Deputy Commissioner of Taxation v Lencal Excavations P/L

CATCHWORDS : Application for order that the winding-up of a company be terminated - Adequacy of evidence of the financial position of the company - Proposal to postpone debts owed to directors in event of later liquidation of company rather than inject funds as to capital - Failure to serve notice of application on ASIC - Service of notice of application on creditors whose debts would not be discharged by application. LEGISLATION CITED : Corporations Act 2001 (Cth) Income Tax Assessment Act 1997 (Cth) Mercy & Sons Pty Ltd v Wanari Pty Ltd (2000) 35 ACSR 70 Re Nature Springs Pty Ltd (in Liquidation) (1994) 13 ACSR 50 Re Data Homes Pty Ltd (1971) 1 NSWLR 338 CASES CITED : Sutherland v Rahm Enterprises Pty Ltd (2003) 21 ACLC 1385 McPherson, The Law of Company Liquidation 4 ed Supreme Court (Corporations) Rules 1999 Deputy Commissioner of Taxation v Sydney Concrete Steel Fixing Pty Ltd (1999) 17 ACLC 972 Deputy Commissioner of Taxation PARTIES : v Lencal Excavations Pty Ltd (in Liquidation) FILE NUMBER(S) : SC 2506/04 COUNSEL : Plaintiff: Korakis Applicant: J Chard (sol) SOLICITORS : Plaintiff: ATO Legal Services Applicant: Paul Bard

IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION

2506/04 DEPUTY COMMISSIONER OF TAXATION v LENCAL EXCAVATIONS PTY LTD JUDGMENT 1 HIS HONOUR: On 17 June 2004 the company was ordered to be wound up on the application of the Deputy Commissioner of Taxation. Mr Steve Nicols was appointed liquidator. This morning the applicant, Leonard Barry Johnston, made an application by interlocutory process for an order under section 482 of the Corporations Act 2001 that the winding up of the company be stayed and terminated (sic). The applicant is one of two shareholders of the company, the other shareholder is Carole Anne Johnston, who has sworn an affidavit in support of the application. 2 The statutory demand which led ultimately to the winding up order was served on the company by posting it on 8 January 2004 to its registered office. The statutory demand claimed the amount of $33,276.94, being a debt then due under the BAS provisions as defined in subsection 995-1 (1) of the Income Tax Assessment Act 1997, as well as administrative penalties and interest. 3 In an affidavit filed on 21 April 2004 in support of the originating processing for winding up, a Mr Glenn Treleaven, an employee of the Taxation Office, has sworn that the debt due and payable is $76,293.11 consisting of the sum of $33,276.94, the subject of the statutory demand of 8 January 2004, together with further debts which it accrued since 8 January. The applicant has given evidence that the winding up order was made by mistake, in that he had overlooked the payment of the debt due to the Deputy Commissioner of Taxation and he did not understand the effect of the court documents served on the company and did not seek an investigation on them. In the present application the applicant refers to a Report as to Affairs which he prepared with the assistance of his accountant, Mr Brian Holliday. The Report as to Affairs was signed by the applicant on 28 July 2004. 4 In summary it says as follows: first, as at 17 June 2004 the company assets which are not specifically charged were said to have consisted of cash at bank, sundry debtors of $98,640, plant and equipment with a written down value of $510 and $822,600. It seems clear from other evidence that a substantial part of the plant and equipment is not owned by the company but is subject to lease agreements or hire purchase agreements between the company and the financiers who are the owners of the plant and equipment. Be that as it may, according to the Report as to Affairs the total assets at estimated realisable values as at the date of winding up total $1,020,071 or according to book value, $707,472. 5 The Report as to Affairs discloses total creditors in the amount of $792,605. These consisted partly of unsecured creditors totalling $390,588.43 and partly what was described as secured creditors in the amount of $402,017. The assets over which the latter group of creditors held securities comprised a substantial part of the plant and equipment that was elsewhere described in the Report as "assets not specifically charged". 6 The total for unsecured creditors of $390,588.43 can in turn be broken into two classes. What have been called third party creditors were, at the date of winding up, owed debts of $217,707.72 which included the debts owed to the Australia Taxation Office. The unsecured creditors also included debts said to be owed to Mr and Mrs Johnston of $172,817.71 after being set off against moneys apparently admitted to be owed by them to the company. According to the Report as to Affairs, on the book value of the company's assets as distinct from their estimated realisable values, there was a deficiency between assets and liabilities but on the estimated realisable values there was a surplus. 7 The secured creditors were described in annexure G of the Report as to Affairs. They consisted of three companies including Westpac Banking Corporation Limited, which was shown to be owed $14,261.42 and to have security over two items of plant and equipment, being a mini excavator and a rock saw. The other two debtors, Orix Australia Corporation and CBFC Limited, who were shown to be owed an amount of $387,776.30 were the owners of various items of excavation equipment and a motor vehicle which were subject to hire purchase agreements with the company. 8 Although Mr Johnston set out in annexure G to the Report as to Affairs his estimated value of the security for various items of equipment, which total $615,000, thereby providing an ample margin between the amounts admittedly owed to the creditors and the security, there is no external confirmation of the value of those assets and I am not persuaded, on the present materials, of the expertise of Mr Johnston to value them. 9 In paragraph 3 of his affidavit sworn 10 August 2004 he says that "In estimating the value of the leased equipment in Annexure G, based upon ...". There appears to be something missing from the paragraph. I understand from the submission made on behalf of the applicant by his solicitor that the applicant's estimates as to value are based upon his many years of experience in the excavation industry. Be that as it may, I do not think that there is any independent confirmation of the value of the security shown in annexure G to the Report as to Affairs. 10 The applicant deposes that he and his wife have borrowed moneys and that they will make a sum available towards the payment of creditors. I understand that they are prepared to do that if the winding up is terminated. The amount to be paid by them through their solicitor's trust account, is $115,073.08. That money would be applied to pay the debt owed to the Australian Taxation Office which now totals $104,000 odd, together with its costs of the winding up proceedings and amounts apparently payable to Mr Holliday. The moneys held by the liquidator in cash will then be more than sufficient to discharge the balance of the unsecured creditors identified in schedule H to the Report as to Affairs as well as to pay the liquidator's costs and expenses, except for the related party debts which the Report as to Affairs shows were owed by the company to Mr and Mrs Johnston at the commencement of the winding up. There would also remain outstanding the debts owed by the company to Westpac, Orix Australia Corporation, and CBFC Limited. In relation to those debts, the evidence is that the instalments of payment of the debts owed to those companies have continued to be paid either by the liquidator or by the applicant or both since the commencement of the winding up. 11 The Deputy Commissioner of Taxation consents to the orders sought by the applicant on the basis of the authority, said to be irrevocable, which has been given by Mr and Mrs Johnston to their solicitor to pay moneys to the Australian Taxation Office upon the court staying and terminating the winding up. For reasons which I will come to, I do not propose to make an order under section 482 today. If, when the matter returns before me, I am persuaded to make such an order, the applicant should consider whether or not the order terminating the winding up should in any event be suspended so that it does not come into effect until after the payments described in the affidavits have been made. But that is something which can be dealt with on the next occasion. 12 Mr Johnston and Mrs Johnston have sworn affidavits in which they offer undertakings to the Court that in the event the Defendant is wound up in the future, neither of them will require a liquidator to make any payments to them with respect to the liabilities owed to them that are identified as related party creditors in a balance sheet set out under paragraph 13 of Mr Johnston's affidavit, until all other unsecured creditors are paid in full. 13 The balance sheet in Mr Johnston's affidavit is a pro-forma balance sheet which Mr Johnston says he believes will reflect the financial position of the company after the order terminating the winding up is made. It shows on that pro-forma balance sheet no creditors other than $297,890.79 which would be owed to Mr and Mrs Johnston. Clearly, that balance sheet is heavily dependent upon the value ascribed to the plant and equipment on which I have already made comments. It also assumes that the debts which would continue to be owed to Westpac, Orix and CBFC have, for the purpose of the balance sheet, been set off against what Mr Johnston contends to be the remaining value of the plant and equipment. 14 The position of the liquidator is that, having regard to the cash injection proposed to be made by the applicant and his wife and having regard to the undertakings proffered by them to defer their date for the payment of ordinary unsecured creditors, he does not oppose the making of orders setting aside the winding up or staying the winding up of the defendant. He has also deposed as follows: "While I have only undertaken very limited investigations into the affairs of the Defendant, I have concentrated on ascertaining creditors of the Defendant. The RATA, which has been reproduced between pages 1 to 15 in Exhibit LBJ1, is essentially correct. I have paid all leasing companies up to date as well as during the course of the Liquidation. The situation of Select Credit Union has been correctly described in the affidavit of Leonard Barry Johnston, a director of the Defendant, dated 6th August 2004." 15 I think there is a number of issues which need to be addressed before any order could be made under section 482 staying or terminating the winding up. The first is that the Court will be concerned to ensure that if the company is permitted to resume trading, its new creditors should not be prejudiced by potentially having to compete in a later winding up with the existing unsecured creditors. On the submissions which have been made to me today, I would not be prepared to act on the basis of the proffered undertakings from Mr and Mrs Johnston. In Mercy & Sons Pty Ltd v Wanari Pty Ltd (2000) 35 ACSR 70, Austin J said at 79: "In considering an application to stay or terminate a court-ordered winding up under s 482, the court has regard to various categories of interests. First, the court considers the interests of creditors, taking into account whether they object to the proposed termination. But even if all the existing creditors agree, the court may take the view that the proposed termination puts at risk the interests of future creditors. For example, the court is likely to be concerned where the proposal preserves the existing debts but defers their payment, particularly if the deferment has no enforceable status: see the remarks of Street J at first instance in Re Data Homes Pty Ltd [1971] 1 NSWLR 338 at 341. Similarly, if the proposal is that the principal shareholder/creditor will pay out all the other creditors and seek recovery of his debt by instalments, the court is unlikely to permit the company to start trading again and thereby incur additional debts, since if the company fails again, recovery by the new creditors may be prejudiced by the existing debt. However, if the principal shareholder/creditor capitalizes his debt, the court may well take a different view: Collins v G Collins & Sons Pty Ltd (1984) 9 ACLR 58. The cases concerning the interests of creditors do not, in my opinion, establish inflexible rules. Specifically, I do not believe that there is any absolute rule that a winding up cannot be terminated as long as one or more debts remains discharged. Instead, the cases identify the range of concerns which the court is likely to have in exercising its discretion when an application is made, and therefore give guidance as to the matters upon which the court will need to be satisfied." 16 In Re Nature Springs Pty Ltd (in Liquidation) (1994) 13 ACSR 50, the position was considered by McLelland CJ in Eq, particularly at pages 51 and 52 where he said: "It is a long established principle that it is contrary to the public interest to terminate the winding up of a company if after the termination the company would remain insolvent in the sense that its liabilities will substantially exceed its assets, even if there is contractual subordination of all existing debts to future debts." at 51.

17 His Honour referred to what was said by Street J (as his Honour then was) in Re Data Homes Pty Ltd (1971) 1 NSWLR 338 and by the Court of Appeal in 1972 at 2 NSWLR 22. Street J raised three questions as to why the Court did not look with favour upon such a proposal. First, how the deferred claims would rank in the statutory administration in the event the company was wound up. Secondly, by whom and how would the deferment be enforceable and thirdly, what would happen if the new owner disregarded the deferment. McLelland CJ in Eq held that though since Re Data Homes was decided the Corporations legislation had been amended to recognise subordinated indebtedness, it did not mean that the approach taken in that case should be changed. 18 A further reason why I should not be inclined to view such a proposal with favour is that such an agreement is inherently able to be varied or discharged by further agreement between the same parties or simply to be ignored. In the present case the undertakings would be offered to the Court, so the question of variation by agreement between the company and the person offering the undertakings might not arise. However, the possibility of the undertakings being ignored or indeed being circumvented by the debts being repaid by the company is a difficulty which remains. A further difficulty is that the undertakings are offered only in relation to a liquidation and not to any other form of insolvent administration. 19 So far as I am aware, the question has been most recently considered by Barrett J in Sutherland v Rahm Enterprises Pty Ltd (2003) 21 ACLC 1385 where his Honour followed the line of authority to which I have referred. 20 Another difficulty with the application proceeding today relates to service. I raised with Mr Chard, solicitor who appeared for the applicant, the proposition which appears in the 4th Edition of McPherson, The Law of Company Liquidation at page 659 and 660, where the learned editor Professor Keay said: "It appears to be necessary to serve notice of the application on all creditors and contributories so far as to give those who wish to oppose the order an opportunity of doing so".

I do not think that there is a rule that all creditors must be served with notice of the application, although in appropriate circumstances it may well be desirable that all or some creditors be served with the application particularly where they have interests which may be adversely affected if the order is made. Where the court is satisfied that creditors will not be adversely affected it may well not be necessary to serve the application on those creditors. 21 The position is now dealt with by the Supreme Court (Corporations) Rules 1999, in particular Rule 2.8(3), which provides that unless the court otherwise orders, if an application under subs 482(1) of the Corporations Act is made, it must be served on the Australian Securities and Investments Commission (ASIC) in reasonable time before the hearing of the application. That has not been done in this case. I do not think the circumstances provide good reason for dispensing with the requirement for service on ASIC. It was submitted that I should dispense with such service because the circumstances were such that it could not be a possible concern of ASIC that the order should be made. It was submitted that there was nothing in the materials to suggest that there has been any improper conduct by the officers of the company and that ASIC could not be concerned if the conduct of the affairs of the company were to pass back to the hands of the directors. That may well be, but it is something which I think the court should be told of by ASIC and is not something which I should assume. That means, in any event, the proceedings will have to stand over for a reasonable time. 22 The next question is whether I should direct service of the application on the three existing creditors who appear to have security and whose debts it is not proposed would be discharged. It seems to me that the only reason for not doing so would be if I could be sure that the order terminating the winding up, if made, would not act to those creditors' prejudice. That may be the position, but it might depend upon the value of the equipment over which they hold security and upon whether the consequence of the company having gone into liquidation is immediately to accelerate the debts. I have not been able to answer the last question in the time available and in any event it is a matter upon which, if it is relevant, the affected creditors should be heard. I do not think that a satisfactory reason for not serving those creditors that the present position of the company, namely its being wound up, be kept a secret from them. Accordingly, I will direct service of the interlocutory process and the supporting affidavits upon the three creditors who I have mentioned. 23 Finally, there is a question as to whether I should be satisfied as to the description of the financial position of the company based upon the evidence of Mr Johnston and the support it has to some extent in the affidavit of the liquidator. In Deputy Commissioner of Taxation v Sydney Concrete Steel Fixing Pty Ltd (1999) 17 ACLC 972 Austin J said 973: "It seems to me that an application which relies only on evidence deposed to by a single director-shareholder without any external confirmation is unlikely to be adequate to persuade a Court to exercise the discretion conferred by 482(1)..."

24 That quotation has particular point in this case where, on his own evidence, the applicant apparently forgot a debt of over $30,000 owed to the Australian Tax Office for over six months and later a debt owed to it of over $40,000. That does not engender confidence in his assessment of the assets and liabilities of the company. To some extent his evidence is corroborated by the liquidator. However, the liquidator says that he has only undertaken very limited investigations into the affairs of the defendant. Before I could act on the liquidator's evidence I would need to know what investigations the liquidator has made so as to understand the basis upon which he has satisfied himself of the accuracy of the Report as to Affairs. 25 There is another possibility which may provide additional support to the liquidator's evidence, namely, for there to be evidence from the external accountant, Mr Holliday, as to the company's financial position. That is a matter which can be no doubt dealt with when the matter is returned before me. 26 For these reasons I decline to make an order today as sought under subsection 482(1) of the Corporations Act. I stand over the proceedings to Wednesday 18 August 2004 at 10 am before me. I direct that by noon tomorrow the applicant serve a copy of the interlocutory process and supporting affidavits upon ASIC in accordance with the Supreme Court (Corporations) Rule 2.8 and I also direct service on the three creditors identified in schedule G to the Report as to Affairs.

[Solicitor addressed] 27 The applicant's solicitor submits that it may be difficult to effect service of all of the documents upon the three creditors. I will direct that notice of the application be given to each of the creditors. I will not fix a time for the giving of that notice or as to the form of it. If, however, on the return date I am not satisfied that the notice is adequate or that the creditor has had sufficient time to consider the matter, then that will be at least a factor which I will take into account in deciding whether to grant the orders. 28 The applicant's solicitor says that at the moment he does not know who the appropriate people are with each of the creditors to whom the notice should be given, and, accordingly, for this reason, I will adhere to what I have just said and not fix a particular time by which the notice should be given. But I do expect the notice to be given in writing. I also direct that the exhibits be returned. I reserve the costs of today.

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