Suggested answer to end of chapter problems, and Examiner s tips - by Christopher Symes

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1 2012 Reed International Books Australia Pty Limited trading as LexisNexis. Permission to download and make copies for classroom use is granted. Reproducing or distributing any material from this website for any other purpose requires written permission from the Publisher. Suggested answer to end of chapter problems, and Examiner s tips - by Christopher Symes Chapter 10 Liquidation Problem 1 Parawa Hay and Lucerne Pty Ltd (Parawa) was incorporated in 1924 and has been in the same family since the business started. The company slogan is making hay while the sun shines. The present directors are Olive, Richard and Dwayne Hoover. The shareholders include all three directors and their spouses, Frank, Sheryl and Cindy Hoover. Four years of drought has brought the company to crisis point. The directors have had to act with expediency in order to avoid any creditors petitioning for its winding up. In October the directors decided to hold a meeting with all shareholders. The directors instructed the company s accountant to prepare cash flow forecasts and profit predictions to be presented at the meeting. The directors hoped to be able to present financial plans in order to persuade creditors to allow them sufficient time to turn the company around, however this turned out to be impossible. The directors were unable to make a declaration of solvency and so the meeting resolved to wind up the company. There were no previous resolutions to wind up the company. Ray, a registered liquidator, accepted the appointment and arranged for a meeting of creditors within one week. Yankalilla Bank, a community bank, has a debenture over the plant and equipment of Parawa. It has been reluctant to enforce its security because of the drought and its impact on rural families. However, it is a subsidiary of a larger bank and eventually complies with instructions from its Head Office to appoint a receiver. The receiver has taken possession of one of the company s most valuable assets, the New Holland HW 345 Self-propelled Windrower but he is yet to sell it. Advise the receiver on his legal position. Suggested answer If the receiver is validly appointed from the security documentation then the appointment of the receiver should not present too many difficulties. Section Australian Insolvency Law 2 nd edition Ch10 Answers and Tips Page 1

2 420C permits a receiver to hold and dispose of the secured property even while a liquidator is in place. Ray as liquidator would satisfy himself that the receiver is validly appointed and enter into some discussions as to the progress of the sale of the secured asset. The receiver could be expected to continue with the sale of the Windrower. Parawa has commenced liquidation in a voluntary way. Section 494 permits a company to voluntarily wind up if the directors form the opinion that the company is solvent and will be for a period of 12 months. However, here Parawa s directors cannot make such a declaration. Because of this the liquidator must convene a creditors meeting under s 497. The meeting must be convened at a date, time and place convenient to the majority in value of creditors and must give each creditor at least seven days notice and send to them a summary of the affairs (Form 529) and a list setting out the names and addresses of creditors and the estimated amounts owed. These documents are also to be lodged with ASIC. The notice of meeting must be published in a daily newspaper circulating in each State and Territory in which the company carries on business. Problem 2 Suppose Parawa had not taken the step to voluntarily wind up and had continued on struggling financially. A construction company, Meath Ltd, which was hired by Parawa for earthmoving works for a large shed that was commenced on Parawa s property in 2010, has not been paid $630,000 for the work. After repeated attempts to discuss the debt with Parawa s directors, Meath Ltd has served a statutory demand on Parawa. The statutory demand arrived on 1 October at the company s premises (its registered office) the day before Richard, Parawa s Managing Director, was due to fly to Kiribati for a month s holiday, and it was hidden under the paperwork on Richard s desk for the duration of his holiday. Advise Meath Ltd on the process of winding up Parawa. Suggested answer For Meath Ltd to be able to wind up Parawa it must prove that Parawa is insolvent. To do this Meath Ltd can issue a statutory demand provided that the amount of the debt or debts totals at least $2000 (the statutory minimum) and that this amount is due and payable to Meath Ltd, the person making the demand. The demand will be valid only if it is in writing, specifies the total amount of the debt(s), and requires the company to pay the total amount of Australian Insolvency Law 2 nd edition Ch10 Answers and Tips Page 2

3 the debt(s) within 21 days after the demand is served on Parawa. The demand must be signed by or on behalf of Meath Ltd (the creditor) and be in the form prescribed (Form 509H) and accompanied by a verifying affidavit because the debt(s) are not judgment debts. The above is required under section 459E. Provided that the above process has been followed, it would appear that the 21 days may have passed and there has been non-compliance with the demand. For example, service of the statutory demand is permitted by leaving it at the company s registered office (s 109X) and this has happened as Richard has received it before taking his annual leave. Meath Ltd could apply to the court to wind up Parawa for failure to comply with the statutory demand. In this way it is using the presumption of insolvency and under s 459C the court can presume insolvency if during or after the three months ending on the day the application was made, Parawa failed to comply with a statutory demand. The originating process for the process of winding up in the court follows a Form 2. Under s 459Q the particulars of the service of the demand on the company and the failure to comply with the demand are set out for the court. A copy of the demand is attached. The capacity of Meath Ltd as a creditor is established: ss 459P(1), 462. Problem 3 Assume Parawa is in liquidation, the date of the winding up being 1 December, and consider the following events. A local business, Granpa s Fuels, has been supplying Parawa with diesel, petrol and oil for over 50 years. Parawa owed Granpa s over $19,000 during The relationship between the two businesses had gone back so many years that the directors of Parawa thought that it was the least it could do to use what little money was in the bank to pay Granpa s. About one month before the meeting to appoint a liquidator Parawa paid Granpa s all of what was owing to it. Another creditor, SuperFert Pty Ltd (SuperFert) has had dealings with Parawa for about four years. The business relationship between the two companies has been relatively smooth, except for two occasions when cheque payments to SuperFert were dishonoured by Parawa s bankers. However, reports in the farming magazine Grass Farmer concerning Parawa s financial situation have caused some concern, leading SuperFert to demand settlement of its account in full. Transactions to date have included: Australian Insolvency Law 2 nd edition Ch10 Answers and Tips Page 3

4 Date Transaction Amount Balance 30 June 28,500 9 July Payment 4,000 24, July Delivery of goods 1,000 25,500 9 August Payment 4,000 21, August Delivery of goods 10,000 31,500 9 September Payment 4,000 27, September Delivery of goods 1,000 28,500 4 October Payment 15,000 13, October Delivery of goods 8,000 21,500 4 November Payment 4,000 17, November Delivery of goods 8,000 25,500 There were no transactions during May or June. Dwayne s brother Gerard borrowed $20,000 from the company in Last year, Dwayne convinced both Olive and Richard to write off (forgive) this debt owed to Parawa because Gerard had a dairy farm at Meningie which had been greatly affected by the drought. Olive has possession of the company s BB-A Large Rectangular Baler. In a deal that was agreed by Dwayne and Richard, Olive took the baler to her home in Victor Harbour as payment for past loans she had made to Parawa. Two years ago, when the company was in a similar financial position, Olive s sister Paulini loaned the company $150,000 for a term of 12 months at an interest rate of 22.5 percent to help the company through a difficult time. It was repaid last October after one year. What can Ray as liquidator do about these transactions? Suggested answer Voidable transactions can be unfair preferences (s 588FA), uncommercial transactions (s 588FB), or unfair loans (s 588FD). Section 588FC describes insolvent transactions as either unfair preferences or uncommercial transactions, while s 588FE provides for the relevant time periods applicable to each type of voidable transaction. Australian Insolvency Law 2 nd edition Ch10 Answers and Tips Page 4

5 For unfair preferences For uncommercial transactions For an insolvent transaction of either kind with a related entity of the company (defined by s 9) For an insolvent transaction of either kind entered into for the purpose of defeating or delaying creditors rights For unfair loans Table of time frames applicable to voidable transactions During the six months ending on the relation-back day, or after that day but before the commencement day: s 588FE(2) During the two years ending on the relation-back day: s 588FE(3) During the four years ending on the relation-back day: s 588FE(4) During the 10 years ending on the relation-back day: s 588FE(5) At any time on or before commencement day: s 588FE(6) The court may make appropriate orders in relation to voidable transactions under s 588FF, but must do so if it is proved that a person who became a party to the transaction in question did so in good faith, provided valuable consideration, and had no reasonable grounds for suspecting that the company was insolvent at the time, or a reasonable person in the person s circumstances would have had no such grounds: s 588FG(2). The payment to Granpa s Fuels was made about a month before the relationback day being the date of the appointment. The payment therefore was made by the company in the six-month period ending on the relation-back day. The payment falls into the definition of an unfair preference (s 588FA(1)) since the creditor received better treatment than other creditors. Could Granpa s Fuels have a defence under s 588FG(2)? It is possible that Granpa s Fuels was acting in good faith, had provided valuable consideration and had no suspicion of insolvency? Section 588FA(3) deals with transactions that are an integral part of a continuing business relationship, such as running accounts. These accounts show regular debits and credits and are intended to indicate a continuing relationship between the company and its creditors, despite the payments being made from time to time: Airservices Australia v Ferrier (1996) 185 CLR 983. Australian Insolvency Law 2 nd edition Ch10 Answers and Tips Page 5

6 A running account is treated as a single transaction for the purposes of determining an unfair preference: s 588FA(3)(c). If that single transaction would be an unfair preference under s 588FA(1), it will be a voidable transaction if made when the company was insolvent: s 588FC. The starting point for the single transaction could be at any time during the six months before the commencement of the winding up: Rees v Bank of New South Wales (1964) 111 CLR 210; Olifent v Australian Wine Industries Pty Ltd (1996) 19 ACSR 285. Its end point will be the winding up, or alternatively, when the continuing business relationship otherwise came to an end. For the purposes of a voidable transaction, the period between the relationback day and the beginning of the winding up can also give rise to an unfair preference: s 588FE(2)(b)(ii). In this case there appears to be a running account in operation between the debtor company Parawa, and a creditor, SuperFert. This is a continuing business relationship which is evidenced by dealings over a period of about four years. If the relation-back day is 1 December, six months prior covers the period from 1 June. Thus, if the payments from that date are counted as a single transaction, a total of $31,000 has been paid up to and including 1 December. However, goods were delivered to Parawa from SuperFert during the same period to the value of $28,000. The overall reduction in the account between the two dates was thus $3000. Therefore, if there is a preference it will amount to $3000. However, is s 588FA(1) applicable to this single transaction as determined under s 588FA(3)? Both the company and the creditor are parties to the transaction (s 588FA(1)(a)), and the transaction could be argued to have resulted in the creditor receiving more than it would have received in a winding up as an unsecured creditor: s 588FA(1)(b). The latter point is so because SuperFert has received an overall repayment of debt owing of $3000 in excess of goods delivered during the relevant period. The amount could be an unfair preference and thus voidable, but does s 588FG(2) apply? The section requires that there be good faith by SuperFert, no reasonable grounds for suspecting Parawa was, or would become, insolvent at the time of the payments, and no grounds for such a suspicion to be drawn by a reasonable person in SuperFert s position. Good faith is given its natural meaning of propriety or honesty in this context: Queensland Bacon Pty Ltd v Rees (1966) 115 CLR 266. Reasonable grounds for suspecting insolvency should be considered as an objective assessment of the company s circumstances, while having no grounds for suspecting insolvency as a reasonable person in the creditor s circumstances involves a partially subjective view. Australian Insolvency Law 2 nd edition Ch10 Answers and Tips Page 6

7 In this case the facts do not suggest that SuperFert knew that Parawa was insolvent at the time of the payments. There had been two previously dishonoured cheques, but this does not necessarily amount to insolvency: Queensland Bacon Pty Ltd v Rees (1966) 115 CLR 266. Moreover, these might have occurred outside the relevant six months. Reports in Grass Farmer magazine have apparently caused SuperFert to demand payment of outstanding debt. These reports are not evidence of insolvency but may merely suggest financial difficulty. If it is accepted that both good faith and no reasonable grounds for suspecting insolvency are present, the payments to SuperFert will not be an unfair preference. Section 588FB provides that a transaction will be an uncommercial transaction if and only if it may be expected that a reasonable person in the company s circumstances would not have entered into the transaction having regard to the benefits to the company, the detriment to the company and the respective benefits to the other parties to the transaction and any other relevant matter. Gerard has received the benefit of not having to repay a loan given to him by the company. The transaction appears to be uncommercial from the viewpoint of Parawa, particularly given that it appears to receive no benefit. The test is whether a reasonable person in the company s circumstances would not have entered into the transaction, and given it was in financial difficulties at the time, the circumstances suggest this was unreasonable. Olive has company property that appears to have been transferred to her for past debts. This too appears to suggest that the transaction is uncommercial under s 588FB. See Ziade Investments Pty Ltd v Welcome Homes Real Estate Pty Ltd [2006] NSWSC 457, as it deals with s 588FB and a transaction involving past loans. Ray should ask Olive to return the baler. Unfair loans are defined in s 588FD(1) as those for which the interest or charges are extortionate at the time the loan was made, or which have since become so. In determining whether interest or charges are extortionate regard should be had to matters listed in s 588FD(2). Voidable transactions which are unfair loans are recoverable under s 588FE(6). There is no time limitation involved and no defence available: s 588FG(2). In this case, Paulini has loaned money to Parawa. It could be voidable, even though it was repaid last October after 12 months, if it was unfair. It is difficult to judge whether the 22.5 percent interest rate could be considered extortionate and Ray would be advised to seek expert advice. The payment could also be an uncommercial transaction under s 588FB, particularly as it appears to be with a related party. Problem 4 Australian Insolvency Law 2 nd edition Ch10 Answers and Tips Page 7

8 Ray has realised $67,000 from the sales of Parawa s assets. There are no secured creditors left in the business. Ray authorised the payment of $5000 to Parawa s water supplier, Waterfast Pty Ltd (Waterfast) as he needed to irrigate a large lucerne paddock that was almost ready to cut and this was the only way that Waterfast would do business with Parawa. Employees wages at the time of appointment were $26,000 and this included $6000 of wages owed to Richard. Ray has had his remuneration agreed to by a recent creditors meeting at $25,000. There have been auctioneers fees incurred so far of $8000. Unsecured creditors have proved their debts for $383,000 and this includes a debt to the Australian Taxation Office for $201,000. Advise the order of payments. Suggested answer It is the liquidator s duty to determine payments to unsecured creditors in a winding up. All debts and claims proved in a winding up rank equally, and where funds are insufficient to pay them in full, they are paid proportionately: s 555. Some unsecured creditors, however, are given a statutory priority for policy reasons: s 556(1). A liquidator s business expenses are given priority in s 556(1)(a). The amount of $5000 paid out by Ray to Waterfast is a business expense of the liquidation. Employee wages have priority under s 556(1)(e). However, there is a cap placed upon excluded employees who are defined under s 556(2). Richard as Managing Director is an excluded employee and cannot receive the full amount he is owed in wages as a priority due to s 556(1A) and so of his $6000 only $2000 will be a priority. Therefore, $22,000 will have priority. A liquidator s remuneration receives priority. The definition of relevant authority in s 556(2) includes a liquidator. Section 556(2) also defines deferred expenses and these include remuneration or fees paid to a relevant authority. A deferred expense receives a priority as under s 556(1)(de). Auctioneers fees would be expected to be expenses properly incurred by a relevant authority in preserving, realising or getting in property of the company or in carrying on the company s business under s 556(1)(a). The amount of $8000 will have a priority. Unpaid tax liabilities no longer enjoy any special priority although there are other methods of encouraging tax payments such as placing the onus on directors to make company tax payments. The amount of tax owing of $201,000 is an unsecured claim with no priority. Australian Insolvency Law 2 nd edition Ch10 Answers and Tips Page 8

9 Unsecured creditors enjoy no priority and so the balance of provable debt will not be paid in full if there is insufficient money realised from the sale of company assets. Problem 5 Elliott was Parawa s longest serving employee. The company s financial woes have put him at panic stations as he has now lost his job and is concerned about a very large long service leave payment he was expecting next year upon his retirement. What can you advise Elliott? Suggested answer As the company is being wound up it is usual for employment contracts to be terminated. Elliott will be entitled to a statutory priority for his wages (s 556(1)(e)) and for his other entitlements (s 556(1)(f)(g) and (h)), which include long service leave payments. The General Employee Entitlements Redundancy Scheme (GEERS) provides a safety net and means that Elliott can make a claim through Ray, as liquidator, to be paid his entitlement for long service leave. From 2012 this scheme is to be implemented by legislation. Examiner s tips The statutory minimum dictates the type of creditor who can apply for a winding up using the non-compliance of the statutory demand, therefore exams will often give the scenario of an unsecured creditor with a monetary debt which is clearly more than the statutory minimum. The other matter is the time frame for compliance with a statutory demand. This will mean that dates are crucial. It is important to demonstrate that the statutory demand provides a process to facilitate the presumption of insolvency. Of course, there are other ways of showing insolvency as grounds to wind up. Most exams on liquidation will feature a Pt 5.7B voidable transaction. It is important that students go to the exam prepared to answer on unfair preferences, uncommercial transactions, insolvent transactions of preferences or uncommercial transactions and unfair loans. Each of these have different statutory time frames so in addition to understanding the differences students also need to know the time limitations and consequences for non-compliance. Exams on liquidations can involve many different recipients of a dividend that is to be paid by the liquidation as a distribution of assets. Examiners will often give monetary amounts that are owed by different types of creditors and the Australian Insolvency Law 2 nd edition Ch10 Answers and Tips Page 9

10 task will be to show the order or priority that each will be paid. A sound knowledge of s 556 dealing with priority creditors is essential. Also the subrogation provided by s 561 is often a factor as some other party has paid the priority. Australian Insolvency Law 2 nd edition Ch10 Answers and Tips Page 10