company was always insolvent it should be wound up. The Court did not address the issue as to whether, at the time of the making of the order, whether Mr Miric was indeed still a creditor and therefore had standing pursuant to Section 459P. 4 (1992) 174 CLR 509

3 3 The answer may be that it is sufficient that Mr Miric was a creditor at the date of the filing of the application and after that date it is sufficient that a creditor does not pursue such an application on its own behalf but on behalf of the world at large. In practical terms the lesson to be learnt is that once the presumption of insolvency arises, there is no abuse of process to pursue a Winding Up Application relating to a disputed or even nonexistent debt. 5 Leave to Dispute the Debt Section 459S provides: (1) Demand may not ground opposition In so far as an application for a Company to be wound up in insolvency relies on a failure by the Company to comply with a statutory demand, the Company may not, without the leave of the Court, oppose the application on a ground: that the Company relied on the for the purposes of an application by it for the demand to be set aside; or that the Company could have so relied on, but did not so rely on (whether it made such an application or not). (2) Ground material to solvency The Court is not to grant leave under subsection (1) unless it is satisfied that the ground is material to proving that the Company is solvent. It is common for a Company to attempt to resist an application for winding up on the basis that the debt founding the creditor s statutory demand is disputed. 5 For former position consider Fortuna Holdings Ltd v Deputy Commissioner of Taxation (1976) ACLR 349

4 4 Further, a Company will often seek an injunction to prevent the Applicant/Creditor from proceeding with a winding up based on a disputed debt. 6 However, the introduction of Part 5.4 attempts to restrict the circumstances where such relief could be granted 7. Notwithstanding the sentiment expressed in the Explanatory Memorandum it was still common place for injunctions to be granted against Creditors where the winding up was proceeding in respect to a disputed debt. In Switz 8 however, the New South Wales Court of Appeal expressed the view that Section 459S should be applied strictly and further that the Court is not to grant leave to dispute a debt unless the Court is satisfied that the resolution of such dispute will be material to the Company proving it is solvent. In summary the Court held: if the Company can prove that it is solvent even accepting the existence of the debt then leave will not be granted to dispute the debt as it makes no difference to the Company s solvency; if the Company is insolvent even if ignoring the disputed debt then leave will not be granted to dispute the debt as it makes not difference to the Company s insolvency; only in the circumstances where an examination of the disputed debt will be made is when the debt is material to the Company demonstrating its solvency. Accordingly, the circumstances where leave will be granted will be very rare. While the Court acknowledged that in some circumstances such an application of Part 5.4 may appear to operate harshly it was nevertheless the consistent with the Explanatory Memorandum Fortuna Holdings Limited v Deputy Commissioner of Taxation (1976) ACLR 349 Explanatory Memorandum Corporate Law Reform Bill 1992, paragraphs 685 to 689 (2000) NSWCA 37: (2000) 33 ACSR 723

5 5 and the comments of the High Court in David Grant & Co Pty Ltd (Receiver Appointed) v Westpac Banking Corporation 9. In practical terms the current position can be summarised as follows: (d) a Company seeking to dispute a debt without evidence of solvency will not be given leave under Section 549S or indeed be able to rebut the presumption in Section 459C and hence be wound up; a Company which provides evidence of solvency but that evidence is not sufficient to demonstrate solvency even disregarding the disputed debt will not be given leave under Section 459S(2) and should be wound up; a Company which provides evidence of solvency which demonstrates in the relevant sense solvency even allowing for the existence of the debt will not be given leave under Section 459S(2) but will not be wound up due to the rebuttal of the Section 459C presumption; where a Company provides evidence of solvency but such evidence is not determinative due to the existence of the disputed debt then leave may be given and the matter will proceed as a contested winding up in a manner common prior to the introduction of Part 5.4. Proving Solvency Unfortunately, discussions of solvency in the context of insolvent companies usually involves the reciting of nothing more than statements of principle as opposed to examination at a most basic level of the evidentiary requirements. In Expile Pty Ltd v Jabb s Excavations Pty Ltd 10, the sole issue to be determined was whether the statutory presumption of insolvency was rebutted by the Company (1994) 184 CLR 265 (2003) NSWCA 163: (2003) 45 ACSR 711

6 6 In finding that the Company had rebutted the presumption, Barrett J compiled a useful summary of the evidence that is required. In short, Barrett J made the following observations: (d) (e) (f) (g) (h) the Company is presumed to be insolvent and as such bears the onus of proving its solvency; in order to discharge such onus the Court should be presented with the fullest and best evidence of the financial position of the Company; unaudited accounts or unverified claims of ownership of property or valuation are not ordinarily probative of solvency; bald assertions of solvency arising from a general review of the accounts even if made by qualified accountants who have detailed knowledge of how those accounts were prepared is not sufficient; the relevant test is not a surplus of assets but solvency; while the nature of the Company s assets and the ability to convert those assets into cash at a relatively short time are relevant there must be evidence as to the value of such assets; the question of solvency must be assessed at the date of hearing; it is no abuse of process for a Creditor to seek to wind up a Company presumed to be insolvent by reason of its failure to comply with a statutory demand merely because the Company contends that it is solvent. In Expile Pty Ltd v Jabbs Excavation Pty Ltd 11, the Company relied on evidence from the Director and Shareholders, an external accountant who provided accountancy services to the Company and an accountant specifically retained to provide a report on the Company s financial position for the purposes of the proceedings. 11 (2003) NSWCA 163: (2003) 45 ACSR 711

7 7 Importantly, the financial accounts were supplemented by third party valuation evidence of particular assets. In short, the Company did far more than most. At first instance the Winding Up Application was dismissed on the basis that the presumption of insolvency had been rebutted. However, the New South Wales Court of Appeal allowed the Appeal by the Creditor and found that while the observations of Barrett J in respect to relevant evidence were correct the practical application of the relevant principles to the evidence meant that the presumption had not been rebutted. In particular: (d) (e) the treatment of particular bank loans as a non-current liability was not justified; evidence of sufficient borrowing capacity depending upon the reliability of verification of liabilities and assets should be regarded with suspicion unless there is independent third party valuation; the value of equity in leased assets should be regarded with suspicion; any gaps in financial records particularly concerning acquisition costs of assets must be explained; any reliance on trade debtors as an asset is unreliable. Accordingly, the Court of Appeal found the evidence well short of that required to rebut the presumption. In practical terms as it concerns the Company, this decision has the effect that: an external and independent accountant should be engaged to prepare a special purpose report as to solvency;

8 8 (d) (e) (f) the abovementioned report should be based on independent and third party valuation of assets; liabilities must be brought to account as at the day of the hearing of the application and quantified with precision by corroborating documentation; it is not sufficient that the Company use its own accounts or indeed its own external or compliance accountants to prepare financial accounts for the purposes of a Winding Up Application; evidence and reports prepared for hearing must be obtained in a sufficient time frame; financial accounts produced internally using well known software packages are viewed as unreliable. Conclusion There is no doubt that the abovementioned decisions have swung the balance firmly in favour of creditors making an application for winding up. Once the presumption of insolvency arises it is clear that a Creditor can continue with a winding up and that a Company faces a high hurdle in demonstrating to the satisfaction of the Court that it is solvent in the relevant sense. CD Coulsen Chambers 3 October 2007