Greig & Anor v Commissioner of Taxation & Anor

PROCEDURE - SUPREME COURT PROCEDURE - QUEENSLAND - PROCEDURE UNDER RULES OF COURT - SUMMARY JUDGMENT - where plaintiffs are the liquidators of Allens Services Ltd - where plaintiffs seek summary judgment against defendant for the recovery of payments as voidable transactions - where first, second and fourth third parties were directors of the company against whom defendant claims a statutory indemnity in respect of part of the judgment sought - where defendant has consented to judgment for part of the claim and does not oppose judgment for the balance of the claim - whether there should be judgment for the plaintiffs against the defendant - where if plaintiffs succeed with their application against defendant, defendant brings an application for summary judgment against the third parties

CORPORATIONS - WINDING UP - CONDUCT AND INCIDENTS OF WINDING UP - EFFECT OF WINDING UP ON OTHER TRANSACTIONS - PREFERENCES - GENERALLY - where payments made to defendant within 6 months of the relation back day for the company - where plaintiffs contend each payment is a voidable transaction within the meaning of s 588FE of the Corporations Act 2001 (Cth) and the court may order repayment under s 588FF - where if plaintiffs succeed in obtaining their order against the defendant, defendant relies on s 588FGA which provides that the third parties are liable to indemnify defendant for any loss resulting from that order - where third parties have pleaded defences under s 588FGB to defendant's claims against them - where third parties contend that at the time the payments were made the company was solvent - where third parties submit they had reasonable grounds to expect and did expect the company was solvent at the relevant times and would remain solvent if the payments were made - whether company was solvent at the relevant times and whether third parties had reasonable grounds to expect and did expect that company was solvent at the relevant times and would remain solvent if the payments were made - whether third parties have any real prospect of defending defendant's claim against them - whether defendant should have summary judgment against third parties

Corporations Act 2001 (Cth), s 95A, s 588FA, s 588FC(a)(i), s 588FE, s 588FF(1)(a), s 588FGA, s 588FGB

Taxation Administration Act 1953 (Cth), Sub-div 16-B, Part

Uniform Civil Procedure Rules 1999 (Qld), r 292

Australian Securities and Investment Commission v Plymin [2003] VSC 123; (2003) 46 ASCR 126, cited

Carrier Air Conditioning Pty Ltd v Kurda & Ors (1993) 11 ACSR 247, referred to

Commissioner of Taxation v Sims & Anor [2008] NSWCA 298; (2008) 72 NSWLR 716, cited

Cooper v Commissioner of Taxation [2009] NSWSC 880, cited

Emmanuel Management Pty Ltd v Fosters Brewing Group [2003] QSC 205, cited

Iso Lilodw' Aliphumeleli Pty Ltd v Commissioner of Taxation (2002) 42 ACSR 201, referred to

Melbase Corporation Pty Ltd v Segenhoe Ltd [1995] FCA 1225; 17 ACSR 187, cited

Noxequin Pty Ltd v DCT [2007] NSWSC 87, cited

Powell v Fryer, Tonkin & Perry [2000] SASC 97; (2000) 18 ACLC 480, cited

Sandell v Porter (1966) 115 CLR 666, referred to

Southern Cross Interiors Pty Ltd (In Liq) v Deputy Commissioner of Taxation (2001) 53 NSWLR 13, 224, cited

Sims v Deputy Commissioner of Taxation [2007] NSWSC 998, referred to

M D Martin for the first, second and fourth third parties.

Legal Services Branch, Australian Taxation Office for the defendant.

ClarkeKann for the first, second and fourth third parties.

[1] MARGARET WILSON J: The plaintiffs were appointed voluntary administrators of Allens Services Limited on 13 May 2003. On 4 July 2003 the company's creditors resolved that it be wound up, and the plaintiffs were appointed as its liquidators. In this proceeding they seek to recover payments made by the company to the defendant (the Commissioner of Taxation) on the basis they were voidable preferential payments. The defendant seeks indemnity from the first, second and fourth third parties (directors of the company) against any amount he is ordered to pay the plaintiffs.

[2] The proceeding was commenced on 12 May 2006. On 5 December 2008 the defendant joined five former directors of the company as third parties. He discontinued his claims against the third and fifth third parties on 23 February 2010 and 17 February 2010 respectively.

[3] On 30 September 2009 the proceeding was entered on the Commercial List. The third parties were given leave to defend the plaintiffs' claim against the defendant, directions were given for disclosure and the filing and serving of experts' reports, and an application by the plaintiffs against the defendant for summary judgment was listed for hearing on 9 March 2010.

[4] In the event two applications for summary judgment were filed and made returnable on 9 March 2010:

(a) application by the plaintiffs against the defendant filed 9 February 2010;

(b) application by the defendant against the first, second and fourth third parties filed 24 February 2010.

[5] By an application filed on 5 March 2010 and made returnable on 9 March 2010, the first, second and fourth third parties sought leave to issue Fourth Party Notices against those previously joined as third and fifth third parties and adjournment of the defendant's summary judgment application against them to a date to be fixed. At the commencement of the hearing on 9 March 2010 that application was dismissed.

[6] Rule 292 of the Uniform Civil Procedure Rules (Qld) provides:

(1) A plaintiff may, at any time after a defendant files a notice of intention to defend, apply to the court under this part for judgment against the defendant.

(a) the defendant has no real prospect of successfully defending all or a part of the plaintiff's claim; and

(b) there is no need for a trial of the claim or the part of the claim;

the court may give judgment for the plaintiff against the defendant for all or the part of the plaintiff's claim and may make any other order the court considers appropriate."

Defendant did not oppose the application against it

[7] In its Further Amended Claim and Further Amended Statement of Claim filed on 27 October 2008 the plaintiffs claimed against the defendant:

Fuel rebates between 08.01.03 and 30.04.03 $ 781,003.04

The plaintiffs sought payment of that amount pursuant to s 588FF(1)(a) of the Corporations Act 2001 (Cth) together with interest pursuant to s 47 of the Supreme Court Act 1995 (Qld) and costs.

[8] In their application for summary judgment against the defendant the plaintiffs sought only $3,067,694.71 (plus interest) of the amount claimed in the Further Amended Statement of Claim.

[9] The defendant sought indemnity from the first, second and fourth third parties against only $2,304,310.53 (plus interest) of the amount claimed against him,[1] being payments applied to Pay-As-You-Go ("PAYG") withholding liabilities of the company under Sub-division 16-B of Part 2-5 in Schedule 1 of the Taxation Administration Act 1953 (Cth).

[10] At the commencement of the hearing on 9 March 2010 the defendant consented to judgment against him for that part of the amount claimed in the summary judgment application against which he did not seek indemnity - namely, $763,384.18 together with interest fixed in the amount of $20,000.[2]

[11] Thus, the amount in contest was $2,304,310.53 plus interest.

[12] The defendant did not oppose the application for summary judgment for the amount in contest.

[13] The third parties had been given leave to defend the plaintiffs' claim.[3] Although they had not filed a defence to the plaintiffs' claim, they nevertheless opposed it by their affidavit material and the submissions of their counsel. Their defence to it may be summarised in this way: while they did not take any issue about the making of the payments, their preferential effect or their being voidable if the company was insolvent when they were made, they disputed the allegation that the company was insolvent at all material times.

[14] The defendant's claim for indemnity was based on s 588FGA of the Corporations Act. In their defence to it the third parties relied on s 588FGB - that when the payments were made they had reasonable grounds to expect, and did expect, that the company was solvent and that it would remain so if the payments were made.

(a) on the plaintiffs' summary judgment application against the defendant - the company's actual insolvency when the payments were made; and

(b) on the defendant's summary judgment against the first, second and fourth third parties - the third parties' expectation that the company was solvent when the payments were made and that it would remain so.

[16] By s 588FE of the Corporations Act, if a company is being wound up, a transaction is voidable if it is an "insolvent transaction" entered into during the six months ending on the "relation-back day".[4]

[17] In the present case the relation-back day was 13 May 2003, and all of the payments in question were made within the 6 months ending on that date.

[18] Section 95A of the Corporations Act[5] provides:

(1) A person is solvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable.

In Sandell v Porter[6] the High Court considered the meaning of insolvency under the Bankruptcy Act 1924. Barwick CJ (with whom the other members of the Court agreed) said:

"Insolvency is expressed in s. 95 as an inability to pay debts as they fall due out of the debtor's own money. But the debtor's own moneys are not limited to his cash resources immediately available. They extend to moneys which he can procure by realization by sale or by mortgage or pledge of his assets within a relatively short time - relative to the nature and amount of the debts and to the circumstances, including the nature of the business, of the debtor. The conclusion of insolvency ought to be clear from a consideration of the debtor's financial position in its entirety and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity. It is the debtor's inability, utilizing such cash resources as he has or can command through the use of his assets, to meet his debts as they fall due which indicates insolvency."[7]

[19] A transaction is an insolvent transaction if it is an unfair preference[8] given by the company when it is insolvent.[9]

"Courts may make orders about voidable transactions

(1) Where, on the application of a company's liquidator, a court is satisfied that a transaction of the company is voidable because of section 588FE, the court may make one or more of the following orders:

(a) an order directing a person to pay to the company an amount equal to some or all of the money that the company has paid under the transaction"

[21] The company was incorporated on 20 March 2000. Business Management Limited ("BML") and Quadrant Capital Fund ("Quadrant") provided $10 million of capital through convertible notes, and the company acquired various businesses that had been under the control of John Henry Allen (the third third party) and Lorna Allen. These included an equipment hire business servicing the mining industry.

[22] In 2002 the company experienced declining sales and associated tight liquidity. As at 16 September 2002 its current liabilities were $6 million. As at 30 September 2002 there were "long outstanding current liabilities" of $4.968 million.

[23] An 11 point restructure plan designed to resolve the company's cash flow position was tabled and discussed at board meetings in September and October 2002. It included the sale of some under-utilised plant, an injection of a further $2 million by shareholders and obtaining a moratorium on payments due to certain creditors. At the October meeting the board resolved to proceed with the auction of plant to raise a minimum of $3.6 million, being the difference between the expected net revenue of $6.8 million and finance debt of $3.2 million. The directors discussed the action needed to ensure the company achieved a profit of $300,000 per month - equivalent to a cash flow surplus of $100,000 per month. They rejected the restructure budget that contemplated a $200,000 cash flow deficit per month and directed management to present a new budget generating a positive cash flow.

[24] A new budget was prepared for the period October 2002 to June 2003. It provided for net profits (before tax) in every month except January 2003 (when there was provision for a small loss on account of holidays).

[25] On 14 November 2002 the company's chief executive, John Atwell, sent a memorandum to the board in which he said the company was struggling to maintain contracts at only one month overdue, but that it had avoided any repossession action. The auction of plant was to occur in late November; this was now expected to raise in excess of $4.5 million, which was proposed to be applied towards liabilities to some creditors, namely:

The auction was conducted on 27 November 2002. The actual proceeds (after discharge of the finance debt) were only $1.48 million.

[26] In a further memorandum of 14 November 2002 Mr Atwell reported an increase in the debt factoring agreement with Scottish Pacific Business Finance ("SPBF") from $6 million to $8 million.

[27] The next day Mr Atwell reported to the board that cash flow was extremely tight with many suppliers stopping credit and threatening legal action, and that several statutory demands and summonses totalling over $75,000 had been received. He referred to "the Croesus at Kalgoorlie": the stockpile was increasing and the company could not charge the other party to the contract for unprocessed material in the stockpile. An attempt was being made to negotiate a basis for invoicing against the stockpile: if it were fully invoiced a further $900,000 would be available. There is no evidence that negotiations for invoicing against the stockpile were ever fruitful.

[28] The minutes of the board meeting held on 21 November 2002 record that the National Australia Bank had informed management that the overdraft would now be restricted to payroll transactions only: all other payments would be transacted only if there were sufficient cleared funds in the account. There was reference to the possibility of a claim by the company against Hitachi for approximately $1 million. (By late February 2003 the size of the potential claim was adjusted down to $200,000 to $300,000, and there is no evidence of a successful claim ever being made.) Key performance indicators for October showed a lack of cash to support operations, which was affecting both the payment of creditors and revenue. Financial results for the four months to October tabled by management showed a loss for October of more than $360,000. (The restructure budget had projected a profit of $364,740 for October.) After discussion, the directors rejected the October financial results.

[29] The first payment particularised in the Further Amended Statement of Claim ($20,707) was made on or about 21 November 2002, but the first payment relied on in the summary judgment applications was that made on 6 December 2002 ($200,000).

[30] The next board meeting took place on 5 December 2002. Management presented projected cash flows to 30 June 2003 which showed an accumulative positive cash flow of in excess of $351,000. Major assumptions on which the cash flows were based included the Croesus stockpile generating $600,000 in chargeable revenue by 31 December 2002, the auction generating $1.9 million, financiers agreeing to rewrite contracts to cover $841,000 in arrears and BML and Quadrant agreeing to defer interest payments to 30 June 2003. After discussion, the board agreed that the projected cash flows were too vulnerable and that a cash injection of $1.5 million was necessary. In the course of the discussion, Mr Falk (the fourth third party) expressed concern as to the solvency of the company, saying he was not prepared to sign the annual accounts or a solvency statement, and offering to resign if the remaining directors disagreed. (In fact he ceased to be a director in March 2003.) The company's chief financial officer, Graeme MacKenzie, mentioned that in his review of the financial results to 31 October 2002, the July result was overstated by $230,000.

[31] By 19 December 2002 BML had agreed to provide a convertible note facility of $750,000 on condition that the Allen family inject $750,000. A few days later Quadrant agreed to defer interest due and payable and to extend the term of its convertible note, subject to settlement of the additional funding of $1.5 million from BML and the Allen family.

[32] In an email to Mr Atwell dated 23 December 2002 Dr Coldham-Fussell (the first third party) referred to Mr MacKenzie's having said, "I cannot see how we can meet our immediate creditor commitments." The email was copied to other board members

[33] The board met on 24 December 2002. Figures tabled by management showed that as at 23 December 2002 the company owed $6.4 million to creditors: of that $1.2 million was owing for more than 90 days and $1.9 million for more than 120 days. The size of the potential claim against Hitachi was revised down to $200,000 to $300,000. The directors resolved that they believed that the company was a going concern and that it had the ability to pay its debts as and when they fell due. They approved the financial statements as at 30 July 2002. They resolved that they expected the company to generate sufficient profits in the future.

[34] In a memorandum to the board dated 23 January 2003 Mr MacKenzie reported that the loss for the six months to December was $272,150 with a loss for December of $415,000. (The restructure budget had forecast a small profit for December of almost $46,000.) He forecast trading losses of $250,000 per month unless sales rose in coming months. He reported on the auction results: actual proceeds of $1.48 million.

[35] In another memorandum to the board of the same date Mr MacKenzie reported on summonses and letters of demand received. Some had been paid to avoid further action, the largest outstanding claim being Hitachi's for in excess of $183,000. Several large creditors were "on payment plans": if the company failed to meet the payment dates, summonses would be issued. Major creditors such as Caltex, which was owed in excess of $200,000, had not issued proceedings.

[36] There was a board meeting on 24 January 2003. Mr Allen's resignation as chief executive was noted. Mr Falk (the fourth third party) expressed concern that directors' fees had not been paid. Brokers had been retained to find potential buyers for the company. Dr Coldham-Fussell, Mrs Allen and Mr Blizzard (the second third party) were authorised to enter into discussions with MacMahons Limited which had expressed interest in the company. (Nothing came of those discussions.) Mr MacKenzie presented the financial results showing the loss for the six months to December as $272,150. All finance companies had agreed to defer payments for two months, one of them agreeing to a three month deferral.

[37] In a memorandum to the board of 17 February 2003 Mr MacKenzie said:

"The cash position of the company has reached a critical point where it is now becoming increasingly difficult to meet creditors' demands. Their impatience is growing as we fail to meet commitments.

I have determined the total overdue creditors who require immediate payment is $4.847m as at 31 January 03...

The total funds available from debtors' collections and sales as at 6 February is $2.489m..... This figure is calculated after allowing for debtor funding already received, outstanding slow paying debtors and sale of the Croesus stock pile...

Rod Allen is also negotiating sale of some equipment.

With these initiatives in place the cash shortfall is still $1.48m. This figure is very much dependent the speedy resolution of the stockpile and debtors collections and understates the true cash position.

The difficulty we face is the immediate requirement for cash and the fact that creditors are now calling payment on November accounts and in some instances full settlement of the account. This situation has become more difficult with January sales down to $3.24m against a budget of $3.67m. If the drop in sales against budget continues into February then our cash position will deteriorate further.

[38] Six days later Mr MacKenzie wrote to the board that the loss for January was $861,300,00. (The restructure budget had projected a loss for January of $41,185.) January sales had been $3.06 million compared to projected sales of $3.71 million. Many creditors were refusing supply or giving limited supply until their accounts were paid. Cash issues were affecting sales performance. The company was having difficulty meeting weekly payroll and tax obligations. He considered that sales in the coming months would fall short of previous projections and that a $500,000 reduction in sales was realistic. He concluded:

"Under these assumptions, March through to May will be cash flow negative with March peaking at $1.5m. Obviously this is not possible and creditors will not get paid. This position is not sustainable as creditors continue to take legal action to collect outstanding debt. To my mind the company is insolvent and cannot continue without a sale to MacMahons."

[39] The board met the next day (24 February 2003). Mr MacKenzie presented the February to December cash flow, which was discussed at length. The directors identified certain errors and omissions making it inaccurate and directed Mr MacKenzie to represent it.

[40] By email of 7 March 2003 Mr MacKenzie sent board members a revised cash flow. The projections were for a positive cash flow in March but negative cash flows in April, May and June. He pointed out that:

(a) sales projections would have to be achieved to support the payments profile. Sales in January and February had averaged $3 million, well below original targets;

(b) due to the low level of sales in January and February, amounts owing to long standing creditors had not been reduced significantly;

(c) the company was continuing to sell equipment to provide cash;

(d) a creditor was requiring settlement on equipment worth $750,000;

(e) the security deposit held by a financier had been reduced to $400,000.

[41] Mr MacKenzie resigned on 11 March 2003. In a memorandum he sent to the board that day he doubted that sales projections for March to June would be achieved. Profit projections were dependent on sales being achieved and projected cost savings being crystallised. He was not confident the savings would occur.

"The major hurdle for the company to overcome is the disparity between debtors and creditors.

Excluding outstanding commitments to the ATO and convertible note interest, creditors of all other categories total $6.79m as at 28 February. Debtors were $8.36m of which $4.1m was funded and the money spent. The difference, $4.26m consists of, unfunded debtors, late February sales funded in March and the 15% balance of cash outstanding when debtors receipts are paid. (NB 85% advancing ratio). Therefore the net funds collectable from debtors, after allowing for KSM, is only $3.26m.

The gap between creditors and debtors, $3.53m (6.79 - 3.26) can only be funded from future cash flows, asset sales and the convertible note injection. Trade creditors dating back to November and prior total $2.845m and there is an urgent need for cash to satisfy their demands.

In summary these are the major issues to consider when assessing the cash flow. There is an immediate need for cash to restore confidence in creditors and open supply on stopped accounts. Sales targets are vital to cash performance and if not achieved will increase the disparity between debtors and creditors. You need to consider if the profit projections are realistically achievable and the resulting cash flows are sufficient to satisfy the creditors' demands."

[42] Mr Falk (the fourth third party) resigned from the board on 11 March 2003.

[43] The board met on 18 March 2003. Mr MacKenzie's memoranda of 7 and 11 March 2003 were tabled. Cash flow and profit forecasts were considered in detail, the directors noting the effect on the projections of the injection of the $1.5 million in convertible notes, the need to collect debtors not funded by SPBF, targets set to reduce overdue debts in the creditors ledger, the assumption that overdue directors' fees and employee and director superannuation payments would be caught up by March and May respectively, the inclusion of cost savings in the projections, the need to look at plant disposals where plant was earning income, and that unsecured noteholders had agreed to defer certain interest payments. The cash flow forecast showed positive results over the next 12 month period and the profit and loss forecast showed the ability to achieve positive net profit after tax. The board resolved to adopt the cash flow and profit forecasts as the company's operating plan for the next 12 months, subject to regular review.

[44] The next board meeting was on 17 April 2003. MacMahon Contractors had advised the brokers retained by the company that they had no interest in acquiring the company, or its shareholdings and noteholdings. A new chief executive had been appointed - Ashley Fraser. He expressed an opinion, based not on an analysis of the company's business but rather on "instinct and general business perceptions", that the company could trade out of its difficulties and put forward a list of initiatives. He tabled profit and loss statements showing a loss of $536,000 for February and $681,000 for March - even greater losses than Mr MacKenzie had forecast. There had been a continuing decline in sales revenues. Cash flow targets had not been achieved.

[45] According to Dr Coldham-Fussell he had discussions with Mr Blizzard (the second third party) about a proposal by Quadrant to inject a further $2.5 million capital into the company. Although he does not say when these discussions occurred, it seems from the sequence of his affidavit that it was some time before the February board meeting. He says that Mr Blizzard told him Quadrant would provide further money after receiving revised financial budgets and accounts from the company. It was agreed that if Quadrant invested $2.5 million, the Allens and BML would inject a further $250,000 each. Quadrant was an existing financier and in December 2002 it had agreed to defer interest payments on condition that other funding came from related entities - which it did.

[46] Quadrant retained Deloitte Touche Tohmatsu to conduct a business review before deciding whether to invest. Deloitte issued a draft discussion document in May 2003, which was unfavourable. In their opinion the company was suffering from a chronic short term cash crisis and worsening liquidity. It was under high pressure from all its creditors, including the ATO. It could not service additional debt in the short term. All key suppliers were on COD or had stopped supply. Plant and equipment financiers were in arrears and some were threatening repossession. The business was unable to operate on a normal basis.

[47] When Quadrant declined to advance the money, voluntary administrators were appointed.

[48] Insolvency is a question of fact to be ascertained from a consideration of the company's financial position taken as a whole.[10] Generally a cash flow test is applied,[11] although the state of a company's balance sheet is still relevant.[12] Counsel for the plaintiffs submitted that applying such a test to the uncontested facts in the instant case, the company was plainly insolvent when each of the payments was made.

[49] The plaintiffs relied on the solvency report prepared by Mr Greig of Deloitte (one of the plaintiff liquidators) dated 24 December 2009. According to Mr Greig:

(a) The company made substantial losses and had a substantial deficiency of net assets during the entire period in question. Although a restructuring plan to reduce costs and make the company profitable was approved in October 2002, the execution of the plan was dependent on a number of factors, including a successful auction of part of the company's equipment in late November 2002. The auction yielded a disappointing result. The plan failed in that the company did not return to positive cash flow before the plaintiffs were appointed administrators. Its position substantially worsened, partly because of declining revenues;

(b) Part of the restructuring involved the provision of debt capital by two shareholders totalling $1.5 million by way of convertible notes. The funding was insufficient to arrest the company's loss making. Attempts to obtain third party finance, sell the business or raise additional capital were unsuccessful. Indeed it was an unsuccessful attempt to raise additional capital which seems to have prompted the appointment of the plaintiffs as administrators;

(c) The company had an endemic cash shortage. There were difficulties collecting debtors. Some creditors were deferred. Many were simply not paid despite being well overdue. The company received many formal demands and was the subject of recovery proceedings by several creditors. Many creditors withdrew credit and the company's bank refused to permit its overdraft to be used for other than payroll transactions.

[50] Relying on the evidence of Dr Coldham-Fussell,[13] counsel for the third parties submitted that the plaintiffs had not shown that there was no real prospect of their defending the plaintiffs' claim and that there was no need for a trial of the insolvency issue - in other words, that the plaintiffs had not satisfied the test for summary judgment.[14]

[51] Dr Coldham-Fussell opined that the company was not insolvent when the payments were made. Of course, as Barwick CJ observed in Sandell v Porter[15] insolvency is a question for the Court:

"Whether that state of affairs has arrived is a question for the Court and not one as to which expert evidence may be given in terms though no doubt experts may speak as to the likelihood of any of the debtor's assets or capacities yielding ready cash in sufficient time to meet the debts as they fall due."

[52] Dr Coldham-Fussell challenged many of the points made by Mr Greig in his report:

(a) Mr Greig observed that the "value of plant and equipment was likely to have been significantly overstated as at November 2002".[16] Dr Coldham-Fussell said this was incorrect because Mr Greig had failed to acknowledge that the value of a company's plant and equipment as a going concern is significantly greater than it is in liquidation.

(b) Mr Greig considered that the company should have reviewed the carrying value of its plant and equipment in November 2002 in light of the auction results.[17] However Dr Coldham-Fussell contended that the company made a provision of $6.917 million for the diminution in value in its 30 June 2002 annual accounts which were completed and signed off on 24 December 2002. Counsel for the third parties submitted that whether the true financial position of the company was shown in its books and records is a matter for cross examination at trial.

(c) There were a number of other matters upon which Mr Greig and Dr Coldham-Fussell disagreed. For instance, while Mr Greig suggested the company demonstrated poor liquidity by its negative current asset position, Dr Coldham-Fussell highlighted that while the company was required to record hire purchase and finance costs for the next 12 months in the current liabilities, its current assets in the balance sheet included only the historical balance of assets. Dr Coldham-Fussell asserted that the solvency tests for equipment hire companies was "best determined by an examination of a company's total net asset worth and coverage of trade creditors by trade debtors, business value and financing and funding resources available to the company." Again counsel for the third parties submitted that this is a matter requiring determination at a trial.

(d) Dr Coldham-Fussell acknowledged that Mr Greig was correct in referring to the company's making losses from November 2002, but asserted that in the seven months from July 2002 to 31 January 2003 the company's earnings/profits before interest and tax were in surplus. But, once large finance and convertible interest for the seven months to January 2003 were taken into account, the result was a loss of over $1 million.

(e) Dr Coldham-Fussell asserted that Mr Greig's statement that the company had difficulty paying its creditors from November 2002 failed to account for the funds received from the auction late that month.

(f) Dr Coldham-Fussell also deposed to successful negotiations with financiers who all agreed to defer interest payments in order to allow the company to rearrange its funding.

[53] The submissions on actual insolvency made by the defendant in his application against the third parties are relevant also to my consideration of actual insolvency on the plaintiffs' application against the defendant.

[54] Counsel for the defendant relied on the decision in ASIC v Plymin[18] in which Mandie J of the Supreme Court of Victoria outlined a number of indicia of insolvency. Counsel for the defendant submitted that the following were all present prior to any of the preference payments being made:

(a) Continuing losses - The company incurred a net loss before tax of $7.3 million in the financial year ending 30 June 2002. It made losses every month from October 2002 until liquidation. As at 23 February 2003 it had made a year to date loss of $1 million and the chief financial officer believed it would continue to make losses of $250,000.00 a month.

(b) Liquidity ratio <1 - The company had a liquidity ratio less than 1 considering the realisable value of its assets (and a cash on hand deficit of $3.461 million at June 2002, increasing to $5.9 million at November 2002 and $6.75 million at March 2003).

(c) Overdue taxes - The company had taxes overdue of $812,000.00 at 27 June 2002, increasing to $1.35 million at 14 November 2002, and further increasing to $1.43 million at liquidation.

(d) Poor relationship with the bank - NAB reduced the company's overdraft from $500,000.00 to $100,000.00 and restricted its use to payroll transactions only in November 2002.

(e) No access to alternative finance - The company was refused finance by St George and GE Finance.

(f) Inability to raise further working capital - While the company had been able to increase its factoring limit with SPBF, it was restricted in access to these funds by the number of bad debtors. Also, while it received a cash injection from BML and the Allen Family of $1.5 million, this was well below the amount of approximately $6 million required to pay outstanding creditors. Further, proposed injections of $2.5 million, also insufficient to pay out creditors, were not provided due to noteholders' concerns regarding the company's solvency.

(g) COD or stop supply from creditors - Many creditors were stopping credit and threatening legal action in November 2002. The company's WA operations were hindered by creditors stopping supply of fuel and parts because of non-payment.

(h) Paying creditors outside trading terms - The company was struggling to keep payments "only one month overdue".

(i) Letters of demand, judgments - The company was receiving demands and was served with court proceedings from creditors, commencing prior to the preference payments being made and increasing in number and frequency throughout the relation-back period.

Conclusion on the plaintiffs' claim against the defendant

[55] Having considered the objective facts and the submissions of counsel for the plaintiffs, the defendant and the third parties, I am satisfied that the third parties have no real prospect of defending the plaintiffs' claim against the defendant on the only ground which is in issue - the actual insolvency of the company when the various payments were made. The defendant consents to judgment against it. There is no need for a trial of the plaintiffs' claim against the defendant. Accordingly there should be judgment for the plaintiffs against the defendant for $2,304,310.53 plus interest.

[56] Section 588FGA of the Corporations Act provides:

"Directors to indemnify Commissioner of Taxation if certain payments set aside

(1) This section applies if the Court makes an order under section 588FF against the Commissioner of Taxation because of the payment of an amount in respect of a liability under any of the following provisions of the Income Tax Assessment Act 1936: ...

... or under a provision of Subdivision 16-B in Schedule 1 to the Taxation Administration Act 1953.

(2) Each person who was a director of the company when the payment was made is liable to indemnify the Commissioner in respect of any loss or damage resulting from the order."

"Loss or damage" has been held to include interest and costs the Commissioner of Taxation might be ordered to pay the plaintiff in consequence of reasonably but unsuccessfully defending a claim made against him under s 588FF.[19]

[57] The first and second third parties were directors throughout the period in question, but the fourth third party ceased to be a director on 11 March 2003. The defendant sought the following:

(a) as against the first and second third parties - $2,304,310.53 plus any interest and costs he was ordered to pay the plaintiffs;

(b) as against the fourth third party - $1,765,044.74, plus any interest and costs he was ordered to pay the plaintiffs proportionate to this sum;

(c) as against the first, second and fourth third parties - costs of and incidental to the Third Party Notice fixed in the amount of $160.00.

[58] The third parties relied on s 588FGB of the Corporations Act which provides:

"Defences in proceedings under section 588FGA

(3) It is a defence if it is proved that, at the payment time, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it made the payment.

(4) Without limiting the generality of subsection (3), it is a defence if it is proved that, at the payment time, the person:

(a) had reasonable grounds to believe, and did believe:

(i) that a competent and reliable person (the other person) was responsible for providing to the first-mentioned person adequate information about whether the company was solvent; and

(ii) that the other person was fulfilling that responsibility; and

(b) expected, on the basis of information provided to the first-mentioned person by the other person, that the company was solvent at that time and would remain solvent even if it made the payment.

[59] The Full Court of the Supreme Court of South Australia considered whether a director "had reasonable grounds to expect, and did expect, that the company was solvent" within the meaning of s 556(1) of the Companies (SA) Code in Carrier Air Conditioning Pty Ltd v Kurda & Ors.[20] Debelle J, with whom the other members of the Court agreed, said:

"The objective facts must be viewed as they would be by a reasonable and prudent director of reasonable ability, who in the proper discharge of his duties as a director, is making the assessment, immediately before the debts were incurred, whether there are reasonable grounds for expecting that the company will be able to pay its debts as and when they fall due. By the expression 'in the proper discharge of his duties as a director' I refer to the obligation of company directors to act in accordance with the duties of a director as prescribed by the Code, the common law and equity duties which include the obligation to keep himself informed of the financial affairs of the company.[21]

The meaning of the word 'expect' should not lead to difficulty. It is to be understood according to its usage in ordinary parlance, namely, 'to regard as likely to happen' or 'to expect to find' or 'to expect that it will turn out that'.[22] Thus what s 556 requires to be proved is whether a reasonable and prudent director of the company has reasonable grounds for regarding it as likely to happen that the company will not be able to pay its debts as and when they fall due."[23]

"A reasonable and prudent company director would assess whether a company is in a position to pay its debts as and when they fall due by reference to the legal obligations of the company not by reference to any indulgences which the company might have received from its creditors. He would have regard to the fact that the credit policy of any particular creditor might suddenly change and require any outstanding debts to be paid forthwith. The possibility of such a change could result from any one of a number of factors including the fact that the creditor is itself experiencing financial stringency or, as the circumstances of this case illustrate, a change in management. A reasonable and prudent director must found his expectations on reasonable grounds. An expectation that creditors will continue to permit late payment of accounts is founded on hope or optimism, not on reason. It is a policy fraught with danger and could only be reasonably adopted if the company was experiencing a temporary lack of liquidity. A reasonable and prudent director would acknowledge that, while his company might have enjoyed periods of grace in the payment of its debts, there could be no reasonable expectation that that situation would continue. Apart from these considerations, he would recognise that the very fact that the ability of a company to continue to trade depends on indulgences from its creditors points to the conclusion that it is unable to pay its debts as and when they fall due. In other words, a reasonable and prudent director will, generally speaking, be directing his attention to whether the company will be able to pay its debts on the date stipulated for payment."[24]

[60] In Sims v Deputy Commissioner of Taxation[25] Hammerschlag J of the Supreme Court of New South Wales said of s 588FGB(3):

"'Reasonable grounds' to expect requires more than a mere hope or possibility: Tourprint International Pty Ltd (in liq) v Bott.[26]

The test requires the director subjectively to have that expectation and for the expectation to be reasonably based.

The director's conduct is to be judged not only on what he knew but on what he ought to have known: Deputy Commissioner of Taxation v Saunig[27]."

[61] In relation to s 588FGB(4), his Honour[28] approved the following statement by Davies AJ of the same Court in Iso Lilodw' Aliphumeleli Pty Ltd v Commissioner of Taxation:[29]

"Section 588FGB(4) is directed primarily to the circumstance where directors must rely primarily upon other persons, particularly accountants and actuaries to prepare accounts which will disclose the financial position of a company. The section does not negate a director's duty to keep himself informed, and to form his own judgment about the affairs of the company, of which he is a director."

[62] The third parties have sworn to believing that the company was solvent and that it would remain so if payments were made to the defendant in the relevant period. In the case of the fourth third party, this is contrary to the concerns about solvency he expressed at the board meeting on 5 December 2002.

[63] Whether or not they in fact expected that the company was solvent when the payments were made and that it would remain solvent even if they were made, they do not have a defence under s 588FGB(3) unless their expectation was reasonably based.

[64] The objective evidence points overwhelmingly to the absence of reasonable grounds for such an expectation. The third parties were at all times aware of the company's financial circumstances. Their reliance on the forecasts and proposed capital injections to ground an expectation that the company was solvent and would remain so was not reasonably based for the following reasons -

(a) The forecasts were based on assumptions that the directors considered to be "optimistic". They did not accept the restructure budget presented to the board meeting on 10 October 2002, which contemplated a cash flow deficit, and directed management to present a new budget that generated a positive cash flow.[30] The forecasts were for monthly profits, but the company made monthly losses from October 2002. By the time the first preference payment was made in December 2002, actual sales and cash flow were well short of the forecasts - an objective indicator that the forecasts were unreliable.

(b) The auction of surplus plant in November 2002, before the first of the preference payments, was expected to provide a return of $4.5 million, which would have been insufficient to pay out all existing creditors. In fact it produced a return of only $1.48 million. This was an objective indicator that the forecasts were unreliable, that the company was unable to pay its debts and that its assets were significantly overvalued in its balance sheet - in other words, that the company was both cash flow and balance sheet insolvent.

(c) That the company needed to rely on noteholders and creditors to defer collection of their debts in order to continue trading was another objective indicator that it was unable to pay its debts when they were due, and was therefore insolvent.

(d) The company increased its factoring facility with SPBF from $6 million to $8 million, but access to this amount was dependent on a sufficient number of qualifying debtors at any point in time. There were no profits to sustain repayments of the increasing debt. In those circumstances the increase to the factoring facility (which was insufficient to pay creditors) was another objective indicator that the company was insolvent.

(e) MacMahon retracted its interest in purchasing the business as a going concern, and Quadrant refused to provide further capital after receiving independent advice - further objective indicators that the company was insolvent.

[65] In so far as the third parties rely on s 588FGB(4), assuming they had reasonable grounds to believe, and did believe, that Mr Atwell and Mr MacKenzie were competent and reliable persons to provide them with adequate information about whether the company was solvent and that they were fulfilling that responsibility, I nevertheless accept the submissions of counsel for the defendant:

(a) that, on the basis of information supplied, the third parties could not have expected that the company was solvent; and

(b) that in any event they did not rely on information provided by Mr Atwell or Mr MacKenzie or any other competent and reliable persons.

[66] Before the first payment was made, Mr Atwell (the chief executive) provided the directors with information which indicated clearly that the company was insolvent -

• The company was struggling to maintain financier contracts at "only one month overdue";[31]

• The sale of assets in November 2002 was expected to produce a net surplus of $4.5 million, which was short of the amount required to pay outstanding current liabilities of the company;[32]

• Many suppliers of the company were stopping credit and threatening legal action;[33]

• Several statutory demands and summons had been received and the company had not been able to satisfy all of the demands through payment or agreed terms;[34]

• The company was not able to access additional funding from their factoring agent SPBF, in the amount of $1.165 million, due to their high number of unacceptable debtors;[36]

• NAB had restricted the company's use of their overdraft facility to payroll transactions only;[37]

• The company had been approved for an increased factoring facility with factoring agent, SPBF;[38]

• The company's accounts showed significant reductions in revenue from Townsville Heavy Haulage and UPH, the latter due to a lack of cash to support the operations, and overall showed a loss for October 2002.[39]

[67] At the board meeting of 24 December 2002 Mr Atwell provided information that as at 23 December 2002 the company had total debts due of $6.4 million, with $1.2 million owing for greater than 90 days and $1.9 million owing for greater than 120 days, and that the company had made a loss for November 2002. It ought to have been obvious to the directors that the proposed capital injections by the Allen Family and BML of $1.5 million would be inadequate to enable the company to pay its aged creditors, let alone ongoing costs. Given the Mr Atwell had anticipated that the proceeds of the auction of company assets in November 2002 would result in a surplus to pay creditors of $4.5 million, when the actual surplus was only $1.48 million, it ought to have been clear to the directors at that time that the company's plant and equipment assets were grossly overstated, and that the company was insolvent on a balance sheet test as well as a cash flow test.

[68] The information Mr MacKenzie (the chief financial officer) provided to the third parties between 5 December 2002 and 11 March 2003 made it clear that the company was unable to pay its debts as and when they were due and payable. He told them -

• The company's results for July 2002 appeared to be overstated by $230,000.00;[40]

• The company made a loss again in December 2002 and would make a loss of $250,000.00 per month unless sales rose in coming months;[41]

• He had located a negative balance in the costings account in the amount of $492,000.00, which would result in further losses;[42]

• The auctions of plant in November 2002 had produced surplus funds of only $1.488 million;[43]

• The company was unable to draw down the full factoring facility with SPBF because of the amount of disqualified debtors;[44]

• Cash flow would be impacted by King Solomon's Mine going into administration with a debt to the company of $981,985.82;[45]

• Sales were expected to be significantly below budget for January 2003;[46]

• Weekly payroll was not paid when due on 4 February 2003 but the company was expecting to pay it on 5 February 2003;[47]

• Cash flow had reached a critical point with January sales $30,000.00 below budget;[48]

• The amount of cash injection from noteholders would not be enough to impact on creditors;[49]

• He was of the view that the company would not survive without further financial support, and should be sold;[50]

• The company made a loss in January of $861,300.00 as sales of $3.06 million were well below projected sales of $3.71 million;[51]

• WA performance was significantly adversely affected by the company's inability to source fuel or parts due to the suppliers putting it on stop credit because of outstanding debts;[52]

• The company required sales of $4.4 million to $4.6 million per month ($52.8 million to $55.2 million per annum) to break even. In the year to January 2003 it made sales of only $27.6 million and so made a loss of $1.8 million;[53]

• He projected that sales would be $500,000 per month short of projections, resulting in negative cash flow over the months from March 2003 to May 2003, peaking at $1.5 million.[54]

• In his view the company was insolvent;[55]

• The company had made continual losses since July 2002 and he considered the losses would continue.[56]

[69] The cash injections by BML and the Allen family were clearly inadequate to enable the company to pay all of its outstanding creditors, and the approval of increased factoring credit limits with SPBF was no basis for expecting the company was solvent, since it was already unable to draw down to its existing limits before the increase due to its high number of bad debtors.

[70] The objective evidence demonstrates that the third parties did not rely on information provided by Mr Atwell or Mr MacKenzie or any other competent and reliable employee about whether the company was solvent, rejecting it when they disagreed with it, particularly when there were clear indications that the company was insolvent. For example -

• The minutes of the board meeting on 10 October 2002 record that the directors "could not accept" the re-structure budget which contemplated a $200,000 cash flow deficit per month and resolved that management should present a new budget that generated a positive cash flow. "Failure to do so would mean that accounts would not get audit clearance";

• At the board meeting on 21 November 2002 they "agreed not to accept the October financial results" provided to them by the Mr Atwell;

• In February 2003 Mr MacKenzie told them the company was insolvent, but they did not act on that advice or take steps to have the company placed into administration or wound up;

• On examination of the company's cash flow at the meeting dated 24 February 2003, they identified certain errors and omissions making the cash flow inaccurate and asked Mr MacKenzie to provide a new one;

• They did not accept the reduced projections provided by the WA Region manager.

Conclusion on the defendant's claim against the third parties

[71] I am satisfied that the third parties have no real prospect of defending the defendant's claim against them, and that there is no need for a trial of it. Accordingly the defendant should have summary judgment against them.

[72] I will ask the parties to submit draft orders, including orders as to interest and costs.

[1] The amounts claimed against the various third parties varied because they were directors for different periods: against the first and second third parties the defendant claimed $2,304,310.53 plus interest, and against the fourth third party he claimed $1,765,044.74 plus interest.

[2] See consent order 9 March 2010 - document 47 on Court file.

[3] Order made 30 September 2009 - document 20 on Court file.

[4] Corporations Act 2001 (Cth) s 588FE(2)(a) and (b)(i).

[6] (1966) 115 CLR 666.

[7] (1966) 115 CLR 666 at 670.

[8] For the meaning of "unfair preference", see Corporations Act s 588FA.

[9] Corporations Act s 588FC(a)(i).

[10] Southern Cross Interiors Pty Ltd (In Liq) v Deputy Commissioner of Taxation (2001) 53 NSWLR 13, 224; Emmanuel Management Pty Ltd v Fosters Brewing Group [2003] QSC 205.

[11] Powell v Fryer, Tonkin & Perry [2000] SASC 97; (2000) 18 ACLC 480.

[12] Cooper v Commissioner of Taxation [2009] NSWSC 880 at para 19; Melbase Corporation Pty Ltd v Segenhoe Ltd [1995] FCA 1225; 17 ACSR 187; Noxequin Pty Ltd v DCT [2007] NSWSC 87.

[13] An experienced company director, as well as a certified practising accountant for 50 years and a registered tax agent, with impressive academic credentials.

[15] (1966) 115 CLR 667 at 670-671

[16] See Exhibit JLG-1 to the Affidavit of J L Greig filed 9 February 2010 (Court Document 25) at paras 2.3 and 5.10.

[17] See Exhibit JLG-1 to the Affidavit of J L Greig filed 9 February 2010 (Court Document 25) at para 5.10.4.

[18] [2003] VSC 123; (2003) 46 ACSR 126.

[19] Commissioner of Taxation v Sims & Anor [2008] NSWCA 298; (2008) 72 NSWLR 716 (CA).

[20] (1993) 11 ACSR 247.

[21] Statewide Tobacco Services Ltd v Morley [1993] VicRp 32; [1993] 1 VR 423 at 428 to 429; (1990) ACSR 405 at 411 to 412; Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115 at 125 to 126; Rema Industries & Services Pty Ltd v Coad (1992) 107 ALR 374 at 381-2; Group Four Industries Pty Ltd v Brosnan (1992) 59 SASR 22 at 502 to 503.

[22] see Macquarie Dictionary, Shorter Oxford English Dictionary and Fowler's Modern English Usage, 2nd ed and Commonwealth of Australia v Friedrich (1991) 5 ACSR 115 at 126 to 127.

[23] (1993) 11 ACSR 247 at 250.

[24] (1993) 11 ACSR 247 at 254 - 255.

[25] [2007] NSWSC 998 at para 173 - 175.

[26] [1999] NSWSC 581; (1999) 32 ACSR 201.

[27] [2002] NSWCA 390; (2002) 55 NSWLR 722 at 731.

[28] [2007] NSWSC 998 at para 205.

[29] [2002] NSWSC 644; (2002) 42 ACSR 561 at para 80.

[30] See Solvency Report filed 24 December 2009 (Court Document 23) at 6.1.13.

[55] 23 February 2003 and 16 October 2002.