[1994] FCA 1117; (1994) 122 ALR 531

[1994] FCA 1117; (1994) 13 ACSR 766

[1994] FCA 1117; (1994) 51 FCR 425

Corporations - directors' liability - insolvent trading - liability of directors and managers to creditors for debts incurred - matters to be considered.

Corporations - directors' liability - insolvent trading - whether an independent duty owed to creditors of the company.

Corporations - directors - resignation - whether acceptance by representative of holding company binds subsidiary.

3M Australia Pty Limited v Kemish (1986) 10 ACLR 371

In re Duomatic Limited (1969) 2 Ch 365

Walker v Wimborne [1976] HCA 7; (1976) 137 CLR 1

Kinsela v Russell Kinsela Pty Limited (In Liq.) (1986) 4 NSWLR 722.

Counsel and solicitors: Mr D.A. Hammerschlag instructed by

Counsel and solicitors Mr T.J. Hancock instructed by

Grant leave to the parties to bring in Short Minutes of Order to give effect to the Reasons for Judgment delivered today.

GUMMOW J This is an application under s. 592 of the Corporations Law ("the Law") to recover debts incurred by a company now in receivership from former office holders of that company. The company, New World Alliance Pty Limited ("New World") was a manufacturer of cloth. The applicant ("Sycotex") was engaged by New World to dye quantities of yarn which were later used by New World to manufacture cloth to satisfy particular customer orders. In most cases the yarn was supplied by New World. Between 5 July 1991 and 30 October 1991 New World incurred debts to Sycotex totalling $213,756.09, which have not been paid.

2. A receiver was appointed to New World on 30 October 1991 at the company's request. The appointment was made by the Bank of New Zealand ("the BNZ") pursuant to an equitable charge dated 7 September 1984. When requesting the receiver be appointed, New World was acting under the direction of a New Zealand parent company, Alliance Textiles (N.Z.) Limited ("Alliance Textiles"). The direction was received by New World on 29 October 1991.

3. The first respondent, Mr Baseler, and the third respondent, Mr Munro, were directors of New World throughout the relevant period. Mr Baseler became a director in August 1988 and Mr Munro was appointed in August 1989. The fourth respondent, Mr Wijeyamohan, was company secretary and accountant of New World throughout the relevant period. He commenced as company secretary on 8 December 1989. The second respondent, Mr Carlyle, first became a director in December 1986. He ceased to be a director in August 1989. He was reappointed a director on 4 March 1991, that is, some four months before the first of the relevant debts was incurred. There is a dispute as to whether Mr Carlyle continued to be a director throughout 1991 or whether he resigned in June of that year.

4. In the amended Statement of Claim filed 27 November 1992, Sycotex claims, using the terms of s. 592, that immediately before the time when the debts were incurred the respondents had reasonable grounds to expect that New World would not be able to pay all its debts as and when they became due, or alternatively that the respondents had reasonable grounds to expect that, if New World incurred the debts, it would not be able to pay all its debts as and when they became due. Sycotex also claims that the first, second and third respondents owed a duty to Sycotex to have regard to its interests as a creditor of New World. The latter claim was only referred to briefly in argument, and the emphasis was placed on the former claim.

5. New World is a member of the Renouf group of companies ("the group"). The relevant corporate structure is as follows. New World is a wholly owned subsidiary of another Australian company, Texal Industries Pty Limited ("Texal"). Another company, Alltex International Yarns Pty Limited ("Alltex") is also a wholly owned subsidiary of Texal. Texal and a New Zealand company, Levana Textiles Limited ("Levana"), are wholly owned subsidiaries of Alliance Textiles, which is itself a wholly owned subsidiary of R. & W. Hellaby Limited ("R & W Hellaby"), which is in turn a wholly owned subsidiary of Renouf Corporation Limited ("Renouf Corporation").

6. From the 1989 financial year onwards, New World incurred a substantial trading loss, as revealed by the accounts lodged with the annual returns of New World. For the year ended 30 June 1989, the company made an after tax loss of $2,810,641, giving rise to a retained loss at the end of the financial year of $2,012,817. Included in this figure was an amount of some $935,000 for interest payable to a holding company. I shall return to this. The balance sheet for that year reveals that current assets were $7.9m, non-current assets (consisting of property, plant and equipment) were $4.56m, and total assets were $12.44m. Current liabilities were $6.4m, non-current liabilities were $5.52m, and total liabilities were $11.93m, which gave a shareholders equity of $507,000. The current liabilities included a bank overdraft from the BNZ of $2m, commercial bills (also payable to the BNZ) of $2.75m, and trade creditors of $307,000. The non-current liabilities included two unsecured loans from related corporations totalling $4.795m.

7. The 1990 accounts revealed an operating loss after income tax of $3.765m, giving rise to accumulated losses of $5.778m. This included interest payable to a holding company of $822,000. Current assets had declined more than $2.8m, to $5.06m, non-current assets had declined by half a million dollars to $4.05m, and total assets amounted to $9.11m. Current liabilities declined somewhat to $6.06m. However, non-current liabilities increased to $6.3m, and total liabilities rose to $12.37m, leaving a deficit of shareholders' equity of $3.26m. The indebtedness to the BNZ remained constant. However, the unsecured loans from the related corporation increased nearly a million dollars to $5.73m. In the auditor's report, dated 15 November 1990, to the members of New World accompanying the company accounts, the following paragraphs appeared:

company has incurred an operating loss of

$3,765,180, and total liabilities exceed total

assets by $3,257,997. These factors raise doubt

that the company will be able to continue as a

going concern.

The financial statements have been prepared on a

going concern basis. The validity of this is

dependent on continuing financial support from

the Australian holding company and holding

company in New Zealand, as well as from local

financiers. We have not obtained evidence that

continuing support will be available from these

sources. If it is not able to so continue, the

company may be required to sell assets other

than in the normal course of business and at

amounts different from those which are currently

stated in the financial statements."

9. For the year ended 30 June 1991, the company accounts revealed an operating loss after income tax of $1,152,575, giving rise to an accumulated loss at the end of the financial year of $6.93m. Total assets declined to $8.825m, current liabilities increased significantly to $6.944m, and total liabilities increased to $13.24m, leaving a deficit of shareholders' equity of $4.41m. The bank overdraft increased by $200,000 to $2.19m, and trade creditors increased substantially to $954,000. To put these figures in perspective, it should be noted that the annual revenue of New World for the 1990 and 1991 financial years was approximately $10m.

10. As at 30 June 1991, New World's indebtedness to the BNZ was approximately $5.3m, including an overdraft of $2.19m. The terms of the available facility appear in a letter from the BNZ to New World dated 2 May 1988, forming part of exhibit 1. This indicates that New World was permitted to borrow up to $5.25m, by way of overdraft of $2.45m, commercial bill facility of $2.75m and letters of credit of $52,000. By September 1990 the facility limit had increased to $5.5m and it remained at this level throughout the relevant period. Under the terms of the facility, the overdraft was repayable on demand. The evidence as to the level of additional financial accommodation available to New World in July 1991 was presented in a most unsatisfactory manner. However, it is apparent from various documents in evidence that in early July 1991 New World had some $200,000 - $300,000 of credit available under the existing facility with the BNZ. What is also apparent from BNZ memoranda is that at least from September 1990 the bank was concerned at New World's level of indebtedness and at least from mid-1991 onwards was discussing methods of reducing that indebtedness.

11. As at 30 June 1991 New World was also indebted to its parent company, Texal, for the sum of $5,733,530. This sum is recorded in the accounts as an unsecured loan with no fixed term of repayment. It is upon this loan that the amounts of interest referred to earlier in these reasons were payable. In cross examination, Mr Munro and Mr Baseler stated that this debt was not regarded as owing. Mr Munro said that: "In my mind it was equity". However, he conceded that it was certified as debt in the accounts and that this permitted the payment of interest to Texal in circumstances where no dividends could have been paid. It appears that the interest due on the loan for the years ending 30 June 1990 and 30 June 1991 was not paid.

12. In December 1989 New World entered into cross guarantees for the indebtedness of Alliance Textiles, Texal and Alltex ("the principal debtors") to the BNZ. The guarantees were not limited in amount and New World was potentially liable to pay all amounts owing on any account to the BNZ by the principal debtors. All liabilities under the guarantees were payable on demand by the bank. Of the principal debtors, Alltex for the year ended 30 June 1990 had a deficiency of shareholders equity of $5.65m, and was indebted to the BNZ for $2m. Texal for the year ended 30 June 1990, had a shareholders equity of $7.24m. However its assets of $9.3m consisted entirely of debts due from its subsidiaries, New World and Alltex. Texal owed $500,000 to the BNZ.

13. Alliance Textiles was a more substantial company. For the 1990 financial year, shareholders equity amounted to $23.7m. However this had declined to $22.9m by the end of the 1991 financial year. Accumulated losses as at 30 June 1991 amounted to $25m. At the end of the 1990 financial year Alliance Textiles owed the BNZ $4.85m under a bank overdraft and $15m under various term facilities. The total liability to the BNZ for the 1991 financial year was approximately $16.5m. In the auditors' report for the 1991 financial year, it was noted that Alliance Textiles was dependent on the continued financial support of the financiers to the group.

14. The first recognition that the cross guarantees received in New World's accounts was a note in the 1991 accounts referring to them as a contingent liability. Because no call had ever been made on these guarantees, the potential liability was not included in any of the figures referred to earlier in these reasons. Mr Baseler stated in evidence that he believed liability under the guarantees was limited to $8m. It was conceded by Mr Munro and Mr Baseler that there was no way that New World could have paid $8m if called upon to do so.

15. The evidence of Mr Baseler is that generally no order for dyeing would be placed with Sycotex unless New World had an order from a specific customer for fabric. However, the money received from the purchaser of the fabric could not be used directly to pay for the dyeing by Sycotex. This is because New World would take approximately one month to process the dyed yarn into cloth. The evidence is not entirely consistent as to the delay between the issue of invoices by Sycotex to New World and New World to its clients and payment of those invoices. Both the Sycotex invoices and New World invoices state that payment is to be made within 30 days. However, the evidence suggests that the actual delays in payment were greater, often over 60 days. Mr Baseler stated that New World would be paid by its clients 90 days or longer after invoicing.

16. I find that there was a delay of at least a month between payment to Sycotex by New World and receipt by New World of payment in respect of finished goods. Therefore, the manufacture of the goods, including the services provided by Sycotex, required financial outlay that was only recouped upon the receipt of proceeds from sale of the finished goods. This meant that if the quantity of finished goods ordered in a particular month was higher than normal, New World would incur an additional financial burden until payment in respect of the final goods was received. An additional problem was that over the Christmas period factories supplying raw materials would close, while customers receiving finished goods continued to operate. This resulted in the need for New World to stockpile raw materials prior to the Christmas period, placing an additional financial burden on New World. Since New World took up to two months to pay its suppliers, these financial burdens would manifest themselves as cash flow shortages some two months after the seasonal variation or other fluctuation occurred.

17. The evidence indicates that at the end of the 1991 financial year the level of indebtedness of New World to the BNZ was some $200,000-$300,000 short of the maximum amount allowable under New World's facility. Memoranda from the Sydney office of the BNZ indicate that the bank was by August 1991 concerned at New World's performance and level of indebtedness. There is a record of a conversation on 30 August 1991, to which Mr Munro was a party, discussing the possibility of new equity investors for New World. The file note was signed by the manager of Auckland Group Credit of the BNZ and included a comment that the bank had to accept that New World just could not support $8m. worth of debt.

18. In cross examination Mr Baseler denied that there was a serious deficiency of working capital in July 1991, but conceded it was "tight". This is also borne out by the events that occurred. In September 1991 New World made a profit as a result of an increase in the demand for cloth. However, the necessity for paying for raw materials to meet this demand caused a shortfall in working capital for the reasons discussed above. This shortfall appears to have precipitated the appointment of the receiver in October 1991. The letter requesting the appointment cited "significant cash flow difficulties" and the inability of New World to "pay its debts as and when they fall due".

19. The only other potential source of finance for New World was from other companies in the group. However, the group itself was in difficulties. The directors' report for Renouf Corporation (the company at the head of the corporate hierarchy) for the year ended 30 June 1991 revealed a loss for the year of $61.6m. In the conclusion to the report the directors stated that:

"(T)he significant diminution in shareholders' funds

inevitably places the Corporations' future in doubt. Renouf

Corporation is now more dependent than ever on the support

of its bankers which at the time of compiling this report

has continued to be forthcoming".

The report notes that a debt moratorium agreement entered into with Renouf Corporation's bankers in August 1989 expired on 30 June 1991, and that the banks subsequently agreed to extend the moratorium until 31 August 1991 and then until 13 December 1991. The following note then appears:

"These short term extensions to the moratorium reflect the

banks' wish to closely monitor the ongoing realisation of

the Corporation's offshore assets which have always been

perceived as a principal source of cash to retire the debt".

The auditors in their report noted that the preparation of the accounts on a "going concern basis" was dependent upon the continued support of Renouf Corporation's lenders.

20. The more immediate parent company of New World, Alliance Textiles, was reporting to the credit recovery division of the BNZ in July 1991. Any advance to New World would have required the approval of the BNZ. During the cross examination of Mr Munro, the following exchange occurred:

"Mr Hammerschlag: So you became uncomfortable in

September did you?

Mr Munro: I became concerned in September at the sudden

rapid growth that was taking place.

Mr Hammerschlag: And you knew that that rapid growth

would bring about the downfall of the company, didn't

you?

Mr Munro: No, I knew it would produce working capital

strains on the company.

Mr Hammerschlag: Which the parent company was not in a

position to provide?

Mr Munro: That was not decided until late in October.

Mr Hammerschlag: Was the parent company in a position to

provide that working capital in July, 1991, Mr Munro?

Mr Munro: I believe so.

Mr Hammerschlag: Was it not then reporting to BNZ?

Mr Munro: Yes, it was.

Mr Hammerschlag: Well what had changed between July and

September of 1991?

Mr Munro: Nothing, except that I believe that another set

of accounts had been tabled by the company and I know the

position I had with the BNZ and I'm quite sure that if I

had have pushed it hard enough they would have been

prepared to support that advance ....

Mr Hammerschlag: So why didn't you?

Mr Munro: ... it was capacity there, because we had made

a long term decision that the shareholders didn't want to

pursue that investment."

21. In paragraph 5 of his affidavit filed 14 July 1993, Mr Munro states:

"Since 16 August 1989 Renouf Corporation Limited operated

under a debt moratorium with its bankers with a total

debt repayment objective. Alliance as a consequence has

operated under the tight control of the recoveries

section of the Bank of New Zealand Limited ("BNZ") up

until the time of Alliance's sale on 30 April 1993. In

particular, BNZ were not prepared to give further

financial accommodation to Alliance in New Zealand and

insisted on an overall continuing program of debt

recovery. I dealt with BNZ on a regular basis during

this time."

Mr Baseler also was asked in reply about the restrictions placed by the BNZ on Renouf Corporation. His answers were as follows:

"Mr Hancock: What do you recall of the

restrictive arrangements that you spoke of?

Mr Baseler: I do recall that I was told that the

restrictions on the Renouf Corporation prevented inter

company fund transfer, that funds were not to be moved

within the group companies.

Mr Hancock: Is there anything further that you recall

of that?

Mr Baseler: At that time I was told that we have to

live with the facility we've got and within that

facility, which we did.

Mr Hancock: That was the facility with the Bank of New

Zealand?

Mr Baseler: With BNZ, yes.

Mr Hancock: In Sydney?

Mr Baseler: Yes."

22. I am satisfied that during the relevant period (July-October 1991) no company within the group could advance money to New World without approval from the BNZ and that those managing New World could not rely on the group as a source of finance.

23. Section 592 of the Law, prior to amendment by The Corporate Law Reform Act 1992 ("the 1992 Act"), relevantly was as follows:

"592(1) Where:

(a) a company has incurred a debt;

(b) immediately before the time when the debt was

incurred:

(i) there were reasonable grounds to expect

that the company will not be able to

pay all its debts as and when they

became due; or

(ii) there were reasonable grounds to expect

that, if the company incurs the debt,

it will not be able to pay all its

debts as and when they become due; and

(c) the company was, at the time when the debt

was incurred, or becomes at a later time, a

company to which this section applies;

any person who was a director of the company, or

took part in the management of the company, at the

time when the debt was incurred contravenes this

subsection and the company and that person or, if

there are 2 or more such persons, those persons are

jointly and severally liable for the payment of the

debt.

(2) In any proceeding against a person under

subsection (1), it is a defence if it is proved:

(a) that the debt was incurred without the

person's express or implied authority or

consent; or

(b) that at the time when the debt was incurred,

the person did not have reasonable cause to

expect;

(i) that the company would not be able to

pay all its debts as and when they

became due; or

(ii) that, if the company incurred that

debt, it would not be able to pay all

its debts as and when they became due.

..."

24. Section 592 has now been superseded by the more detailed provisions in Part 5.7B, inserted by s. 111 of the 1992 Act, which commenced on 23 June 1993. However, sub-s. 1384(1) of the law relevantly states:

"1384(1) If, immediately before the commencement of s.

112 of the Corporate Law Reform Act 1992, a

company ... was a company to which sections

590 to 593 (inclusive) of this Law apply,

then ... sections 590 and 592, of this Law,

as in force before that commencement,

continued to apply in relation to the company

..."

25. The circumstances in which ss. 590 to 593 apply to a company are set out in sub-s. 589(1). It is sufficient for present purposes to refer to para. 589(1)(e) which is, and was immediately before the commencement of s. 112 of the 1992 Act, as follows:

"589 (1) Sections 590 to 593 (inclusive) apply to a

company:

...

(e) in respect of property of which a

receiver, or a receiver and

manager, has at any time been

appointed, whether by the Court

or under a power contained in an

instrument, whether or not the

appointment has been terminated;

..."

A receiver was appointed to New World on 30 October 1991 pursuant to an equitable charge in favour of the BNZ. Thus, by virtue of sub-s. 1384(1), s. 592 in its original form continues to apply to the events in question. It should be noted that the events occurred after 1 January 1991, which was the commencement date of s. 592.

26. Section 592 is in identical terms to s. 556 of the Companies (New South Wales) Code 1981 (NSW). Sub-section (1) involves an objective test: see Taylor v Powell [1993] FCA 87; (1993) 113 ALR 374 at 380 per Davies J and Rema Industries and Services Pty Limited v Coad [1992] FCA 114; (1992) 107 ALR 374 at 381 per Lockhart J By para. 592(1)(b) it is required that there be reasonable grounds to expect that the company will not be able to pay all its debts as and when they become due, without reference to any person who must hold this expectation. The sub-section goes on to provide that any person who was a director or manager of the company at the time is liable for the debt. It is apparent that if sub-s. (1) catches one director or manager it must catch all such persons - factors personal to the director or manager are the concern of sub-s. (2), which provides a defence in certain circumstances. In Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115 at 124, Tadgell J formulated a separate test for non-executive directors; the fact that a director holds a non-executive position properly should be taken into account as a factor that may give rise to a defence under sub-s. (2)).

27. Some particular standard must be invoked when applying sub-s. (1). In 3M Australia Pty Limited v Kemish (1986) 10 ACLR 371, Foster J observed (at 372-373):

"Clearly, material that could provide 'reasonable

grounds' for expectation by a person with the

qualifications of an auditor, could be very different

from material that would provide such grounds for an

office boy. I am satisfied from a reading of the whole

of the sub-section, and having regard to the fact that

it prescribes an offence, that the reasonableness of

the grounds relied upon by the prosecution and/or a

civil plaintiff, must be judged by the standard

appropriate to a director or manager of ordinary

competence."

This passage has been applied in this Court by Lockhart J in Rema Industries and Services Pty Limited v Coad supra at 381, and by Davies J in Taylor v Powell supra at 383. The expectation which this officer of ordinary competence must have is an expectation that the company "will not be able to pay all its debts as and when they become due". This necessarily introduces temporal considerations, and thus contingencies and the potential to raise money must be taken into account. The question is not answered simply by ascertaining whether liabilities exceed assets.

28. There is some dispute in the authorities as to whether a debt falls due when it is legally required for payment or whether the court can take into account normal or likely indulgences granted to the company by its creditors: see Pioneer Concrete Pty Limited v Ellston (1985) 10 ACLR 289 at 301, Carrier Air Conditioning Pty Limited v Kurda (1993) 11 ACSR 247 at 254; c.f. 3M Australia Pty Limited v Kemish supra at 378. The issue is relevant in the present case because Mr Baseler conceded that if New World had been required to pay all its creditors according to their stated terms in July, August and September 1991 it could not have done so.

29. Any conflict between the authorities may be more illusory than real and factual rather than legal. I would not consider such an issue to be a question of law to be decided by the application of a rigid rule. Rather, the statute appears to focus attention upon what it is reasonable to expect in a given set of circumstances, such a consideration necessarily being made by someone operating in a practical business environment. Attention is focussed at whether a person would expect that at some point the company would be unable to meet a liability. Such a question is necessarily a factual one to be decided in light of all the circumstances of the case. At one end of the spectrum a company may be operating in an industry where a code of practice of paying 60 days after invoicing has arisen, despite stated terms of 30 days. If the company has a large number of creditors, it may be reasonable to expect that all of them would not suddenly insist on being paid in 30 days. At the other end of the spectrum would be a case where a single creditor had granted an indulgence on one occasion. It may well not be reasonable to expect a repetition of that event.

30. In the present case, I do not think that the concession made by Mr Baseler of itself means that it was reasonable to expect that New World would be unable to pay its debts as they fell due. The possibility that some companies could insist on payment strictly according to their stated terms is merely something to be taken into account in assessing whether it could be expected the company could not pay its debts.

31. I turn to consider the defence in para. 592(2)(b), which was relied upon in this case. What is required for a person to establish a defence that at the time when the debt in question was incurred that person did not have reasonable cause to expect that the company would not be able to pay all its debts as and when they became due (sub-para. 592(2)(b)(i))? The form taken by the legislation has at least two curiosities which do not assist. First there is a double negative (i.e. "did not have reasonable cause .... company would not be able to pay ..."). Secondly, sub-s. 592(2), whilst giving a defence to a particular person, reintroduces objective criteria found in a different formulation in sub-s. 592(1).

32. The question of whether the defence is made out is approached by examining material personal to the particular defendant. One then considers whether this amounts to absence of reasonable cause for expectation as to the inability of the company to pay, a reflection of that which already it has been found reasonable to expect when applying para. 592(1)(b). If there are "objective" factors which outweigh the material personal to the defendant and these result in a reasonable cause to expect non-payment, the defence has not been made out.

33. It should be noted that in considering what is known to the defendant, one may have regard to facts and circumstances which by reason of the defendant's duties ought to have been known to the defendant: Metal Manufacturers Limited v Lewis (1986) 11 ACLR 122 at 133. This is significant in this case, for example, in considering the position of Mr Carlyle.

34. Sub-s. 592(1) requires three elements to be satisfied. The first of these is that the company must incur a debt. In the present case, New World incurred a number of debts to Sycotex between 5 July 1991 and 30 October 1991. The second element is that immediately before the incurring of the debt there must exist reasonable grounds for the relevant expectation. In the present case, each individual debt is relatively small and there is no perceptible difference in the financial position of the company before and after the incurring of each debt. Therefore, there is no need to rely upon sub-para. (ii) of para. (b).

35. Where a number of debts are the subject of the proceeding, sub-s. (1) requires each debt to be treated separately. Paragraph (b) thus requires consideration of the circumstances existing before the incurring of each debt. In the present case, it is clear that the financial position of the company worsened between 5 July 1991 and 30 October 1991. I therefore propose to consider matters as they stood at 5 July 1991. If the relevant elements give rise to a liability for the debt incurred on that date then it follows that liability is established for the debts incurred on subsequent occasions. I shall return to para. 592(1)(b).

36. The third requirement of sub-s. 592(1) is that the company was at the time of the debt, or becomes at a later time, a company to which s. 592 applies. I have dealt with this requirement earlier in these reasons when discussing sub-s. 1384(1). It is clearly satisfied in the present case.

37. The remaining question is whether, in terms of para. 592(1)(b), on 5 July 1991 there were reasonable grounds for a director or manager of ordinary competence to expect that New World would not be able to pay all its debts as and when they became due. At the trial, a great deal of attention was focussed on the level of indebtedness of New World and whether its liabilities exceeded its assets. However, this in itself does not directly answer the issue raised by para. (b). The issue is not dealt with by analysing a hypothetical instantaneous liquidation: see Dunn v Shapowloff (1978) 2 NSWLR 235 at 244 per Mahoney JA, dealing with the comparable, but not identical, provision in the 1961 uniform companies legislation, sub-s. 303(3). If debts are long term, and the company is making profits, it may be that a company with a substantial indebtedness could trade its way out of difficulties. What is required is an analysis of the assets and financial resources of the company, and its likely liabilities and probable dates that these will fall due, to ascertain whether it is reasonable to expect that one or more of these liabilities will not be able to be met.

38. I have already set out in broad terms the financial position of New World as at the beginning of July 1991. The evidence indicates that New World was in a very precarious position at this time. It had a serious deficiency of shareholders' equity, and a high level of indebtedness. Working capital was "tight" and the inter-company situation meant that New World could only look to its facility with the BNZ for the provision of finance. As mentioned earlier, there was some $200,000 - $300,000 available under the existing facility with the BNZ. Mr Baseler and Mr Munro conceded in cross examination that New World would have been unable to pay the Texal debt if called upon to do so, or even the interest on that debt. Mr Baseler also conceded that if in July, August and September 1991 creditors had insisted on being paid according to their stated terms of trade, New World could not have paid them. While, as I have discussed, this does not of itself dispose of the issue in para. 592(1)(b), it is certainly an important factor to be taken into account as it indicates the severity of the financial constraints placed on New World.

39. Mr Baseler contended in cross examination that during the relevant period he thought that in time New World could pay its debts, that the company was coming out of a difficult period of restructuring and could commence making a profit. An internal company report on New World prepared in October 1991 by a Mr Hoobin at the request of Mr Munro suggested quite the opposite. Mr Hoobin, after analysing New World's performance and potential, stated:

"Even if the interest payments and the debt burden were

removed I would still regard (New World) as a 3 year

turnaround proposition because of ......"

This report was attached to a memo by Mr Munro apparently sanctioning the report.

40. Even if Mr Baseler's view was correct, this would not assist in resisting the claim. New World was not a company emerging from a period of loss with sources of capital to fund the developments necessary to turn the business around and begin earning profits. It was a company with a serious deficiency in working capital. If New World were to make profits it would have to increase sales. But, for reasons discussed earlier, any increase in sales would produce a cash flow shortage. This is in fact what occurred in September 1991. Thus New World lacked the necessary financial resources to trade its way out of difficulties. The only potential significant source of finance, an inter-company accommodation, was in the hands of a third party, the BNZ. Consequently, no director or manager of ordinary competence could have relied upon such an accommodation being available.

41. All of these matters were clear in July 1991. The inter-company lending freeze was in place. The bankers of Renouf Corporation were offering short term debt moratoriums only. It would have been clear at this time that New World itself had insufficient capital to trade out of its debt position.

42. When one considers that at this time events external to New World made it increasingly likely that the principal and interest owed to Texal or the potential liability under the inter-company guarantees would be called in, the position is even clearer.

43. As at 30 June 1991 New World had a deficiency of shareholders' equity of $4.41m. Counsel for the respondents submitted that the Texal debt of $5.73m should not be included when assessing the financial position of the company. This, he said, would result in a shareholders' equity as at 30 June 1991 of $1.32m. Such an approach is said to be based upon the perception of those involved in the management of New World that the Texal amount was equity, and that it was unlikely that the amount would be called for until New World had the capacity to pay it.

44. There are a number of problems with this approach:

1. The figure of $1.32m may be unrealistic. Even ignoring the

Texal debt, the company was in a precarious position in July

1991 for the reasons set out above. The auditors of New World

had warned on two occasions that upon any break up of New

World, the assets might not realise their book value. In the

Receiver's report to the BNZ dated 10 December 1991 on the

financial position of New World as at 30 October 1991, it is

estimated that upon sale the assets of the company would

achieve somewhere between their $10.7m book value and a $5.5m

estimated auction price.

2. It is not an answer to a claim made under s. 592 to say that

there was sufficient equity to enable creditors to receive 100

cents in the dollar upon a winding up; see Dunn v Shapowloff

supra at 240, per Reynolds JA, Glass JA agreeing. The

question is whether there exist reasonable grounds for an

expectation that the debts would not be paid as they fell due.

The conclusions I have expressed above, with respect to the

ability of New World to continue its business, are therefore of

more significance than the company's balance sheet.

3. There is no reason why the Texal debt should be ignored. It

was certified in the accounts as an unsecured loan, at least

some interest was paid, and additional interest was included in

the accounts as paid, though not in fact paid according to the

respondents. Presumably, upon a winding up Texal would

participate in any distribution as an unsecured creditor.

4. The treatment of the debt as equity by Texal was dependent upon

the continued independence of that company to make such

decisions. However, the troubles of the group as a whole and

the position of the BNZ made it foreseeable that decisions to

waive indebtedness might be taken out of the hands of Texal.

In the circumstances as they existed in July 1991, no director

or manager of ordinary competence could rely upon the Texal

debt not being called for repayment until New World had

sufficient money to pay the debt.

45. As noted earlier, the liability under the cross-guarantees, being a contingent liability, was not included in the company accounts. However, the potential liability was considerable. I have already referred to the precarious financial position of the companies whose debts were guaranteed by New World. Once again, events external to New World demanded that consideration be given to the likelihood that a claim might be made on the cross-guarantees. In the Receiver's report referred to above, reference is made to an amount of $2.46m due to the BNZ as at 30 October 1991 under the cross-guarantees. Such an eventuality was clearly foreseeable as at July 1991. It is clear that the company could not have paid such a sum in the second half of 1991, or indeed a much smaller sum.

46. It follows that the material available at the beginning of July 1991 indicated that the company had insufficient money to trade its way out of difficulties and that it would not be able to pay all its debts, even assuming no extraordinary claims were made on New World. When there is added the significant possibility that claims may be made by Texal or by the BNZ under the cross-guarantees, it is abundantly clear that there were reasonable grounds to expect that the company would be unable to pay its debts.

47. There is a dispute as to whether Mr Carlyle was a director of New World over the relevant period. On 13 June 1991 Mr Carlyle attended a director's meeting of New World. Also in attendance at that meeting was Mr Munro. Mr Carlyle and Mr Munro had travelled from New Zealand to attend the meeting. Mr Carlyle and Mr Munro both stated in their affidavits that in a taxi on the way back to the airport from the meeting, the following exchange took place:

"Mr Carlyle: I want to resign as a director.

Mr Munro: Fine. We will need to organise the

necessary paperwork."

It was understood that Mr Carlyle was referring to resignation as a director of New World. In cross examination, Mr Carlyle stated that he simply forgot to confirm his resignation in writing to New World. He eventually did so after the Receiver and Manager was appointed. In the annual return of New World for the year ended 30 June 1991, Mr Carlyle is shown as a director of the company. The annual return was prepared by Mr Wijeyamohan. Mr Wijeyamohan even amended the address of Mr Carlyle from that shown on the form as printed by the A.S.C. In the directors' report forming part of this annual return and signed by Mr Munro and Mr Baseler on 31 January 1992, Mr Carlyle is recorded as being a director of New World. When asked in cross examination why he signed a report certifying Mr Carlyle's directorship, Mr Munro stated that he believed he had no choice but to do this, as the company's records still showed Mr Carlyle as a director. The following exchange then took place:

"Mr Hammerschlag: But he had spoken to you in a cab

on 13 June 1991?

Mr Munro: That is correct.

Mr Hammerschlag: Was it your understanding that he

had then resigned?

Mr Munro: Yes, it was.

Mr Hammerschlag: So why did you sign this report

then, Mr Munro?

Mr Munro: In fact, on the 13 of - that cab thing - I

indicated that I would accept that and I thought it

was the only sensible thing to do because of the

conflict of personalities that existed between Lutz

Baseler and John (Carlyle). I indicated that I would

have to refer to the managing director of Renouf

Corporation but he could assume that it was accepted.

Mr Hammerschlag: Why did you have to report it to the

managing director of Renouf?

Mr Munro: All changes in directors and secretaries in

our group were all dealt with through Renouf

Corporation, at the Renouf Corporation level.

Mr Hammerschlag: You told him that he could assume

that it was accepted by ....?

Mr Munro: Well, I knew that my recommendation would

be accepted.

...

Mr Hammerschlag: Did you tell Mr Carlyle that you

would have to attend to the paperwork?

Mr Munro: I don't believe that it was discussed."

48. Mr Wijeyamohan testified that he was unaware at the time of the preparation of the 1991 annual return that Mr Carlyle had resigned as a director. Mr Baseler testified that Mr Carlyle did not discuss his resignation or tender it to Mr Baseler (who was the managing director) during 1991.

49. Article 74 of New World's Articles of Association provided as follows:

"74. A director may retire from office upon giving

one week's notice in writing to the Company of his

intention to do so and such resignation shall take

effect upon the expiration of such notice or its

earlier acceptance."

Clearly, the purported resignation of Mr Carlyle did not conform with this requirement. However, the attempted oral resignation does raise an interesting legal question. Counsel for the respondents submitted that the acceptance by Mr Munro of Mr Carlyle's resignation amounted to a waiver by the shareholders of New World of strict compliance with the articles. This argument involves two distinct steps:

1. That a company may by resolution waive non compliance with the

articles of association of the company; see Latchford Premier

Cinema Limited v Ennion (1931) 2 Ch 409.

2. In a case such as the present where there was no resolution,

nevertheless the shareholders acting in unison can do all that a

general meeting of the company could do. This principle is

sometimes known as the "Duomatic" principle, after the case of In

re Duomatic Limited (1969) 2 Ch 365 at 373 where Buckley J, with

reference to a line of authority, stated:

"(W)here it can be shown that all shareholders who have a

right to attend and vote at a general meeting of the

company assent to some matter which a general meeting of

the company could carry into effect, that assent is as

binding as a resolution in general meeting would be."

50. In the present case, Texal owned all of the shares of New World and Mr Munro was a director of Texal. Counsel for the respondents submitted that in accepting Mr Carlyle's resignation, Mr Munro was acting on behalf of all the shareholders of New World, thus invoking the Duomatic principle. There are a number of problems with this approach.

1. The doctrine discussed in Duomatic is a function of the contractual

relationship between the company and its members. The doctrine

arises from a series of cases in which the company or a liquidator

standing in the shoes of the company attempted to sue directors or

former directors for breaches of duty or non-compliance with the

articles. As was said by Meagher JA in Herrman v Simon (1990) 4

ACSR 81 at 83 (Samuels and Priestley JJA agreeing), the

doctrine is essentially one of waiver or acquiescence; see also War

Assets Pty Limited v Federal Commissioner of Taxation (1954) 91

CLR 53 at 88. As such, it cannot be invoked to defend an action

by a third party against, for example, a director.

2. The doctrine was formulated in cases where the shareholders were

natural persons all present and assenting to a particular course of

action. The application of the doctrine to corporate shareholders

may be preserved by s. 249 of the Law. Sub-ss. (3) and (4) of that

section are as follows:

"249 (3) A body corporate may, by resolution of

its board, authorise a specified person

to act as the body's representative at

specified meetings that the body would,

if it were a natural person, be entitled

to attend as a member or creditor

(including debenture holder) of a

company.

(4) A person who is authorised under

subsection (3) is, in accordance with the

authority and until it is revoked,

entitled to exercise on the body's behalf

the same powers as the body could, if it

were a natural person, exercise as a

member or creditor (including debenture

holder) of the company."

The position of a wholly owned subsidiary is specifically

dealt with in sub-s. 249 (7) which states:

"249 (7) Where a holding company holds the whole

of the issued shares in a subsidiary and

a minute is signed by a representative of

the holding company authorised pursuant

to subsection (3) stating that any act,

matter or thing, or any ordinary or

special resolution, required by this Law

or by the memorandum or articles of the

subsidiary to be made, performed, or

passed by or at a general meeting of the

subsidiary has been made, performed, or

passed, that act, matter, thing or

resolution shall, for all purposes, be

deemed to have been duly made, performed

or passed by or at a general meeting of

the subsidiary."

The specific provisions of this sub-section would exclude a

more general application of the Duomatic principle. There is

no evidence that the procedures in sub-ss. (3) or (7) were

complied with in the present case.

attempting to bind New World at the time he accepted

Mr Carlyle's resignation. Mr Munro stated that he

told Mr Carlyle that he would have to refer the

resignation to the managing director of Renouf

Corporation, but that Mr Carlyle could assume that

his resignation was accepted because "I knew that my

recommendation would be accepted".

51. For these reasons, the purported resignation by Mr Carlyle was ineffective and he remained a director of New World throughout the relevant period.

52. The conclusion I have reached renders it unnecessary to consider the further question as to whether a director may rely upon a waiver by the company of a requirement that resignations be made in writing as a defence to an action by a third party creditor under s. 592.

53. Mr Wijeyamohan was the company secretary of New World over the relevant period, and was also New World's accountant. In order for Mr Wijeyamohan to be liable under s. 592 it is necessary to find that he "took part in the management of the company, at the time when the debt was incurred". The evidence indicates that Mr Wijeyamohan's role in the company was little more than an accounting one. He saw to the day to day running of the accounts department, ensured that the supplies were delivered and dealt with customers. He prepared management reports and the company accounts. He also determined the order in which creditors would be paid each month, however this was liable to be overruled by Mr Baseler. Mr Wijeyamohan was sole signatory of the New World bank account when Mr Baseler was absent. Mr Wijeyamohan did attend management meetings and was often consulted before steps were taken. However, his assistance appeared to be of a technical accounting nature - Mr Wijeyamohan was included because he had an intimate knowledge of the accounts of New World. I am satisfied that Mr Wijeyamohan was not responsible for making any of the management decisions of the company and that at most his role would involve the making of suggestions of an accounting nature which may or may not have been acted upon by the directors of New World.

54. The mere fact that Mr Wijeyamohan was company secretary of New World does not determine whether he took part in the management of the company within the meaning of sub-s. 592(1). What is required is to examine his actual role in the position of company accountant: see Holpitt Pty Limited v Swaab (1992) 33 FCR 474 at 476. In that case, Burchett J dealt with the question of whether a person who was company secretary and solicitor was liable under s. 556 of the Companies (New South Wales) Code 1981, (N.S.W.), (which is in identical terms to s. 592 of the Law). Burchett J stated (at 476-477):

"Section 556 is a section which imposes criminal

liability, including imprisonment. It would be quite

inappropriate to give to the statement of an

ingredient of such an offence, "any person who was a

director of the company, or took part in the

management of the company", some loose meaning

ignoring that context. Particularly is this so when

the rationale must be that the person whom the

section singles out is an offender because of the

significance of his role in the company which

incurred the debt. If his role is a junior one,

giving him no real influence on the decision, or if

his role is that of an outside professional, who

might advise, but would certainly not be taking the

decision, there is no reason to think that the

language of the section should be stretched to

include him."

55. On this approach, what is required is that the person have some decision making role in the company. In the present case, it is clear that Mr Wijeyamohan was a mere employee who took orders from those who actually made the management decisions. It follows that he is not a person liable under sub-s. 592 (1).

56. The result is that sub-s. 592(1) applies to the three directors, Mr Baseler, Mr Munro and Mr Carlyle. It remains to consider any available defence under para. 592(2)(b). For this purpose it is necessary to consider the position of each respondent separately. However, it should be noted that at least as regards Mr Baseler and Mr Munro, the thrust of the case for the respondents was that sub-s. 592(1) did not apply. Much less attention was given to any defence under sub-s. 592(2).

57. Mr Baseler was managing director of New World over the relevant period. As such, he was in charge of the day to day operation of the company. Mr Baseler, Mr Munro and Mr Wijeyamohan would meet on a monthly basis to discuss the monthly management accounts. Each monthly account would appear about the middle of the next month. Mr Baseler also received weekly management reports from Mr Wijeyamohan. Mr Baseler was therefore well aware of the financial position of New World and well aware of the likely future demands placed on the company finances by the course of trading. He also knew that there were restrictions placed on inter-company loans and that New World had to survive with the facility at the BNZ. In addition, Mr Baseler knew that Renouf Corporation was in financial difficulties, and he knew that Alliance Textiles was dependent on the support of its bankers.

58. I find that Mr Baseler was aware of all of the elements which I have taken into account in dealing with sub-s. 592(1). Even if I had not made such a finding, they are all matters of which he ought to have been aware. The financial health of the group, in particular, was a matter vital to the continuing viability of his company. There was no material of any significant weight to support a consideration that Mr Baseler did not have reasonable cause to expect the inability of the company to pay its debts, in terms of sub-para. 592(2)(b)(i). No defence has been made out.

59. Mr Munro's position is even clearer. He was a director of New World over the relevant period as well as being a director of Alliance Textiles and R. & W. Hellaby. He was fully aware of the financial position of New World as he was sent the management accounts on a monthly basis, attended New World Meetings in Sydney every month and was in regular contact with Mr Wijeyamohan regarding New World's finances. He would have been well aware in July 1991 of the likely financial performance of New World over the remainder of the year. In addition, Mr Munro was fully aware of the financial position of the rest of the group. I therefore find that no defence under sub-s. 592(2) is available to Mr Munro.

60. From November 1985 Mr Carlyle was managing director of Levana. This was a wholly owned subsidiary of Alliance Textiles. He believed he became a director of New World as a result of his position at Levana. Mr Carlyle looked to Alliance Textiles as parent company of both Levana and New World. He regarded Mr Munro as representing the New Zealand entities in the group. From February to June 1991 New World manufactured fabrics for Levana. It was as a result of this "interaction", as Mr Carlyle put it, that he rejoined the board of New World on 4 March 1991. After the commencement of the receivership, Levana expressed an interest in buying certain machinery from New World.

61. After a directors' meeting on 13 June 1991, the date of the alleged resignation, Mr Carlyle did not attend any further board meetings of New World. However, the minutes of the meeting of 13 June 1991 indicate that it was a meeting of importance and that the financial position of New World was discussed in a detailed manner. Subjects covered at the meeting included the management accounts for May 1991, various provisions to be made in the accounts for the financial year ending 30 June 1991, and the budget for the following financial year. There is nothing to indicate that the position of New World changed materially between 13 June 1991 and 6 July 1991. I am satisfied that Mr Carlyle was aware of the financial position of the company as at the beginning of July 1991. Indeed, there is some evidence that Mr Carlyle was concerned at the position of the company. In cross examination, after being asked about his purported resignation, the following exchange took place:

"Mr Hammerschlag: But did you ultimately ever

confirm (the resignation) in writing?

Mr Carlyle: Yes, I did.

Mr Hammerschlag: Why?

Mr Carlyle: Because I had been instructed - advised - to do so.

Mr Hammerschlag: That was after the company went

into receivership, was it?

Mr Carlyle: That's correct, yes.

Mr Hammerschlag: And you were then concerned that

you as a director might be liable for its debts?

Mr Carlyle: I was concerned a long time before

that.

Mr Hammerschlag: Why, if you had resigned, Mr Carlyle?

Mr Carlyle: Because my name was still showing as a

director on the company when I had no influence

over its affairs.

Mr Hammerschlag: And you knew that?

Mr Carlyle: Pardon?

Mr Hammerschlag: You knew that it was being shown,

you were being shown as a director of the company,

is that correct:

Mr Carlyle: Well, obviously, because I'd been

served with papers in that capacity."

62. Even if Mr Carlyle was not aware of the precise financial position of the company through the relevant period, this is something of which he ought to have been aware. From the meeting on 13 June 1991, he was aware that and believed that the company was in considerable financial difficulty. It is worth recalling that what is in issue here is whether Mr Carlyle has made out a defence and that in this matter the Court may have regard to what, by reason of the duties of his office, he ought to have known. His duties obliged him to have informed himself of the subsequent financial position of the company. Any failure on the part of Mr Carlyle to so inform himself cannot be used in aid of a defence under sub-s. 592(2). In addition, as managing director of Levana, a direct wholly owned subsidiary of Alliance Textiles, Mr Carlyle should have been aware of the restrictions placed on Alliance Textiles and the rest of the group with respect to inter-company lending.

63. Again, there was no material of any significant weight to support the conclusion that Mr Carlyle did not have reasonable cause to expect the inability of the company to pay its debts, in terms of sub-para. 592(2)(b)(i). No defence has been made out.

64. In the amended Statement of Claim, Sycotex also alleges that the first, second and third respondents (that is, the directors of New World) owed a duty to Sycotex to have regard to its interests as a creditor of New World. As I have noted, this claim was only referred to briefly in argument. The authorities in this area are somewhat unsatisfactory. Statements in some cases appear to have resulted from a misreading of comments by Mason J in Walker v Wimborne [1976] HCA 7; (1976) 137 CLR 1 at 7, where it is stated:

"In this respect it should be emphasised that the

directors of a company in discharging their duty

to the company must take account of the interest

of its shareholders and its creditors. Any

failure by the directors to take into account the

interests of creditors will have adverse

consequences for the company as well as for them."

That case involved an action by the liquidator against former directors of the company to recover losses sustained by the company as a result of the making of certain payments. Section 367B(1)(b) of the Companies Act 1961 (N.S.W.) empowered the liquidator to recover damages for breach of duty from directors of the company. The comments of Mason J emphasised that the duty is owed to the company, not to third parties.

65. The circumstances in which the duty to the company includes an obligation to take account of the interests of third parties appears from the decision of Kinsela v Russell Kinsela Pty Limited (In Liq) (1986) 4 NSWLR 722. In that case, the liquidator sought to avoid a lease of business premises owned by the company to former directors of the company. At first instance, Powell J found that, the lease not being in the interests of the company, the powers of the directors had been exercised for an impermissible purpose. He went on to hold that, there having been an absence of full disclosure to the shareholders, the transaction was not authorised by the shareholders. The appellants sought to rely upon the unanimous approval of all the shareholders as placing the transaction beyond successful attack by the company. After considering a number of authorities, Street CJ (Hope and McHugh JJA agreeing) stated (at 732):

"It is, to my mind, legally and logically

acceptable to recognise that, where directors are

involved in a breach of their duty to the company

affecting the interests of shareholders, then

shareholders can either authorise that breach in

prospect or ratify it in retrospect. Where,

however, the interests at risk are those of

creditors I see no reason in law or in logic to

recognise that the shareholders can authorise the

breach. Once it is accepted, as in my view it

must be, that the directors' duty to a company as

a whole extends in an insolvency context to not

prejudicing the interests of creditors ... the

shareholders do not have the power or authority to

absolve the directors from that breach."

66. It is clear that the duty to take into account the interests of creditors is merely a restriction on the right of shareholders to ratify breaches of the duty owed to the company. The restriction is similar to that found in cases involving fraud on the minority. Where a company is insolvent or nearing insolvency, the creditors are to be seen as having a direct interest in the company and that interest cannot be overridden by the shareholders. This restriction does not, in the absence of any conferral of such a right by statute, confer upon creditors any general law right against former directors of the company to recover losses suffered by those creditors: see the discussion by Mr J.D. Heydon QC, "Directors' Duties and the Company's Interests" in Finn, ed, Equity and Commercial Relationships, 1987, p 120. As Mr Heydon there notes, at 131, the result is that there is a duty of imperfect obligation owed to creditors, one which the creditors cannot enforce save to the extent that the company acts on its own motion or through a liquidator.

67. The result is that the application against the fourth respondent should be dismissed and that there should be an order that Mr Baseler, Mr Carlyle and Mr Munro (the first, second and third respondents) are jointly and severally liable, along with New World itself, for the payment of the debts owing to Sycotex the subject of these proceedings. The costs of the applicant should be paid by the first, second and third respondents. The fourth respondent's costs should be paid by the applicant. As was noted earlier, the debts were agreed to amount to a total of $213,756.09. In the course of his submissions, counsel for the applicant suggested that interest should be calculated as if this entire sum fell due 90 days after 31 October 1991. Consequently, the only order I shall make at this stage is that liberty be granted to bring in short minutes of order to give effect to these reasons for judgment. Any questions of set-off of costs should be dealt with in the short minutes.