Ace Contractors & Staff Pty Ltd v Westgarth Development Pty Ltd

The evidence initially led before the Court 10 On 9 February 1999 Westgarth gave notice of its intention to appear at the hearing of the winding up application, and of its intention to oppose that application. The grounds of opposition stated are: "(i) The Company is solvent. (ii) The Company has a counterclaim/cross claim which exceeds the amount of the claim." 11 In support of these grounds of opposition, Mr Dominic Follacchio, a director of Westgarth, swore an affidavit dated 22 February 1999 in which he set out a number of salient facts. 12 The respondent is the trustee of a unit trust. It is currently involved in the development of thirty-three townhouses in Westgarth Street, Northcote. That development is taking place in two stages, the first involving seventeen townhouses and the second sixteen townhouses. 13 In about June 1996 Westgarth entered into an agreement with a building company, J.G. King Pty Ltd, to construct the townhouses and to complete associated works, such as roads, kerbs, drainage, sewers, electricity and gas. J.G. King Pty Ltd entered into a sub-contracting agreement with Ace Contractors for the carrying out of those works. A dispute over payments occurred between J.G. King Pty Ltd and Ace Contractors. This culminated in Ace Contractors' stopping work on the project. In October 1997 J.G. King Pty Ltd withdrew entirely from the townhouse development. 14 In November 1997 Westgarth itself entered into an agreement with Ace Contractors with regard to its outstanding account, and also with regard to completion of the associated works. 15 Mr Follacchio claimed that, notwithstanding a payment of $50,000.00 by Westgarth to Ace Contractors, the necessary work did not proceed as it should have. A further agreement was reached between the parties which was evidenced by a letter dated 2 February 1998. That agreement provided that Ace Contractors would re-start construction works immediately, and would complete those works by 28 February 1998. A penalty of $1,500.00 per week, or part thereof, would apply in default. Mr Follacchio contended that notwithstanding this further agreement, the applicant failed to complete the construction work by 28 February 1998. Westgarth therefore refused to make an agreed payment scheduled for 15 March 1998. 16 Mr Follacchio stated that as a result of the applicant's failure to complete the works as scheduled, the entire development was delayed. Individual certificates of title for each townhouse could not be obtained. The replacement builder for J.G. King Pty Ltd, Apollo Homes Pty Ltd, could not proceed with the actual construction of the townhouses until the civil works had been completed. Moreover, the work carried out by Ace Contractors was performed negligently, resulting in considerable loss to the respondent. Mr Follacchio claimed that Westgarth had suffered loss and damage in an amount of approximately $320,000.00. 17 Mr Follacchio said that the respondent had assets which greatly exceeded its liabilities. He produced two sworn valuations, each dated 3 August 1998, which Westgarth had obtained for the purpose of obtaining mortgage finance from a corporate financier, Victorian Securities Corporation Ltd. Those valuations showed that the valuation of Lots 8-25 on completion was $4.3 million, and the valuation of Lots 26-40 on completion was $3.8 million. Mr Follacchio stated that the builder, Apollo Homes Pty Ltd, had informed Westgarth that the anticipated completion date for the first stage of the townhouse development was 12 March 1999, and the anticipated completion dated for the second stage was 2 August 1999. Nearly all of the townhouses had been pre-sold off the plan and settlement of those pre-sales would take place on completion of the first stage. This, Mr Follacchio claimed, would provide the respondent with a substantial cash flow. 18 Mr Follacchio also exhibited to his affidavit of 22 February 1999 a set of draft accounts prepared by Mr Gregory Marino of Banks MBP Pty Ltd, the respondent's accountants. These draft accounts purported to show that, as at 15 February 1999, the respondent had total assets of $8,565,280, total liabilities of $5,927,294.00, and net assets therefore of $2,637,986. Mr Follacchio asserted, in reliance upon those draft accounts, that the respondent was solvent. He stated that it was in a position, if necessary, to pay the applicant's claim as set out in the statutory demand of 21 October 1998. He denied, however, that it was under any obligation to do so because it had a cross claim or counterclaim which exceeded the amount set out in that demand. He also claimed that the dispute between the applicant and the respondent was not one which should be dealt with by a winding up application. He asserted that such an application was an abuse of the process of the Court. 19 On 1 March 1999 Mr Geoffrey Frost, the company accountant, and a director, of Ace Contractors, swore an affidavit in which he set out additional interest said to be owed by Westgarth by reason of the period which had lapsed between 22 October 1998 and 2 March 1999 - a total of $6,528.66. 20 Mr Frost also deposed that Westgarth had applied, on 18 November 1998, to set aside the statutory demand by making application pursuant to s 459G of the Corporations Law. That application was dismissed because it had not been made within the twenty-one day time period provided for in that section. It had been agreed that the respondent would pay $1,000.00 in costs arising out of that unsuccessful application. 21 Finally, Mr Frost stated, the applicant claimed an additional $40,021.50 from the respondent. That sum was said to represent amounts which the respondent had acknowledged to be due and payable in two letters, dated 12 November 1997 and 2 February 1998. These amounts represented the value of work said to have been completed by Ace Contractors after November 1997. 22 Mr Frost disputed Mr Follacchio's contention that the respondent was solvent. He disputed also Mr Follacchio's assertion that there was a genuine off-setting claim capable of extinguishing the debt owed by Westgarth to the applicant. 23 Mr Frost swore a second affidavit on 29 March 1999 in which he updated the claim for interest on the sum sought under the statutory demand. The total now sought in relation to the demand was $120,391.18.

The proceedings before the Court 24 The matter first came before me on 29 March 1999. It was adjourned to enable further affidavit material to be filed. Mr Follacchio swore a second affidavit on 20 April 1999 to which he exhibited an audited balance sheet prepared by Mr Marino for the period ending 31 March 1999. This was in substitution for the unaudited balance sheet previously relied upon in the earlier draft accounts. The audited balance sheet, together with the notes thereto, disclosed total assets of $8,531,058, and total liabilities of $6,703,662 with net assets therefore of $1,827,396. 25 The audit report which was attached to the balance sheet purported to have been prepared in accordance with Australian Auditing Standards. It expressed several qualifications. These included contingent liabilities for interest payable on mortgages, certain payments said to have been made by a company known as Metro Pacific Pty Ltd on behalf of the respondent representing repayments of loan and construction costs, and a contingent liability for construction costs of $2,271,303.08 (being the extent of the undrawn loan facility with Victorian Securities Corporation Ltd). 26 On 22 April 1999 Mr Marino swore an affidavit in which he stated, inter alia: "The Respondent has sufficient assets to meet all its liabilities including the amount of $112,106.04 claimed by the Applicant Ace Contractors & Staff Pty Ltd by way of statutory demand dated 23 October 1998. The Respondent's net assets total $1,827,396.00." 27 Mr Marino also stated that Westgarth had sufficient assets to pay the further amounts claimed by the applicant in the earlier affidavits of Mr Frost. These amounts included interest on the original amount, and the sum of $40,021.50 claimed by Mr Frost to be owing to the applicant for work completed after November 1997. 28 On 24 April 1999 Mr Geoffrey Kelly, a partner in the firm of Greenwood Clarke, Chartered Accountants, swore an affidavit on behalf of the applicant in response to the affidavit and report of Mr Marino. 29 Mr Kelly is a Fellow of the Institute of Chartered Accountants. He has been a registered Liquidator for nine years, and an Official Liquidator of the Supreme Court of Victoria and of the Federal Court of Australia for six years. He has had extensive experience in the investigation of company books and records and in the analysis of accounting entries. He has conducted investigations into the solvency of companies for the purpose of establishing whether they have traded while insolvent and/or whether certain transactions have constituted voidable preferences. 30 Mr Kelly had been asked by the solicitors acting for Ace Contractors to consider and comment upon the audited balance sheet dated 31 March 1999 prepared by Mr Marino. Mr Kelly prepared a report on that audited balance sheet. He expressed the opinion that it was not possible to conclude, on the basis of Mr Marino's financial statements, that as at 31 March 1999 Westgarth was solvent. 31 In substance Mr Kelly's reasons for arriving at that conclusion were: · A balance sheet is nothing more than a statement of the position of a company at a point in time, in this instance 31 March 1999. One could not properly conclude that Westgarth was solvent merely because its assets were said to exceed its liabilities. What was needed, but what had not been provided, was a series of cash flow projections. · He had doubts as to the treatment in the accounts of a sum of $716,300 which had been shown as a current asset, but described as "Deposit Monies held in Trust". No corresponding liability for such an amount was shown in the balance sheet. It ought to have been so shown. · Of the amount of $8,173,751 shown as current assets, $7,351,600 was shown as "Receivables". This resulted from the bringing to account as "Sales" an amount equal to the total of the contracts for the pre-sale of the properties. Such an accounting treatment was not in accordance with Australian Accounting Standard AAS11 on Construction Contracts. As the accounts prepared by Mr Marino were "Special Purpose" accounts, compliance with those standards was not required. Nevertheless, the question was whether the profit brought to account by Mr Marino on the basis described had been earned. Moreover, the recording of profits on contracts was not directly related to the issue of solvency. That involved the capacity to pay debts as and when they fell due, and not the projection of profits. · The costs to complete which were brought to account in determining the profit appeared to have been based on the balance of the available funding. That involved an assumption which was, in Mr Kelly's view, "heroic". The project may have incurred losses to date which would not be recognised by that process. The profit projection derived was a result of this estimation, and not of a proper review of the project's profitability. · The audit report contained several qualifications which were, in Mr Kelly's view, unclear. 32 On 26 April 1999 Mr Frost further updated the amount said to be due and payable by the respondent arising out of the demand. The interest component now took the figure up to $121,175.80. 33 The matter came before me again on 26 April 1999. Because affidavit material had been filed late, I adjourned the proceedings to give the respondent time to have Mr Marino consider Mr Kelly's report, and to comment on it. 34 I also indicated that I would be assisted in my consideration of this matter if both Mr Marino and Mr Kelly were available to give evidence before me. 35 On 4 May 1999 Mr Marino swore an affidavit in response to that of Mr Kelly. It is sufficient for present purposes to say that Mr Marino took issue with a number of points made by Mr Kelly. He noted, in particular, · He had prepared a balance sheet, and not a cash flow statement. He had intended to prepare a cash flow statement, but had not yet received from the directors, who were overseas, the necessary information to enable him to do so. · There was no need to record a corresponding liability in the balance sheet for monies held in trust as deposit. These monies were accounted for in sales. · Even though Australian Accounting Standard AAS11 was not applicable to the respondent (because it was not a reporting entity) he had taken the opportunity of preparing an additional set of financial statements in accordance with that Standard. He had, in those additional financial statements, adopted an accruals rather than costs based approach. These additional statements included a profit and loss statement for the period 1 July 1998 to 31 March 1999, and a balance sheet as at 31 March 1999. They confirmed that the respondent had a substantial excess of assets over liabilities (utilising the accruals method), net assets totalling $841,382.00. · Mr Kelly did not, in Mr Marino's opinion, appear to understand how construction projects worked in practice. The profit and loss statement which Mr Marino had prepared in accordance with AAS11 showed that Westgarth would generate a substantial profit from the completion of the project. · There was no lack of clarity in the qualifications expressed in the earlier audited balance sheet which he had prepared. · Mr Kelly had failed properly to take into account the fact that, as at 31 March 1999, the undrawn balance of the respondent's facility with Victorian Securities Corporation Ltd was $2,271,303.08. That amount had been included as a contingent liability by Mr Marino in the financial statements which he had prepared. If all of the monies (approximately $160,000) claimed by Ace Contractors to be owed by Westgarth had to be paid, Westgarth could draw down on that loan facility to make that payment almost immediately. The respondent was therefore solvent. It could pay all its debts as and when they fell due. 36 Evidence was also tendered before me to demonstrate that settlement of the first stage of the development was scheduled to take place on 14 May 1999. Certificates of occupancy for thirteen of the units were tendered. 37 On 11 May 1999, when the matter came before me again, I heard directly from both Mr Marino and Mr Kelly. It is fair to say that both of these gentlemen adhered to the positions taken in their earlier affidavits. 38 Mr Marino reiterated that, in his opinion, the respondent was able to pay its debts as and when they fell due. It could simply utilise the draw down facility available to it from Victorian Securities Corporation Ltd, the principal financier of the development. 39 Mr Kelly reiterated that, in his opinion, the respondent had not demonstrated by any of the financial statements prepared by Mr Marino that it was solvent. This was so even if it could safely be concluded (which in Mr Kelly's opinion it could not) that the respondent's assets substantially exceeded its liabilities.

The credibility of the experts 40 Having observed both Mr Marino and Mr Kelly give their evidence, and be cross-examined, I have come to the conclusion that Mr Kelly was generally a more impressive witness than was Mr Marino. Mr Kelly has had significantly more experience than has Mr Marino in the field of corporate insolvency. Despite Mr Marino's doubts as to whether Mr Kelly understood how construction projects were funded, Mr Kelly demonstrated a thorough knowledge of these matters. Mr Kelly has also had considerable experience in corporate insolvency arising out of failed construction projects. His opinions were, in my view, expressed in terms which were both clear, and well reasoned. He made concessions where they ought properly to have been made. He was prepared to acknowledge the force of some of the points which Mr Marino had made in criticising his report. 41 Mr Marino, on the other hand, was not an impressive witness. He was reluctant to acknowledge any errors on his part in the preparation of the various accounts, even those which were glaringly obvious. He was unconvincing in some of the answers he gave to questions put to him in cross-examination. He did not appear to me to grasp the import of some of the matters upon which he was questioned. 42 Where the evidence of Mr Marino conflicts with that of Mr Kelly, I prefer to act upon the evidence of Mr Kelly.

The relevant legal principles 43 Westgarth, having failed pursuant to s 459G to set aside the statutory demand served upon it by the applicant, is presumed to be insolvent. In order to avoid an order that it be wound up in insolvency it must either rebut that presumption, and prove that it is solvent, or rely upon the exercise of the discretion of the Court pursuant to s 459A of the Corporations Law to decline to order that it be wound up. 44 The authorities which govern the operation of s 459G of the Corporations Law seem to me to establish the following propositions: · The respondent is presumed to be insolvent and as such bears the onus of proving its solvency: s 459C(2) and (3); Elite Motor Campers Australia v Leisureport Pty Ltd (1996) 22 ACSR 235 per Spender J; Commissioner of Taxation v Simionato Holdings Pty Ltd. (1997) 15 ACLC 477 per Mansfield J. · In order to discharge that onus the Court should ordinarily be presented with the "fullest and best" evidence of the financial position of the respondent: Commonwealth Bank of Australia v Begonia (1993) 11 ACLC 1075 at 1081 per Hayne J. · Unaudited accounts and unverified claims of ownership or valuation are not ordinarily probative of solvency. Nor are 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: Simionato Holdings Pty Ltd (supra); Re Citic Commodity Trading Pty Ltd v JBL Enterprises (WA) Pty Ltd [1998] FCA 232 per Heerey J; Leslie v Howship Holdings Pty Ltd (1997) 15 ACLC 459 at 463 per Sackville J. · There is a distinction between solvency and a surplus of assets. A company may be at the same time insolvent and wealthy. The nature of a company's assets, and its ability to convert those assets into cash within a relatively short time, at least to the extent of meeting all its debts as and when they fall due, must be considered in determining solvency: Rees v Bank of New South Wales (1964) 111 CLR 210; Re Tweeds Garages Ltd [1962] Ch 406 at 410 per Plowman J; Simionato Holdings Pty Ltd (supra); Melbase Corporation Pty Ltd v Segenhoe Ltd (1995) 13 ACLC 823 at 832 per Lindgren J; Leslie v Howship Holdings Pty Ltd (supra) at 465-466. · The adoption of a cash flow test for solvency does not mean that the extent of the company's assets is irrelevant to the inquiry. The credit resources available to the company must also be taken into account: Sandell v Porter (1966) 115 CLR 666 at 671 per Barwick CJ (with whom McTiernan and Windeyer JJ agreed); Leslie v Howship Holdings Pty Ltd (supra) at 466; Taylor v ANZ Banking Group Ltd (1988) 6 ACLC 808 at 812 per McGarvie J. · The question of solvency must be assessed at the date of the hearing. However, this does not mean that future events are to be ignored: Leslie v Howship Holdings Pty Ltd (supra) at 466-467. · It is no abuse of process for an applicant to seek to wind up a company presumed to be insolvent by reason of its failure to comply with a statutory demand merely because that company contends that it is solvent, or because there may be alternative means available to the applicant to vindicate its rights: Elite Motor Campers Australia v Leisureport Pty Ltd (supra).

Has Westgarth succeeded in rebutting the presumption that it is insolvent? 45 Westgarth is presumed to be insolvent unless it proves, to the requisite civil standard, that it is able to pay all its debts as and when they become due and payable. I have concluded, after considering the evidence led before me, that the company has failed to demonstrate that it is relevantly solvent. 46 My reasons for arriving at that conclusion are essentially to be found in my acceptance of the evidence of Mr Kelly in preference to that of Mr Marino. Mr Kelly said in evidence that it would not be possible, in his opinion, to conclude that Westgarth is presently solvent upon the basis of the various accounting records produced by Mr Marino. His reasons for arriving at that conclusion were spelled out in detail in his affidavit of 24 April 1999, and were further elaborated upon in his evidence before me on 11 May 1999. He is an experienced, and obviously competent, accountant, with special expertise in matters of corporate solvency. His evidence was unshaken in cross-examination. I found him to be a persuasive witness, and one whose evidence I should act upon. 47 I am fortified in my view that I should accept Mr Kelly's evidence as to Westgarth having failed to prove its solvency by a number of factors which emerged from the evidence before me. I note, in particular: · Though Westgarth is a trustee company for a unit trust, no trust deed was tendered by the respondent. · No cash flow statement or projections were provided by the respondent notwithstanding the fact that this application to have it wound up had been instituted as far back as December 1998. · The respondent had several opportunities to provide proper accounting records and evidence to support its claim to solvency. It had relied initially upon an unaudited balance sheet, and only later upon an audited balance sheet and profit and loss statement. There were significant deficiencies in each of those sets of accounts. They did not, in any event, establish that the respondent could pay all of its debts as and when they fell due. · Even the final accounts relied upon went no further, when dealing with trade debtors, than 5 March 1999. They did not include debts incurred to 31 March 1999, the date of the balance sheet, or the concluding date of the profit and loss statement. · The respondent's reliance upon its draw down facility with Victorian Securities Corporation Ltd was not supported by any evidence from that company as to its willingness, or ability, to continue to fund the project. No evidence was led of the terms upon which the draw down facility could be utilised, nor whether the amount of the facility would be reduced once there had been settlement of the first stage of the townhouses to be sold. No documents relating to the draw down facility were tendered in evidence. 48 Despite the bald assertions of Mr Follacchio and Mr Marino that Westgarth was solvent, and that it could within a short time rely upon the drawn down facility to meet the debt claimed by the applicant, I am not affirmatively satisfied that this is so. I do not believe that the respondent has placed before the Court the fullest and best evidence of solvency. The presumption of insolvency has not, therefore, been rebutted.

Should the respondent be wound up in insolvency? 49 Even if insolvency is proved, the Court still has a discretion not to order a winding up: s 459A of the Corporations Law; Hamilhall Pty Ltd v AT Phillips Pty Ltd (1994) 54 FCR 173; Re Presha Engineering (Aust) Pty Ltd (1983) 1 ACLC 675 at 676 per Murphy J. 50 There is a general principle that a winding up order will not be made on a debt which is bona fide in dispute, provided that the dispute is based on some substantial grounds: Mibor Investments Pty Ltd v Commonwealth Bank of Australia [1994] 2 VR 290 at 293. 51 It should be remembered, however, that the respondent is unable without the leave of the Court to rely upon the contention that it has a counterclaim or cross-claim which exceeds the amount of the demand. That was a ground which the respondent could have relied upon for the purposes of an application by it for the demand to be set aside, had such an application been made within the requisite period: s 459S(1)(b); Commonwealth Bank of Australia v Begonia (supra) at 1081; Aizen v Essendon Travel (Vic)Pty Ltd (1994) 49 FCR 594 per Olney J. Leave is only to be granted pursuant to s 459S(1) where the Court is satisfied that the ground relied upon is material to proving that the company is solvent: Texel Pty Ltd v Commonwealth Bank of Australia [1994] 2 VR 298 at 299 per Hayne J; Whelpton v Braams Constructions Pty Ltd (1994) 12 ACLC 881 per Tamberlin J. 52 The respondent has not sought to rely upon its alleged cross-claim or counterclaim as the basis for its contention that it is solvent. That claim, which might take many months, or even years, to resolve, does not seem to me to be "material" to proving that the respondent is presently solvent, within the meaning of the term "material" in s 459S(2). The respondent cannot therefore rely on the alleged cross-claim or counterclaim to oppose the application for an order that it be wound up. 53 The matters which I consider to be relevant to the exercise of my discretion to decline to order that the respondent be wound up are as follows: · There was an application made to set aside the statutory demand which was dismissed because it was brought several days late. The respondent did at least make some attempt to challenge the demand: Kekatos v Holmark Construction Company Pty Ltd (1995) 13 ACLC 1581 at 1582 per Young J. · The respondent has failed to persuade me that it is solvent. It is therefore to be treated as being insolvent by reason of the statutory presumption created by s 459C. The evidence, apart from the presumption, does not, however, demonstrate that the respondent is insolvent. The applicant does not contend that the evidence does demonstrate that the respondent is insolvent. Mr Kelly went no further than to say that, in his opinion, the respondent had failed to discharge the onus which rested upon it of proving that it was solvent. Notwithstanding the effect which the Court must give to the presumption, and to the company's failure to discharge the onus of demonstrating actual solvency, Westgarth may, in reality, be solvent. · The amount claimed under the statutory demand is not great when compared with the profit projected from the completion of the entire project: Aizen v Essendon Travel (Vic) Pty Ltd (supra) at 601. · If Westgarth were to be wound up at this time this would put at risk a going concern. The interests of other unsecured creditors might also be adversely affected. The appointment of a liquidator would involve considerable cost and delay. It would, in all likelihood, jeopardise the successful outcome of the entire townhouse development. 54 While I accept that it is not in the public interest that an insolvent company should continue trading, this is not a case where actual, rather than presumed, insolvency, has been found. 55 While as a general rule an applicant is entitled to a winding up order against a company which has failed to comply with a statutory demand it may, in appropriate circumstances, be better for the creditors as a whole to allow the company to trade on rather than have the company wound up. The Court has a duty when considering whether to make an order for the winding up of a company to have regard not only to the interests of the applicant creditor, but to the interests of all creditors, particularly those who are unsecured: Re Presha Engineering (Aust) Pty Ltd (supra) at 677. 56 Counsel for Westgarth submitted that if I found that the company had not discharged the onus which rested upon it of proving that it was solvent I should nonetheless decline to order that the company be wound up at this stage. He submitted that it would be open to me to adjourn the application for a winding up order, upon suitable terms. 57 Counsel for Ace Contractors accepted that it would be open to me to adjourn the present application for a winding up order for an appropriate period, upon suitable terms. He noted that the respondent had maintained throughout that it was in a position to pay the amount claimed by the applicant in its statutory demand and, if necessary, the additional amounts claimed as well, within a comparatively short time, simply by drawing down on the facility which had been made available by Victorian Securities Corporation Ltd. He submitted that if I were to exercise my discretion in favour of the respondent, by not ordering that it be wound up, that proposition should be put to the test. 58 I propose to adjourn this matter for a period of fourteen days, until 15 June 1999. If before that date the respondent has paid to the applicant the sum of $112,106.04 (being the amount said to be due and payable to the applicant pursuant to the statutory demand), the application to have the company wound up will stand dismissed. If, on the other hand, that sum is not paid by that time, I will, on 15 June 1999, entertain an application that I order forthwith that the respondent be wound up. 59 I am not inclined to order the respondent to pay the interest on the demand after the date upon which it was served, the $1,000.00 costs, or the sum of $40,021.50 additionally claimed. These amounts may be the subject of other proceedings, to be brought by the applicant, as may be the cross-claim and counterclaim said by the respondent to be available to it. Those disputes should be sorted out between the parties as they are best advised. 60 The respondent should pay the applicant's costs of this application, including all reserved costs. I certify that the preceding sixty (60) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Weinberg.

Associate: Dated: Counsel for the Applicant: Mr S Minahan

Solicitor for the Applicant: Deacons Graham & James

Dates of Hearing: 29 March 1999, 26 April 1999 & 11 May 1999