Austral Brick Co Pty Ltd v Falgat Constructions Pty Ltd

REASONS FOR JUDGMENT 1 Section 482(1) of the Corporations Act 2001 (Cth) provides that the winding up of a company may be stayed or terminated by the court. For most purposes nothing turns on the difference between a stay and termination, although if there is a stay of a compulsory winding up the order remains undischarged: Austral Brick Co Pty Ltd v Falgat Constructions Pty Ltd (1990) 21 NSWLR 389, 393; McAusland v Commissioner of Taxation (1993) 47 FCR 369, 384. The liquidator of Origin Internet Solutions Pty Ltd applied under the section and on 10 September 2004 I ordered that the company's liquidation be terminated with effect from 22 September 2004. The liquidator's application was opposed by SASI Marketing and Advertising Pty Ltd, a judgment creditor, but I made the order over its objection. However, I granted SASI leave under s 588T to bring an action under s 588M against the directors of the company for recovery of compensation for loss resulting from insolvent trading. This was despite the fact that the liquidator had not consented to the bringing of the action. In each instance, that is on the liquidator's application for termination and SASI's application for leave to commence proceedings, I indicated that I would, in due course, provide my reasons for making the orders. 2 Before stating the principles upon which I based my decisions, I must refer to some facts. The company was established in 1999 and has two shareholders. It conducted business as an internet service provider, but fell into financial difficulty and in 2002 sold its business. In June 2003 the company's sole director (by that time the other directors had resigned from office) put the company into administration and appointed Mr Taylor as administrator. At that point the company had no assets, and its liabilities exceeded $260,000. The administrator carried out an investigation as required by s 438A. He formed the view that it would be in the creditors' interests for the company to be wound up. The creditors agreed and passed a resolution under s 439C to that effect. By operation of ss 446A(2) and (4) the resolution was deemed to be a special resolution that the company be voluntarily wound up and that the administrator be appointed liquidator for the purposes of the winding up. 3 The liquidator conducted an inquiry into the company's affairs. He identified several causes of action which the company could pursue. One was for unfair preferences against a former director in respect of payments totalling $258,774.29 which the former director said "he would vigorously defend". Another was for an uncommercial transaction with a company which was not at arms length. The liquidator was not able to quantify the value of this potential claim but it looks to have been in the vicinity of $200,000. The other company said it would "vigorously defend any recovery action". The final claim was for insolvent trading by the directors in respect of amounts exceeding $300,000. The directors said they would "vigorously defend" this action. 4 The liquidator took no action to pursue any of the claims other than reporting them to creditors. He did not take any action because he had no funds to cover his costs and any costs which might be ordered against him. The company's only assets were two disputed debts. One debt was due by a company which was itself without funds and in the process of being deregistered. The company's creditors, including some who were described as contingent creditors, were owed in excess of $460,000. The liquidator contacted the creditors to see if any of them would fund the claims. No one came forward. This is not surprising. It is always difficult to convince a creditor who has already lost money to risk more for the purpose of minimising his loss. Many would regard such action as a risky gamble. The only criticism I have of the liquidator is that he did not inform the creditors that if they funded the liquidator's claims, they may have received a benefit under s 564. I do not press this criticism too far because I suspect that s 564 would not have been much of an encouragement. Most creditors were owed only small amounts and it may not have been worth their while to risk losing more. There was one large creditor who probably had access to a lawyer who may well have been advised about s 564. 5 While this was going on, the sole director put forward a proposal that the company again be placed into administration so that the creditors might consider whether they would agree to a deed of company arrangement under which the director would contribute, at that stage, $150,000 to be applied first, in payment of costs and expenses of the liquidator and administrator and second, pari passu to all arms length creditors in discharge of their claims. The liquidator regarded this a favourable proposal from the creditors' point of view. So much seems obvious. If it were not adopted the creditors would not receive any dividend out of the liquidation. 6 The liquidator could appoint an administrator under s 436B. He appointed himself pursuant to leave granted under s 436B(2): Taylor, in the matter of Origin Internet Solutions Pty Ltd (in liquidation) [2004] FCA 382. In due course the creditors resolved that the company execute a deed of company arrangement. The deed was made on 14 May 2004. The deed required the director to pay the administrator $195,000 ($45,000 more than the director had initially proposed to contribute) within sixty days of the execution of the deed. If the amount was not paid it would became "a debt due and payable to the Company". According to the deed, after payment of all costs and expenses, the contributed amount was to be divided pari passu between all creditors, other than "Excluded Creditors". The Excluded Creditors were the sole director, a former director and any entity associated or related to the sole director. 7 The deed contained two releases. First, upon being paid their share of the contributed amount, the creditors (other than Excluded Creditors) released their claims against the company. Second, the Excluded Creditors were themselves "released from any claim that might be available to the Administrator in his capacity as liquidator of the Company" including, but not limited to, claims for unfair preferences, uncommercial transactions, and insolvent trading. The deed also contained a provision requiring the administrator to "make application to the Court to terminate the Liquidation of the company". It is for this reason that the liquidator brought the application upon which I made the order terminating the company's liquidation. 8 It seems that both the liquidator and the director believed that the deed (or at least the provisions of the deed pursuant to which the director would contribute $195,000) was conditional upon the termination order being made. Perhaps the creditors who voted for the deed thought the same thing. They were all mistaken. That was not what the deed provided. Nevertheless, there was a problem. The director paid $195,000 to the administrator, but the payment was to be held in escrow until the termination order was made. The administrator accepted the payment on that basis. But a conditional payment did not amount to performance by the director of his obligations under the deed. To the contrary, he had a positive obligation to make the payment and that obligation was not satisfied by a conditional payment or by the payment of an amount to be held in escrow. That the payment had not been made was of little comfort to the administrator who had no funds to bring an action against the director. It was of less comfort to the creditors who again stood to receive nothing from the company. These were the circumstances in which the termination order was sought. 9 The considerations that should be applied in assessing the merits of an application to terminate a winding up are generally those which are applied in bankruptcy law to an application to rescind a sequestration order. On this point reference is usually made to the well known decision of Buckley J in In re Telescriptor Syndicate, Limited [1903] Ch 174, 180-181. The factors that I must consider are as follows. The court will not act simply on the assent of the creditors even though, of course, their assent is important: Krextile Holdings Pty. Ltd. v Widdows [1974] VR 689, 694. The views of members must also be taken into account: In re Calgary and Edmonton Land Co. Ltd. (In Liquidation) [1975] 1 WLR 355, 360. Then it is necessary to consider whether the termination will be conducive or detrimental to commercial morality and to the interest of the public at large: In re Golden Butterfly Gold Mining Company (No Liability) [1916] SALR 177, 178-179; In re Trix Ltd [1970] 1 WLR 1421, 1423-1424; Re Skay Fashions Pty Ltd (in liq) (1986) 10 ACLR 743, 746; McAusland v Commissioner of Taxation (1993) 47 FCR 369, 373-374, 383-384. 10 The usual reasons for granting a stay or termination of a liquidation were not present in this case. It was not proposed that the company continue to trade for the benefit of its shareholders: In re South Barrule Slate Quarry Company (1869) 8 LR Eq 688; Re Filshie Broadfood & Co. Ltd. [1913] QWN 46. The termination was not required as part of the scheme of arrangement (In re Stephen Walters & Sons, Ltd. [1926] WN 236) although it mistakenly believed that it was. Nor was it part of a reconstruction as in Re The Steamship "Titian" Company Limited (1888) 58 LT 178. Here the termination was sought to ensure that the deed of company arrangement was given effect, not in law but in fact. Ordinarily this would be an insufficient reason to make the order, especially when the director was required to hand over $195,000 unconditionally. However, my concern was that unless I made the order the administrator would not take any steps to recover the debt because he had no money to spend on litigation and he was under no obligation to spend his own money. I feared that if I did nothing the creditors would lose out completely. In the end I was not prepared to stand in the creditors' way if I was satisfied that there was no public policy reason why the order should not be made. 11 On this point I required the liquidator to provide me with a report as regards whether his investigations suggested that any officer of the company had breached his duties or had contravened any provision of the Corporations Act which should be further investigated or prosecuted. The liquidator filed an affidavit in which he said that although his investigations indicated that offences may have been committed, "the circumstances were such that proof of those offences would … be difficult and did not warrant further investigation or action". The liquidator lodged a report to that effect with ASIC under s 533. He subsequently received a letter stating that ASIC did not propose to commence any investigation. On that basis I made the order he sought. I wish to make it clear, however, that I regarded this as an exceptional case and, but for the prejudice which would be suffered by the creditors if the liquidation were not terminated, I would not have interfered. 12 This brings me to SASI's application. I should mention that I approached the application on the basis that provided SASI could show a good arguable case against the directors and there were no countervailing reasons to refuse relief, I would grant it leave to bring the action. SASI claims to be owed several debts which were incurred while the company was insolvent. It wanted to bring an action for loss and damage under s 558M based on the directors' breach of s 588G. To bring the action SASI required either the consent of the liquidator (s 588R) or the leave of the court (s 588T). The liquidator would not give his consent because he thought that the act of giving consent might itself breach the deed of company arrangement. In addition, the liquidator believed that the deed had extinguished SASI's claim. 13 The liquidator was wrong on the first point and may be wrong on the second, although it is unnecessary for me to express any final view on that issue. The deed of company arrangement will certainly result in the company being released from SASI's claim on payment to it of its share of the contributed amount. On the other hand, the deed does not expressly release SASI's claims against the directors. Perhaps the release of the principal debt would operate to discharge the derivative claim, but I doubt this to be so. Even if the deed contained an express provision releasing the claim against the directors (here I do not have in mind a covenant not to sue for which different considerations would apply), such a provision may not be binding. This is because the effect of s 444D(1) is to bind creditors to the terms of a deed "so far as concerns claims [against the company]". It would require a very broad meaning to be given to the phrase "so far as concerned" to cover derivative claims, such as claims against directors for insolvent trading. Perhaps the genie that hides in the magic of s 447A(1) could be called in aid. While nowadays that section seems to know no bounds, extending the operation of s 444D to permit a deed to bind creditors in their capacity as creditors of third parties may be going too far. Be that as it may, the only issue that concerned me was whether SASI's claim against the directors was released. Arguably it was not. 14 There were a number of other problems which confronted SASI's application. As the application proceeded, they were identified and then overcome. The first problem was whether SASI had a claim in debt against the company. The insolvent trading provisions are only concerned with the improper incurring of a "debt". The difficulty arose because at one point it seemed that SASI's claim was for a contribution from a joint venturer. SASI said that it and the company were in a joint venture arrangement and its claim was against the company in its capacity as a joint venturer. Such an action would not be in debt but for the taking of accounts or for an account of profits, both actions in equity. However, SASI filed further affidavits which revealed that its claims were indeed for debts incurred for marketing and advertising services which were provided to the company. That was sufficient for my purposes. 15 The second problem concerned the termination of the company's liquidation. SASI's opposition to the liquidator's application was based on the premise that SASI could not commence an action under s 588M unless the company was in the process of being wound up. It referred to the elements of the cause of action in s 588M; subparagraph (1)(d) provides that one element is that "the company is being wound up". I accommodated both SASI's concern about its cause of action and the liquidator's desire to terminate the winding up by providing that the termination order was not to take effect until 22 September 2004, which then enabled SASI to commence its action before the termination took effect. Section 482(1) permitted an order along those lines. During submissions passing reference was made to the possibility that SASI may also need to establish that the company was being wound up at the time it sought judgment, if it established the other elements of its claim. The parties (here I should mention that the directors had been given notice of SASI's application and appeared through counsel) acknowledged that if this were necessary SASI could apply to have the termination order vacated. The termination order provides for that eventuality. 16 This brings me to SASI's third problem. One element of the cause of action under s 588M is that the company was insolvent when the debt was incurred and that the director who is being sued knew or ought to have known of the company's insolvency. SASI could establish a prime facie case of insolvency as at October 2001; in that month the directors met and considered whether the company should be placed into administration on the ground of insolvency. I infer from this meeting that the company was, or was likely to be, insolvent. I do not know precisely when the meeting took place, so I proceeded on the basis that it occurred in the middle of the month. SASI did not produce evidence to show that the company had been insolvent before that point. It seemed to me reasonable to infer that the company was in financial difficulties well before October. I was prepared to go so far as to assume that the company was insolvent as at mid August. Consequently, I limited SASI's claim to any debts incurred between 15 August 2001 and 14 February 2002. Moreover, as I was still concerned about the lack of evidence on this aspect of the case, I imposed as a condition of leave being granted, that SASI verify by affidavit the statement of claim in any action that it brought against the directors. I took this course rather than require SASI to tender further evidence because SASI's claim is for a small sum, and if I had prolonged the application, the cost of obtaining leave would have become prohibitive. I certify that the preceding sixteen (16) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Finkelstein.