KMS Imports (Aust) Pty Ltd (In Liq) v Wang, in the matter of KMS Imports

Federal Court of Australia|2016-12-22|Before: Mr J, Gilmour J

The second defendant pay to the plaintiff: (a) the sum of $74,159.37 pursuant to s 588M of the Corporations Act 2001 (Cth); plus (b) interest pursuant to s 51A of the Federal Court Act 1976; plus (c) the plaintiff's costs (to be taxed in default of agreement). Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

GILMOUR J: 1 On 31 October 2014, the plaintiffs commenced proceedings in the Federal Court of Australia by originating process in which they sought numerous orders against the first defendant (Mrs Wang) pursuant to Part 5.7B of the Corporations Act 2001 (Cth) (Act). 2 On 7 April 2016, the second defendant (Mr Li) was added as a defendant to the proceedings. 3 On 11 April 2016, the plaintiffs filed a further amended originating process and statement of claim in which they sought orders against Mr. Li pursuant to s 588M of the Act.

Plaintiffs' claims 41 The Liquidator contends that Mr Li has breached s 588G(2) of the Act and, pursuant to s 588M of the Act, the Liquidator may recover from Mr Li as a debt due to the Company the sum of $74,159.37 plus interest and costs.

Trading Whilst Insolvent 42 Section 588G(1) of the Act provides: This section applies if: (a) a person is a director of a company at the time when the company incurs a debt; and (b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and (c) at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be; and (d) that time is at or after the commencement of this Act. 43 Section 588G(2) of the Act provides: By failing to prevent the company from incurring the debt, the person contravenes this section if: (a) the person is aware at that time that there are such grounds for so suspecting; or (b) a reasonable person in a like position in a company in the company's circumstances would be so aware. 44 Section 588M of the Act provides: (1) This section applies where: (a) a person (in this section called the director) has contravened subsection 588G(2) or (3) in relation to the incurring of a debt by a company; and (b) the person (in this section called the creditor) to whom the debt is owed has suffered loss or damage in relation to the debt because of the company's insolvency; and (c) the debt was wholly or partly unsecured when the loss or damage was suffered; and (d) the company is being wound up; whether or not: (e) the director has been convicted of an offence in relation to the contravention; or (f) a civil penalty order has been made against the director in relation to the contravention. (2) The company's liquidator may recover from the director, as a debt due to the company, an amount equal to the amount of the loss or damage.

Debt incurred 45 On or about 12 January 2012, the DCT lodged a proof of debt with the Liquidator. The proof of debt is described as "Running Balance Account deficit debt in respect of BAS amounts as at 7 December 2011" in the sum of $74,159.37 (Debt). According to the running balance account, the Debt was incurred between 2 January 2009 and the date of winding up. The plaintiffs contend Mr Li was a director of the company during this period and he is liable to compensate the Company the sum of $74,159.37.

Mr Li was a director when the debt was incurred 46 A 'director' of a company is defined in s 9 of the Act as: (a) A person who: (i) is appointed to the position of a director; or (ii) is appointed to the position of an alternate director and is acting in that capacity regardless of the name that is given to their position; and (b) unless the contrary intention appears, a person who is not validly appointed as a director if; (i) they act in the position of a director; or (ii) the directors of the company or body are accustomed to act in accordance with the person's instructions or wishes. 47 According to the records maintained by ASIC: (a) On 23 November 2006, Mr Li was appointed a director of the Company; and (b) On 15 December 2011, a Form 484 - "Change to Company details" (Form) was lodged with ASIC which states that Mr Li purportedly resigned as a director of the Company on 1 July 2011. 48 The Form was lodged: (a) 167 days after Mr Li purportedly resigned as a director of the Company. (b) 8 days after the Court ordered that the Company be wound up in insolvency. (c) 7 days after the Liquidator sent Mr Li a letter advising him of the winding up of the Company. 49 The Liquidator did not lodge the Form nor did he authorise anyone to lodge the Form on behalf of the Company. 50 Importantly, the Form is not, in and of itself, evidence of when (if at all) Mr Li validly resigned as a director of the Company. The validity and effectuation of the resignation will be determined according to the Company's constitution (or the replaceable rules) and the common law. For example, for companies which have elected to have replaceable rules apply to them, s 205A of the Act permits a director or secretary who retires or resigns to give ASIC written notice. In the case of resignation, the notice must be accompanied by a copy of the letter of registration given to the company. 51 In circumstances where no letter of resignation or minutes of meetings of the directors of the Company or any such similar documents have been produced evidencing Mr Li's resignation as a director of the Company, and in circumstances where Mr Li has not sought to file any affidavit material explaining the circumstances of his resignation as a director of the Company, the Court should infer that Mr Li was, as a matter of fact, a director of the Company at the date of winding up. 52 Mr Li states in his defence that he had ceased working with the Company in any capacity from January 2010. No evidence was tendered in support of the assertion contained in Mr Li's defence. Even if Mr Li did cease working with the Company, according to the ASIC register, he remained after January 2010 a director of the Company.

Company was insolvent 53 The plaintiffs contend that at the time that the Company incurred the debt in respect of which the s 588M(2) claim has been brought, the Company was presumed to have been insolvent. Alternatively, the plaintiffs contend that the Company was, as a matter of fact, insolvent. 54 Section 286(1) of the Act provides: A company, registered scheme or disclosing entity must keep written financial records that: (a) correctly record and explain its transactions and financial position and performance; and (b) would enable true and fair financial statements to be prepared and audited. 55 Section 286(2) of the Act provides: The financial records must be retained for 7 years after the transactions covered by the records are completed. 56 Financial records is defined in s 9 of the Act as including: (a) invoices, receipts, orders for the payment of money, bills of exchange, cheques, promissory notes and vouchers; and (b) documents of prime entry; and (c) working papers and other documents needed to explain: (i) the methods by which financial statements are made up; and (ii) adjustments to be made in preparing financial statements. 57 Section 588E(4) of the Act provides: Subject to subsections (5) to (7), if it is proved that the company: (a) has failed to keep financial records in relation to a period as required by subsection 286(1); or (b) as failed to retain financial records in relation to a period for the 7 years required by subsection 286(2); the company is to be presumed to have been insolvent throughout the period. 58 The presumption applies for the purpose of a proceeding for a contravention of s 588G(2) in relation to the incurring of a debt by the company (including proceedings under section 588M in relation to the incurring of the debt not including proceedings for an offence). 59 The Liquidator has made numerous demands for the delivery up of the Company's books and records. No book and records have been produced. In the circumstances, the Company has not complied with s 286 of the Act and it can be presumed, pursuant to s 588E(4), that the Company was insolvent since incorporation. 60 Even if books and records exist, the Company failed to lodge business activity statement for the quarter ended 31 December 2011 and income tax returns for the years ended 30 June 2007, 30 June 2010, 30 June 2011 and 30 June 2012. In the circumstances, the books and records could not correctly record and explain the Company's transactions and financial position and performance and would not enable true and fair financial statements to be prepared and audited. In the circumstances, the Company would not have complied with sections 286(1) of the Act and it could be presumed pursuant to s 588E(4) of the Act that the Company was insolvent since 30 June 2007. 61 In the alternative, s 95A(1) of the Act provides that a person is solvent if, and only if, the person is able to pay all of the person's debts, as and when they become due and payable. Further, s 95A(2) of the Act provides that a person who is not solvent is insolvent. 62 On 23 February 2009, the Company became indebted to the DCT for outstanding tax liabilities in the sum of $1,248. The debt amount continued to increase until the date of winding up. The Company made no payments to the DCT in respect of its outstanding tax liabilities. In the circumstances, the Company was insolvent since at least 23 February 2009.

Reasonable grounds to suspect the Company was insolvent 63 The next issue for consideration is whether the Liquidator has shown that there were reasonable grounds for suspecting that the Company was insolvent at the time that it incurred the Debt in respect of which compensation is claimed in this proceeding. 64 In Australian Securities and Investments Commission v Edwards (2005) 220 ALR 148 at [249]- [250], Barrett J made the following observations in relation to the approach to be taken in assessing whether an applicant has satisfied the requirements of s 588G(1)(c): [249] The inquiry relevant to s 588G(1)(c) is not an inquiry concerning the particular director whose conduct is under scrutiny. It is an inquiry into the objectively formed state of mind of a person of ordinary competence. These propositions are supported by cases such as 3M Australia Pty Ltd v Kemish (1986) 10 ACLR 371 and Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699. As Einfeld J observed in the latter case (at 703) questions of the particular director's knowledge of and participation in the incurring of the debt play no part in this aspect of the s 588G inquiry. [250] The central word in s 588G(1)(c) is "suspecting". The criterion is one of suspicion, which is something less developed and less well formulated than expectation. The matter was explained by Kitto J in Queensland Bacon Pty Ltd v Rees [1966] HCA 21; (1966) 115 CLR 266 at 303 in this way: In the first place, the precise force of the word "suspect" needs to be noticed. A suspicion that something exists is more than a mere idle wondering whether it exists or not; it is a positive feeling of actual apprehension or mistrust, amounting to "a slight opinion, but without sufficient evidence", as Chambers's Dictionary expresses it. Consequently, a reason to suspect that a fact exists is more than a reason to consider or look into the possibility of its existence. The notion which "reason to suspect" expresses in subs (4) is, I think, of something which in all the circumstances would create in the mind of a reasonable person in the position of the payee an actual apprehension or fear that the situation of the payer is in actual fact that which the subsection describes - a mistrust of the payer's ability to pay his debts as they become due and of the effect which acceptance of the payment would have as between the payee and the other creditors. 65 In McLellan, in the matter of The Stake Man Pty Ltd v Carroll (2009) 76 ACSR 67 at [144], Goldberg J observed: The test prescribed by s 588G(1)(c) is an objective test: Powell v Fryer [2001] SASC 59; (2001) 159 FLR 433, Hall v Poolman (above) at [231]. The concept of "suspecting" or "suspicion" involves having a state of mind which falls between having a firm belief or a significant degree of satisfaction that insolvency exists on the one hand and wondering whether it exists on the other. The concept of having a "suspicion" requires an affirmative feeling: Hall v Poolman (above) at [231]. 66 The plaintiffs contend that a person of ordinary competence would, on the basis of the foregoing facts and circumstances, objectively have suspected that the Company was not able to pay all of its debts as and when they fell due. Accordingly, the requirements of s 588G(1)(c) of the Act have been satisfied.

Reasonable person would have suspected the Company was insolvent 67 Section 588G(2) of the Act provides: By failing to prevent the company from incurring the debt, the person contravenes this section if: (a) the person is aware at that time that there are such grounds for so suspecting; or (b) a reasonable person in a like position in a company in the company's circumstances would be so aware. 68 In Australian Securities & Investments Commission v Plymin (No 1) (2003) 46 ACSR 126 at [325], Mandie J held: It would seem to follow … the essence of a failure by a director to prevent a company form incurring a debt is a failure by that director to take all reasonable steps within his power to prevent the company form incurring such a debt. The effect of the provisions, shortly stated, is that if the requirements of s 588G(1) are proved in circumstances where either ss (a) or ss (b) of s 588G(2) is also proved, a director will be taken to have failed to prevent the company form incurring the debt unless it is proved that the director to all reasonable steps to prevent the company form incurring the debt. 69 Mandie J further held at [426]: What s 588G(2)(a) requires is proof of a subjective awareness by the director of grounds, whether or not the director has a "subjective suspicion" of insolvency, which grounds may be objectively characterised as reasonable grounds" for suspecting insolvency. If, on the other hand, it cannot be shown that the director was aware of such grounds, s 588G(2)(b) provides an alternative basis for the plaintiff to establish a contravention. That is to say, under that provision, if a reasonable person (in a like position to the particular director in a company in Water Wheel's circumstances) would be aware of the existence of reasonable grounds for suspecting insolvency, it does not matter that the particular director was not so aware. Section 588G(2)(b) would therefore typically deal with the case where the particular director was unaware of the facts and matters constituting reasonable grounds for suspecting insolvency because he had failed to ascertain them, if a reasonable person in a like position would or ought to have ascertain those facts and matters." 70 In Green in his capacity as liquidator of Arimco Mining Pty Ltd (in liq) v CGU Insurance Ltd (2008) 67 ACSR 398 at [313], Einstein J held: Subsection 588(2)(b) applies to cases where the directors did not know of the relevant facts and matters because they had failed to ascertain them, but a reasonable person in a like position would or ought to have ascertained those facts and matter. 71 In Rema Industries and Services Pty Ltd v Coad (1992) 7 ACSR 251 at 259, Lockhart J said: The test of 'reasonable cause' in the context in which the expression appears imports an objective standard, but it must be applied to the facts and circumstances known to the defendant and facts and circumstances which, by reason of the defendant's duties as a director or officer of the company, ought to have been known to him. It would be absurd for a defendant to be able to establish a defence simply on the basis of what he in fact knew. This would reward the incompetent director who ought to have known a great deal more than he in fact knew. 72 The plaintiffs concede that in light of Mr Li's recent evidence that he didn't know what was happening with the Company after January 2010, they are unable to establish Mr Li was aware at the time the debt was incurred that there were grounds for suspecting the Company was trading whilst insolvent. 73 Nevertheless, the plaintiffs rely on s 588G(2)(b) and contend that Mr Li was a director of the Company at all relevant times and a reasonable person in the position of a director of the Company would have monitored whether the Company was meeting and was able to meet its tax obligations as and when they fell due. Further, that director would have also monitored the state of the Company's financial affairs. Such activities would have invoked an awareness of reasonable grounds to suspect that the Company was insolvent. In the circumstances, a reasonable person in the position of Mr Li, as a director of the Company, would have been aware that there were reasonable grounds to suspect from at least 23 February 2009 that the Company was unable to pay its debt as and when they fell due.

Conclusion 74 In light of the above, the plaintiffs contend they have satisfied each of the elements in section 588G of the Act. The plaintiffs further contend that the ATO has suffered loss or damage in relation to the incurring of the Debt, which is unsecured, because the Debt is still owed to the ATO and there is unlikely to be any recovery in the winding up. 75 It is noted that Mr Li was self-represented in this proceeding. To the extent Mr Li's defence is capable of constituting a defence in reliance on s 588H(4) of the Act, the plaintiffs contend that Mr Li's lack of involvement in running the Company does not constitute "some other good reason" within the meaning of that sub-section. The words "good reason" must be read down in accordance with the scope and purpose of the legislation in which they appear "so that they do not conflict with the obligation of directors generally to participate in the management of the company". Reasons which cause a director never to participate in management are not capable of constituting "good reason" for not participating at a particular point of time. 76 For reasons outlined above, the Court will make the following orders: The second defendant pay to the plaintiff: (a) the sum of $74,159.37 pursuant to s 588M of the Corporations Act 2001 (Cth); plus (b) interest pursuant to s 51A of the Federal Court Act 1976; plus (c) the plaintiff's costs (to be taxed in default of agreement). I certify that the preceding seventy-six (76) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Gilmour.

Bankruptcy Act 1966(Cth)s 58(3)(b)

Corporations Act 2001(Cth)ss 9, 95A(1), 95A(2), 205A, 286, 286(1), 286(2), 588E(4), 588G(1), 588G(1)(c), 588G(2), 588H(4), 588M, 588M(2), 596B

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