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[2005] NSWCA 243
respondent. Appeal dismissed with costs.
The Court of Appeal upheld Palmer J and dismissed the liquidator's appeal. The principal legal conclusions were: (1) when testing insolvency under s 95A the court must look to commercial realities, and voluntary intra-group funding may be treated as a real available resource if, realistically, it was available to meet debts; (2) the 1994 intra-group debt restructuring (replacing an on-demand debt from Holdings with a six-year debt from DCA) was not an uncommercial transaction in the factual matrix because it had a legitimate commercial purpose and Constructions had access to group funds; (3) journal entries posted later did constitute acts giving effect to the transaction for avoidance purposes; and (4) causation for avoidance requires a reasonably close link between the transaction and insolvency, but the restructure could be one contributing cause. The appeal was dismissed with costs.
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Facts in brief. Doran Constructions Pty Ltd ("Constructions") was part of a family-owned group including Doran Constructions (Australia) Pty Ltd ("DCA") and Doran Holdings Pty Ltd ("Holdings"). On 1 November 1994 directors resolved a group debt restructuring: Holdings would repay (or the accounts be adjusted to show repayment of) $4.1 million to Constructions, Constructions would lend $4.1 million to DCA for six years, and DCA would apply that sum to reduce its indebtedness to Holdings. The net effect replaced an on‑demand debt owing by Holdings to Constructions with a long‑dated unsecured debt owing by DCA to Constructions ([2], [16]-[17], [19]-[21]).
No immediate cheques passed. Journal entries giving effect to the restructure appear in the books at 4 September 1995 ([21], [22]). Constructions executed a deed of charge in favour of Holdings on 18 July 1995 ([35]). Over the next three years intra‑group payments and advances continued; in aggregate about $5.1M was provided from group entities to Constructions between 1 Nov 1994 and 24 Dec 1997 ([66]-[69], [116]). Holdings gave notice on 16 December 1997 it would cease providing funds; Constructions was put into liquidation on 24 December 1997 ([62]-[64]). The liquidator sued the directors and Holdings alleging breach of statutory and fiduciary duties and sought avoidance of the transaction as an insolvent/uncommercial transaction under the Corporations Law (principally ss 588FB/588FC/588FE) ([3], [24], [28]-[34]).
At first instance Palmer J dismissed the liquidator’s claims. The liquidator appealed; the Court of Appeal (Giles JA, Hodgson JA, McColl JA) dismissed the appeal with costs, upholding the primary judge's findings and legal approach ([1], [3], [161]-[163]).
Three interlocking legal questions drove the decision:
How to apply the statutory insolvency test (s 95A) where intra‑group support exists. Giles JA accepted Palmer J’s conclusion that s 95A should be applied by reference to commercial realities. The court concluded that resources available from related companies, voluntary extensions of credit or advances, may be taken into account if, as a matter of commercial reality at the relevant time, those resources were available to meet the company’s debts ([79], [106], [116], [118]).
Key factual inputs: (a) reconstructed balance sheet and the absence of usual indicia of insolvency as at 1 Nov 1994, (b) evidence that creditors were paid and continued to be paid for about three years after the restructure without complaint, and (c) the reality that the group had been habitually moving cash intra‑group and Holdings had acted as the group's banker ([75]-[76], [116]-[119], [114]-[116]). These facts permitted the trial judge to find Constructions solvent at relevant times.
Whether the restructure was an uncommercial transaction (s 588FB). The statutory test is objective (what a reasonable person in the company’s circumstances would do) and requires balancing benefits and detriments to the company and benefits to other parties. The court accepted that the restructure had a legitimate commercial purpose, segregation of property‑holding and construction activities to improve finance prospects, and that this could provide a real benefit to Constructions through the practical operation of Holdings as banker to the group. On balance, the detriment (a substituted deferred debt from DCA) was not shown to be unreasonable in the context of the group’s commercial reality ([156]-[160], [125]-[129], [151]-[153]).
Whether the later posting of journal entries and later insolvency made the transaction voidable or in breach. The Court accepted that the September 1995 journal postings were acts done for the purpose of giving effect to the 1994 resolution and so fall within the scope of s 588FE(4) for the temporal window ([121]-[123]). On causation, Giles JA emphasised a common‑sense but circumscribed approach. The insolvency that must be shown to be “because of” the transaction should be fairly closely related to entering into or giving effect to it; the avoidance provisions are not intended to sweep in remote later events. The Court nonetheless accepted that the restructure could be one contributing cause of insolvency later when support was withdrawn in 1997 ([133]-[141]).
Because the liquidator failed to establish that Constructions was insolvent at the relevant times or that the restructure was objectively uncommercial, the primary factual and legal findings were upheld and the appeal dismissed ([119], [160], [161]).
Before this decision there was debate about whether a creditor‑oriented cash‑flow test should ignore voluntary intra‑group support for the purpose of s 95A. Some experts argued a company's ability to pay should be confined to its own assets and trading cash flows; other authorities recognised that borrowings and access to funds can count (cited authorities include Sandell v Porter, re RHD Power, re Adnot, re Kerisbeck) ([75], [80]-[81], [107], [110], [112]).
Giles JA endorses and articulates a clear statement: the omission of the older wording “from his own monies” removes an artificial restriction; s 95A requires a pragmatic assessment of commercial realities and may include voluntary extensions of credit or borrowings (even unsecured) if, factually, those resources were available to meet debts as they fell due ([79], [106], [116], [109]-[111]). That is not an invitation to unfettered hindsight, the facts known to directors and the immediate foreseeable future must be considered ([103]-[104]). The decision thus confirms that intra‑group support, if demonstrably available in commercial reality, is relevant and can be decisive on solvency.
On insolvent transactions/avoidance, the Court reiterates that s 588FB is an objective balancing test and that causation under s 588FC requires a sufficiently close connection between transaction and insolvency; the Court resists an overly expansive causation test that would make directors’ commercial decisions unduly risky ([156]-[160], [133]-[140]).
Paragraph 116: "s.95A requires ... by reference to the commercial realities." Translation: When testing whether a company can pay its bills, the court looks to how things would actually operate in business terms, including whether the company could realistically get money from related companies or lenders, not a narrow paper-only test.
Paragraph 75 (selected parts): listing absence of usual indicia of insolvency. Translation: There were no warning signs like bounced cheques, demands from banks, or unpaid statutory liabilities. That factual picture supports a conclusion of solvency.
Paragraph 118: "What actually occurred ... proves that the funds of the other companies ... were a resource available." Translation: The fact that the group actually provided money for years shows those funds were truly available then; you cannot ignore what actually happened when deciding solvency.
Paragraph 123: "Posting the journal entries was doing what had been agreed should be done." Translation: Even if no cheques changed hands, adjusting the accounting records to show the new loan positions was the practical step that put the restructuring into effect and can be the act the statute targets.
Paragraph 128: "Holdings' role as banker ... it could be seen as reasonably in the interests of Constructions to facilitate the Restructure." Translation: If Holdings was acting as the group's bank, then helping Holdings raise finance (by tidying accounts) could reasonably benefit Constructions too.
A company in a group depends materially on predictable, voluntary funding or advances from a related company, with a track record of intra‑group payments and no immediate bank or creditor pressure; fact evidence of actual advances strengthens the conclusion that such funds were a commercial resource ([66]-[76], [114]-[119]).
Restructuring that substitutes one related party debtor for another (particularly where the receiving related company plays a banker role) will not automatically be an uncommercial transaction if the directors' contemporaneous purpose was a legitimate commercial one and the company retained realistic access to funds ([125]-[129], [151]-[153]).
Journal entries or other book adjustments made within the statutory avoidance window can be treated as acts done to give effect to a prior agreement and thus attract s 588FE(4) scrutiny ([121]-[123]).
However, the availability of intra‑group resources must be proven by evidence showing the funding was real and within the directors’ control or legitimately expected; mere optimism is insufficient ([116], [118], [116]-[119]).
(This judgment itself is a Court of Appeal decision and will be cited as authority. The decision endorses a pragmatic approach to s 95A and to intra‑group funding; subsequent courts dealing with intercompany support and directors' duties should treat this case as authoritative in New South Wales on the relevance of voluntary group support as a commercial reality. Practitioners should expect courts to require strong fact evidence of actual and reliable intra‑group support before treating a company as solvent where it depends on related parties. The judgment also provides useful guidance on causation in avoidance claims: a causal link must be reasonably close, not merely remote or contingent ([116], [133]-[141]).)
Quantum and reliability of intra‑group support. The Court accepted historical provision of funds as evidence that such funds were a resource. But where the evidence is less clear (informal promises, no consistent pattern), the line between a credible available resource and mere hope remains fact-specific.
Effect of breaches of directors’ duties by the supporting entity. Giles JA noted the court did not have to treat Holdings' provision as improper; but if support came from a parent/holding company in breach of its own duties, can a court still treat such funds as a legitimate resource for s 95A? The judgment assumes absence of such breach ([113]).
Balance between objective test and director knowledge. The Court emphasised the company's circumstances include knowledge of its directing minds. How courts will weigh subjective beliefs against objective financial indicators in marginal cases will continue to require careful fact-finding.
The role of security arrangements. The decision accepted that borrowings secured on third-party assets could be considered; the precise treatment where informal intra‑group funding is backed by weak security remains to be fleshed out.
Causation scope under s 588FC(b). Giles JA warns against expansive causation. Future cases will test how close is 'close enough' when a transaction contributes alongside other events to insolvency; that will involve policy judgments sensitive to context.
Practitioners: document and produce contemporaneous evidence of (a) the commercial rationale for intra‑group restructures; (b) predictable, actual intra‑group funding patterns and authority to obtain funds; and (c) careful contemporaneous financial analysis of solvency using realistic cash‑flow timings. That evidentiary focus is decisive under this authority.
Background 5 The Doran family had been engaged in the building and construction industry in and around Newcastle since at least the 1950s. The directors' father began the business, and all the directors went into it when they left school. 6 Constructions was incorporated in February 1977 and took over the family construction business. By the 1990s the group comprised some fourteen companies in addition to Constructions, DCA and Holdings. The companies in the group had varied activities; as well as building and construction work, they engaged in property development, plant and machinery hire, operating a real estate agency and a tavern, and conducting two large shopping centres, two private hospitals and a medical centre. 7 As did Palmer J, without intending disrespect I will refer to the directors by their given names. Paul was the managing director of the companies in the group. Palmer J described him as having the most experience in business, management, finance and accounting and as a highly intelligent, articulate and capable businessman. Peter was primarily responsible for the property development activities of the group. Michael was mainly involved in day to day construction and supervision on building sites, and did not participate in management of the group's businesses. John had been engaged in the plant and machinery hire activity, and was otherwise not involved in management of the group's businesses. 8 From 1989 Mr Bradley Joyce, a qualified accountant, was employed as the group's financial controller. In about 1994 he became the general manager within the group. At material times Price Waterhouse acted as external accountants and, at least until 30 June 1994, auditors, Mr Martin Linz being the responsible partner. Price Waterhouse prepared the annual financial statements and provided accounting advice as required. 9 Over the period 1989-1992 the composition of the group was altered, with advice also from Ernst & Young, accountants and Holman Webb, solicitors. One of the purposes was to make DCA the holding company of those companies in the group carrying on building, construction and associated activities and Holdings the holding company of the remaining companies. As part of this process, in July 1992 Holdings lent $3,156,662 to DCA to enable it to purchase from Holding all the share capital in Constructions and a further $1,655,069 to enable it to purchase from Holdings all the share capital in another company in the group, Doran Property Services Pty Ltd ("DPS"). The loans were repayable on demand and "interest free reviewable every 3 years". 10 As at 31 October 1994 DCA owed Holdings $4,592,145. The July 1992 loans to DCA were a substantial component of DCA's debt, but there must have been other components of or movements in the DCA loan account prior to the debt restructuring. 11 As at 31 October 1994 Holdings owed $5,288,811 to Constructions. The debt represented loans made from time to time by Constructions over the preceding years, the detailed makeup being unclear. Holdings' indebtedness was shown in the audited accounts (as a non-current liability) at $3,802,094 as at 30 June 1993 and $5,335,967 as at 30 June 1994, but there was evidence that Holdings transferred over $1.2 million to Constructions in the fifteen months or so prior to 31 October 1994; there must have been a lot of movements in the loan account. The debt was repayable on demand and, so far as the evidence showed, interest free. 12 There were other inter-company loan accounts, apart from these debts between DCA, Holdings and Constructions. They included debts of Holdings to DPS of $1,382,575 and of Dyspane Pty Ltd ("Dyspane") to Constructions of $1,210,000 as at 31 October 1994.
The debt restructuring 13 Directors' meetings of at least Holdings and Constructions were held on 1 November 1994. All the directors were present. In attendance were Mr Joyce, Mr Linz and Mr Christopher Freeman, the solicitor for the group. There were two sets of minutes for Holdings and one for Constructions. All were signed by Paul as chairman. 14 Taking them in the appropriate sequence, the minutes of the meetings relevantly recorded as follows. 15 The first minutes for Holdings recorded - " BUSINESS The meeting was called to discuss the payment of the money due by Doran Constructions Australia Pty Limited to this Company being the money lent to Doran Constructions Australia Pty Limited to enable it to purchase shares in Doran Constructions Pty Limited and Doran Property Services Pty Limited. It was noted during the course of discussions that there existed no arrangements for repayment and that the loan was repayable on demand. The Balance Sheet of the Company needed to be tidied up to give a better view of the assets and liabilities of the Company to Financiers and inter group and intra group loans needed to be rationalised to limit any problems which may arise from the charging or payment of interest on those loans. RESOLVED The Company shall demand the repayment by Doran Constructions Australia Pty Limited of the sum of $4,592,145.62." 16 The minutes for Constructions recorded - " BUSINESS The Company has received a request from Doran Constructions Australia Pty Limited, the holder of all of the issued shares in this Company, for a loan of $4,100,000.00 for a minimum term of six (6) years (with the right for early repayment without penalty) at such interest rate or rates as may from time to time be agreed upon by and between this Company and Doran Constructions Australia Pty Limited. The purpose of the loan was to enable Doran Constructions Australia Pty Limited to discharge part of the amount lent by Doran Holdings Pty Limited to Doran Constructions Australia Pty Limited. Doran Holdings Pty Limited required the payment to enable it to rationalise inter group and intra group lending and avoid any problems which might arise in the payment of interest. Doran Constructions Australia Pty Limited also requested a loan from this Company for the same purpose. This Company from time to time advanced moneys to Doran Holdings Pty Limited while Doran Holdings Pty Limited was the holder of the shares issued in this Company and the amount of that loan stood in excess of $4,100,000.00. The Board agreed that it would be in the interests of this Company to rationalise inter group and intra group loans and understood the commercial benefit to all parties to commence with a fixed term. The Board also thought that the loan should be used only for the purpose of rationalisation of loans and made this a condition of the giving of a loan. RESOLVED 1. To demand repayment by Doran Holdings Pty Limited of the sum of $4,100,000.00 forthwith; and
The liquidator's allegations 24 Breach of the statutory or fiduciary duties sounded in damages. If the debt restructuring was avoided, Holdings' debt to Constructions would remain. For the damages claim, account would have to be taken of payments to Constructions in reduction of the substituted DCA debt. There was contention as to whether and how the partial repayment should be taken into account in the avoidance claim, in which there would be a wider question of undoing the transaction in other respects.
(i) Breach of statutory and fiduciary duties 25 Under s 232 of the Law, the directors owed a duty to Constructions to act honestly in the exercise of their powers and the discharge of their duties, and with the care and diligence that a reasonable person in a like position would exercise in the company's circumstances. They owed fiduciary duties to Constructions to exercise their powers for proper purposes and for the benefit of the company. In discharging their duties to Constructions they had to take account, if the company was insolvent or the company's financial situation otherwise put them at risk, of the interests of creditors as well as those of the company. 26 The Liquidator alleged that the directors caused Constructions to enter into the debt restructuring in breach of these duties -
(a) because they acted not in the interests of Constructions and its creditors, but in order to protect Holdings from pending claims against Constructions by Beresfield Aluminium Pty Ltd ("Beresfield") and the University of Newcastle ("the University");
(b) alternatively, because to the detriment of Constructions and its creditors there was substituted for a debt payable on demand by Holdings, a company with substantial assets and the capacity to repay $4.1 million to Constructions, a debt payable in six years time by DCA, a company without substantial assets or the capacity to pay $4.1 million to Constructions. 27 The Liquidator contended that Holdings was under accessory liability because it was involved in the directors' breaches of duty. It is unnecessary in these reasons to deal separately with Holdings' liability. Reference in the reasons to the directors as parties extends where appropriate to include Holdings as a party.
(ii) Avoidance under the Law 28 By s 588FF of the Law, a company's liquidator could apply for various orders in relation to a transaction of the company which was voidable. By s 588FE(4), a transaction was voidable if it was an insolvent transaction of the company, a related entity of the company was a party to it, and - "(c) it was entered into, or an act was done for the purpose of giving effect to it, during the 4 years ending on the relation-back day". 29 Holdings and DCA were related entitles of Constructions. The relation-back day was 24 December 1997, and the debt restructuring was within the preceding four years. Was the debt restructuring an insolvent transaction? 30 Section 588FC relevantly provided that a transaction was an insolvent transaction if, and only if, it was - "… an uncommercial transaction of the company, and: (a) any of the following happens at a time when the company is insolvent: (i) the transaction is entered into; or
(ii) an act is done, or an omission is made, for the purpose of giving effect to the transaction; or (b) the company becomes insolvent because of, or because of matters including: (i) entering into the transaction; or
(ii) a person doing an act, or making an omission, for the purpose of giving effect to the transaction." 31 Section 588FB(1) provided - "(1) A transaction of a company is an uncommercial transaction of the company if, and only if, it may be expected that a reasonable person in the company's circumstances would not have entered into the transaction, having regard to: (a) the benefits (if any) to the company of entering into the transaction; and
(b) the detriment to the company of entering into the transaction; and
(c) the respective benefits to other parties to the transaction of entering into it; and
(d) any other relevant matter." 32 By s 95A - "95A(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.
(2) A person who is not solvent is insolvent." 33 Before Palmer J the Liquidator alleged that the debt restructuring was an uncommercial transaction because it was entered into not in the interests of Constructions and its creditors, but to their detriment, see above as to breach of the directors' duties, and that -
(i) Constructions was insolvent as at 1 November 1994 at the time the transaction was entered into; alternatively
(ii) Constructions became insolvent as at 1 November 1994 as a result of entering into the transaction; alternatively again
(iii) Constructions was insolvent as at 4 September 1995 when an act was done for the purpose of giving effect to it, the act being posting the journal entries; alternatively again
(iv) Constructions' insolvency as at 24 December 1997 was because of, or because of matters including, entering into the transaction. 34 The Liquidator did not maintain on appeal that Constructions was insolvent as at 1 November 1994 when the transaction was entered into.
The deed of charge 35 On 18 July 1995 Constructions executed a deed of charge in favour of Holdings, by which it granted a fixed and floating charge over all its assets and undertaking to secure all money from time to time owing by it or any other person to whom Holdings provided accommodation at its request. The charge recited that Constructions had requested Holdings - " … to advance to it or provide security for [Constructions] to borrow from its Bankers and/or to forbear to sue [Constructions] in and for the sum of One Hundred Thousand Dollars ($100,000.00) upon the terms and conditions hereinafter appearing and [Constructions] may from time to time request [Holdings] to provide further advances and accommodation". 36 Before Palmer J the Liquidator had alleged that the charge was given in breach of the directors' duties and was voidable. His claims in that respect failed, and were not revived on appeal. The charge remained as an event in the group's life.
The Beresfield and University litigation 37 The Liquidator's case made much of Constructions' disputes with Beresfield and the University. They resulted in substantial debts in Constructions' winding-up, although the debts were not established until after the liquidation.
(i) Beresfield 38 Constructions entered into a contract with the Department of Health ("the Department") to build stage 3 of the Gosford Hospital. On 10 August 1990 it entered into a subcontract with Beresfield under which Beresfield was to supply and install curtain walling and aluminium doors and windows for the job. The subcontract price was $1,294,425. 39 Performance of the subcontract works was marked by Constructions' complaints as to delay and workmanship. The subcontract works were certified practically complete on 17 March 1992. On 27 July 1992 Beresfield submitted a final claim for $731,927, and on 13 August 1992 it purported to refer to arbitration a dispute over the claim. There was contention over the effectiveness of the referral. In February 1993 Constructions made a claim for $532,551 against Beresfield. 40 There followed a prolonged course of correspondence between Beresfield, Constructions and the Department. It is not easy to understand what was going on, and the evidence did not well explain or the submissions explore it. Beresfield's claim was variously revised to figures in the order of $400,000. It seems to have been understood that the claim, or a large part of it, depended on whether the Architect or the Superintendent under the contract accepted it, or at least accepted a corresponding claim by Constructions as part of claims being made by Constructions against the Department; at one point Constructions was appointed Beresfield's agent to "seek a settlement" with the Department whereupon Beresfield would execute a deed of release. The Architect was asked to certify the claim(s), and said to the effect that he saw little substance in the Beresfield claim. 41 As at the end of October 1994 Beresfield's claim was for $449,100 and nothing was resolved. In November 1994 the Superintendent wrote rejecting the claim save for about $53,000. Constructions' claim against Beresfield seems to have lain dormant during the correspondence. Where this left Beresfield's claim against Constructions was unclear, but Paul's evidence was to the effect that he thought at the time that the Superintendent's stance vindicated that of Constructions. 42 In January 1995 the Department paid $1,005,226 to Constructions in settlement of Constructions' claims. It was a commercial settlement, without attribution to particular outcomes of claims. Paul agreed that the settlement included "a sum in respect of a number of Beresfield's claims against [Constructions]"; what was included was unclear. Paul said that nothing was paid to Beresfield because Constructions had a greater claim against Beresfield. 43 Beresfield then prosecuted its claim against Constructions. It is not clear whether the earlier referral was revived or there was a new referral to arbitration, but in March 1995 a preliminary conference was held in an arbitration in which Beresfield brought an increased claim and Constructions brought an increased counterclaim. The submissions in the arbitration concluded on 12 September 1997. On 12 January 1998 the arbitrator published an interim award in which he upheld Beresfield's claim to the extent of $447,980 plus interest and Constructions' counterclaim to the extent of $5,148.50 plus interest. Time was allocated for submissions on costs and calculation of interest. Constructions put no submissions, presumably because of the liquidation. On 12 March 1998 the arbitrator made a final award in favour of Beresfield for $656,756.80 plus costs of $470,762. 44 That was not the end. There was litigation over the interim and final awards, see Doran Constructions Pty Ltd v Beresfield Aluminium Pty Ltd [1999] NSWSC 499 (Brownie AJ, 21 May 1999); Doran Constructions Pty Ltd v Beresfield Aluminium Pty Ltd (2001) 17 BCL 215 (Brownie AJ, 8 February 2001); and Doran Constructions Pty Ltd v Beresfield Aluminium Pty Ltd (2002) 54 NSWLR 416 (CA, 8 May 2002). An application for special leave to appeal to the High Court was refused on 14 March 2003. 45 Paul gave evidence that as at 1 November 1994 he believed that Beresfield owed money to Constructions and Constructions did not owe money to Beresfield. In cross-examination it was suggested that Constructions should have passed on to Beresfield part of the settlement with the Department, and did not do so because it was short of money. Paul did not accept that it was due to shortage of money, and said that Beresfield declined to execute the deed of release. Paul's asserted belief as at 1 November 1994 was otherwise not challenged. 46 At least on appeal, the dispute with Beresfield was less prominent in the Liquidator's case than the dispute with the University.
(ii) The University 47 The University's Hunter Building was damaged in the earthquake of 1989. In December 1992 Constructions entered into a contract for remedial work. At the end of June 1993 Constructions delivered to the University a claim for prolongation and disruption costs. There was dispute, which was referred to arbitration, the claim then being for $354,961.35 plus interest. On 11 October 1993 the University served a counterclaim. The amount claimed is not clear, but by mid 1994 appears to have been of the order of $2.5 million. The arbitration was adjourned to a date to be fixed. 48 The University's claim appears to have been for defective work, and the correspondence suggests dispute over whether rectification work was due to defective design for which Constructions was responsible or to design for which it was not responsible or some other cause. The University terminated the contract, which Constructions also disputed. In early December 1994 Constructions brought proceedings in the Supreme Court claiming over $4 million from the University. In due course the arbitral claims were effectively brought within the proceedings. 49 Mediation of Constructions' claim, and the University's foreshadowed claim for rectification and other costs, was unsuccessful. The proceedings were complicated by claims against engineers and others, and by other proceedings between the University and its insurer over the work for which insurance reimbursement would be given. Only in October 1996 did the University actually cross-claim in the proceedings, claiming nearly $2 million and some further unquantified damages. 50 In March 1997 it was ruled that there should be concurrent references in the two proceedings. The order for reference was made on 8 August 1997. Constructions went into liquidation before the reference had progressed. The Liquidator withdrew from participation in the reference and the proceedings, and in March 1998 orders were made dismissing Constructions' claim. The University's cross-claim continued without opposition from the Liquidator. 51 On 13 May 1999 the referee delivered a report upholding the University's claim to rectification costs in the sum of $1,772,038. There was no detailed evidence of what happened thereafter, but the University ended up as a substantial creditor of Constructions. 52 Paul gave evidence that as at 1 November 1994, Constructions having claimed upon the University and there being no cross-claim, he believed that the University owed money to Constructions and Constructions did not owe money to the University. It was put to him in cross-examination that he must have anticipated a cross-claim to the effect of the counter-claim earlier served in the arbitration. He said, in substance, that there had been discussions with the insurer and he thought the problem might be resolved by the insurer agreeing to pay. The evidence was far from clear, but Paul declined to agree that he knew the University's claim was very likely to be pursued.
Other construction works 53 Apart from the Gosford Hospital and Hunter Building jobs, as at 1 November 1994 Constructions had as current construction works jobs identified as Liverpool Aquatic Centre, Manly Library, Moorebank and Big Bear, and another eight jobs in their defects liability periods. After 1 November 1994 it commenced construction works for jobs identified as Kenthurst, Miranda and Holroyd Hospital, and tendered for a number of other jobs. Revenue could be expected on the expiry of the defects liability periods and from the jobs, and for the year ended 30 June 1995 Constructions' operating revenue was over $12 million, almost $6 million in the period from 1 November 1994. However, there was an operating loss for the year of $369,971, and the evidence indicated forecast losses on the Liverpool Aquatic Centre and Manly Library jobs and only a modest profit on the Moorebank job. 54 The evidence more generally was that Constructions' revenue was falling from that of previous years. Constructions had ceased trading by October 1997. There was some evidence that it ceased to trade in July 1995, but the position was not made clear, and that may have meant that it was not seeking new jobs; it is likely that it was completing existing jobs. Whatever the position, it does not seem to have traded profitably from 1 November 1994 onwards.
The August and September 1996 resolutions 55 Unsigned minutes of directors' meetings of Constructions, Holdings and DPS on 27 August 1997 provided for resolutions to the effect that, once it had repaid DPS, Holdings would provide additional funds to Constructions and "the Doran Constructions (Australia) Pty Limited group" and receive a charge over their assets and the assets of DPS, the first $100,000 of the funds as a loan to Constructions and the funds beyond $100,000 to be treated as loans to DPS but "forwarded to [Constructions] … via [DCA] as a repayment of the loan amount owing to [Constructions] by [DCA]". 56 Signed minutes of directors' meetings of Constructions and Holdings on 18 September 1996, at which all the directors were present, recorded resolutions to the same effect, save that -
(a) the Holdings resolutions included - "4. Doran Holdings Pty Limited would continue to monitor the overall situation and if thought appropriate at some time in the future, provide written notice to the Doran Constructions (Australia) Pty Limited group that no further funds would be made available for potential future commitments"; and
(b) the Constructions resolutions included - "(iii) that Doran Holdings Pty Limited may cease the future provision of funds for potential future commitments by providing notice in writing of such cessation."
The November and December 1997 resolutions 57 On 6 November 1997 Mr Linz wrote to Mr Freeman, seeking his contribution to current consideration of liquidation of DCA and the "situation" of Constructions, Holdings and DPS. He reported as follows. On 30 June 1997 DCA's shares in DPS had been sold to Holdings for $300,000. Prior to the sale DPS had forgiven a debt of $1,366,509 owed to it by DCA. The directors had been funding Constructions' litigation. DCA was thought no longer to serve a useful purpose, and it was proposed that it be put into members voluntary liquidation. Amongst other "rationalisation" of inter company loans and investments, the (balance of the) loan by Constructions to DCA could be written off, which would not disadvantage creditors because it "has no real value". 58 The minutes of a directors' meeting of Constructions on 28 November 1997, at which all the directors were present, recorded resolutions - " Resolved 1. That the terms and conditions attaching to loans from Doran Holdings Pty Limited under the following terms are accepted: · that repayment be at call; · that interest be charged at a rate to be negotiated between the parties; · that Doran Holdings Pty Limited may cease the future provision of funds for potential future commitments by providing notice in writing of such cessation. 2. Funds and property made available by PA Doran, PJ Doran, ML Doran and JC Doran to pay the legal fees of Doran Constructions Pty Limited are to be treated as loans from Doran Holdings Pty Limited and are made available on the same terms and conditions as previously agreed to between Doran Holdings Pty Limited and Doran Constructions Pty Limited.
Constructions goes into liquidation 64 Also on 16 December 1997, the directors of Constructions resolved to seek advice from Mr Lewis "as to the appropriate course of action required to be taken by the company". The advice, also from other professionals, was that Constructions be wound up. A meeting of creditors was called, and on 24 December 1997 it was resolved that Constructions be wound up. The Liquidator was appointed as liquidator. 65 The summary of creditors later prepared listed unsecured creditors totalling $4,476,011.50, including $1,127,518.80 for Beresfield and $2,986,000 for the University. Later again, unsecured creditors were said to total $4,527,990. External unsecured creditors other than Beresfield and the University totalled $358,494. Other than possibly in an insignificant amount, none resulted from trading operations prior to 1 November 1994 or 4 September 1995. Constructions had realisable assets of about $46,000, as established in March 2000 plus the balance of the DCA debt earlier forgiven, but the debt was worthless.
Intra-group transactions 66 In the period after 1 November 1994 substantial sums were paid by Holdings and DCA to Constructions. Holdings repaid to Constructions $1.189 million, the balance of its debt apart from the $4.1 million, between 1 November 1994 and 17 July 1995, and advanced a further $1.225 million to Constructions between 18 July 1995 and 24 December 1997. DCA paid $1.449 million to Constructions between 1 November 1994 and 24 December 1997, which was treated as part repayment of the $4.1 million debt although the debt was not due and payable. This $1.449 million was effectively all provided by Holdings to DCA, and amounted to payment by Holdings to Constructions via DCA. 67 As well, between 1 November 1994 and 24 December 1997 Dyspane was taken to have paid $1.21 million to Constructions in repayment of its indebtedness. This was described as Dyspane "assuming" a mortgage loan facility held by Constructions with a bank, and does not appear to have involved funds effectively provided by Holdings. (The evidence referred also to Dyspane lending $552,032.30 to Constructions in October 1995 - March 1996. The parties were agreed upon $1.21 million as the amount of Dyspane's payment to Constructions, and I do not attempt to fit this evidence into the picture.) 68 Schedules in evidence showed payments made by Holdings in amounts from as little as $600 to as much as $400,000, on about seventy occasions, sometimes to Constructions and sometimes to third parties on behalf of Constructions. The last payment was on 24 November 1997. Payments were particularly made to a bank and to lawyers, as to the latter I infer in connection with the Beresfield and University litigation. 69 The total of the payments by Holdings and Dyspane, rounded out, was the $5.1 million to which Palmer J referred as funds provided from cash resources within the group available to pay Constructions' external creditors, see later in these reasons.
Palmer J's reasons 70 Palmer J first considered the Liquidator's contention that the debt restructuring was entered into not in the interests of Constructions, but in order to protect Holdings in the event that claims against Constructions by Beresfield and the University succeeded. Holdings was exposed, the Liquidator suggested, because successful claims against Constructions could mean that Constructions went into liquidation, whereupon the Liquidator could call for payment of Holdings' indebtedness of $5.289 million (or whatever the indebtedness was at the time) and Holdings' assets would go to satisfy the claims. 71 His Honour was not satisfied that as at 1 November 1994 the claim by Beresfield against Constructions was regarded as a present and substantial financial threat, either to Constructions or to Holdings, and was not satisfied that it played any part in the directors' reasons for the debt restructuring. He found that as at 1 November 1994 the directors were aware that Constructions had a claim against the University and that the University would probably make a substantial claim against Constructions, that that matter was discussed at the meeting on 1 November 1994, and that it was clear to Paul and Mr Joyce, at least, that a major litigious battle with the University was looming. After discussion of the evidence given by Mr Freeman, Mr Linz (via the transcript of his evidence in his public examination) and the directors, and referring also to what he described as objective matters, his Honour said - "65 In my opinion, the most reliable evidence as to the purpose of the Restructure, as discussed at the Directors' meeting on 1 November 1994, is given by Messrs Freeman and Linz. On the basis of that evidence, which I accept, I find that the foreshadowed claim by the University against Constructions was not the driving factor for the Restructure. The driving factor was a desire on the part of the Directors to separate the financial affairs of the property holding companies in the Doran Group, embodied in Holdings, from the financial affairs of the building and construction companies, embodied in Constructions. That desire for separation did not originate in a fear that the University's claim against Constructions would be successful and would result in a liquidator being appointed to Constructions and making a demand upon Holdings. The desire for separation originated in a perception, held for some time before November 1994, that it would be easier to obtain finance for the property holding activities of the Group if they were segregated from the building and construction activities.
66 I am satisfied that the Directors' desire to achieve separation of the financial affairs of Holdings and Constructions was given a sense of impetus and focus by the impending litigation with the University. That litigation would have exemplified the problems and difficulties which could be caused to the property holding activities of the Group by litigation arising from the Group's building and construction activities. However, I accept that the Directors did not actually believe that the University's claim against Constructions would ultimately be successful and that it would result in the liquidation of Constructions. I accept Paul's evidence that he believed that the litigation would result in money being paid to Constructions.
67 Having regard to the evidence of Messrs Freeman and Linz and to the evidence of the Directors, which I accept, and to the objective factors referred to in paragraphs 60 to 62 above, I find that the Directors did not have an actual intention, in effecting the Restructure, to remove the assets of Holdings from the reach of the creditors of Constructions. I accept that they believed that at the time of the Restructure Constructions was solvent." 72 Palmer J then turned to whether Constructions was in fact solvent at the time of the debt restructuring. 73 His Honour accepted the reconstructed balance sheet for Constructions immediately prior to the debt restructuring prepared by the directors' expert, Mr Bryant, in preference to that prepared by the Liquidator's expert, Mr Pascoe. 74 His Honour said - "75 There is no dispute as to the following:
i) as at 1 November 1994 there were present none of the usual indicia of insolvency; · there was no history of dishonouring Constructions' cheques; · suppliers had not been delivering goods only on a COD basis; · Constructions had not been issuing post-dated or 'rounded sum' cheques; · Constructions had made no special arrangements with its creditors; · Constructions was able to produce timely, audited accounts; · Constructions had no unpaid group tax, payroll tax, workers compensation premiums or superannuation contributions; · Constructions had received no demands from its bankers to reduce overdraft limits and it had a good relationship with its bankers; · Constructions had received no statutory demands, solicitors' letters requiring payment of debts or legal proceedings for the payment of trade debts; ii) as at 1 November 1994, Constructions' reconstructed balance sheet showed net total assets of $3.5M and positive net current assets;
iii) all of the $5.9M recorded as Constructions' liabilities as at 31 October was paid (or written back as no longer a liability) prior to Constructions' liquidation on 24 March [sic: December] 1997;
iv) funds of $5.1M were provided to Constructions by other companies in the Doran Group between 1 November 1994 and 24 December 1997;
v) as at 30 June 1995, shortly before the date upon which the Charge was given by Constructions to Holdings, Constructions had recorded liabilities of $3.5M, all of which had been paid or written back prior to 24 December 1997;
vi) of the $1.4M disclosed in Constructions' Report as to Affairs upon its liquidation, only $234,000 was owed to external creditors and none of the external creditors resulted from trading operations prior to 31 October 1994 or 30 June 1995;
vii) there were major decreases in the overdraft facility of Constructions during September and November 1996 and the overdraft was extinguished entirely in November 1996 when Holdings advanced a sum of $400,000 to Constructions;
viii) as at 24 December 1997, Constructions had no outstanding liability in relation to a mortgage facility of $1.2M previously taken out with St George Partnership Banking Limited;
ix) a loan from DCA to Constructions of $98,737 existing as at 31 October 1994 had been discharged by 24 December 1997;
x) as at 31 October 1994, total employee liabilities for Constructions were $110,666 but by 24 December 1997 Constructions had no employees and all of these amounts had either been paid or transferred to the account of Holdings;
xii) there is no evidence of any of the indicia of insolvency to which I have referred between 1 November 1994 and the winding up of Constructions in December 1997.
76 In short, for slightly more than three years after 1 November 1994 Constructions continued to subsist, paying its external debts with the assistance of funds provided by other companies in the Doran Group, without any complaint from its creditors or its financiers." 75 His Honour noted that Mr Pascoe was of the opinion that as at 31 October 1994 Constructions was unable to pay its debts as they fell due "despite the undoubted fact that, as the evidence shows, it actually did so for about three years thereafter". His Honour considered that there were at least three flaws in Mr Pascoe's opinion. 76 The first flaw, in his Honour's view, was that Mr Pascoe had not applied a cash flow test for insolvency, but a "profits test" and a "working capital test". The second and related flaw was expressed by his Honour - "80 The second flaw is that Mr Pascoe never ascertained what debts of Constructions were actually due and payable as at 31 October 1994 and whether those debts were paid as and when they fell due. He took the total figure of $2.661M for trade creditors shown in the reconstructed balance sheet as at 31 October 1994 and applied the "working capital test" to that figure.
81 But, in truth, as Mr Bryant's analysis shows - and Mr Pascoe does not dispute it - only about $160,000 was owing to trade creditors as at 31 October 1994 and there is no evidence to suggest that those creditors were not paid according to their normal trading terms. The absence of any indicia of insolvency as at 31 October 1994 and for about three years later suggests strongly that as at 31 October 1994 trade creditors were being duly paid and that that situation continued for a long time afterwards." 77 The third flaw, on which argument focussed in the appeal, was - "82 The third flaw is that Mr Pascoe disregarded the cash resources within the Doran Group which were available to pay its external creditors, both as at 31 October 1994 and thereafter. As I have noted, funds of $5.1M were provided to Constructions by other companies in the Doran Group between 1 November 1994 and 24 December 1997. Mr Pascoe takes the view that the cash flow test as prescribed by s.95A CA requires that a company's ability to pay its debts is determined, in all circumstances, only by reference to that company's own assets so that what he termed "voluntary payments" by other members of a group of companies must be disregarded.
83 Whether Mr Pascoe's view is correct has some significance in the case. The Directors concede that on and after 31 October 1994 Constructions was unable to pay all its debts solely from the revenue derived from its trading and from its own assets. They concede that it was not able to discharge all of its liabilities except by means of advances from other companies in the Doran Group, principally from Holdings. However, they say that the ability and willingness of other companies in the Doran Group to make cash available to Constructions as needed and not to call up those advances except at times when Constructions was conveniently able to repay was a resource available to Constructions at all relevant times which must be taken into account when determining its solvency." 78 Although his Honour did not refer to it, another of the directors' experts, Mr Hunter, had opined that, in determining a company's solvency, it should be asked whether the company "has the ability to access money from other people or sources and to raise funds from its bankers and stakeholders", and that Constructions "had adequate sources of alternative funding from its bankers and other members of the Doran Group to be able to pay all of its debts as and when they became due and payable". Mr Hunter had had regard to "the cash inflows from other members of the Doran Group". Mr Hunter did not exclude "voluntary payments" as a source of funds, provided the funds advanced were treated as deferred liabilities; he said that the critical question was whether the company could pay its debts. In the course of the hearing his Honour had observed that the difference between the "philosophical approaches" of Mr Pascoe and Mr Hunter (and Mr Bryant) was fairly clear and it was up to him to decide what the law required. 79 Palmer J's reasons turned to that matter. The predecessors to s 95A of the Law had referred to ability to pay the debtor's debts "from his own monies". After an extensive consideration of the legislation and the cases, his Honour said - "106 I think that I must approach the application of s.95A CA with two considerations in mind. First, the words of s.95A must be construed as they stand, without addition or subtraction. Second, the law both before and after the enactment of s.95A is unequivocally and emphatically clear that insolvency is, first and last, a question of fact "to be ascertained from a consideration of the company's financial position taken as a whole. In considering the company's financial position as a whole, the Court must have regard to commercial realities. Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security, and when such realisations are achievable : Southern Cross Interiors Pty Ltd (in liq) v Deputy Commissioner of Taxation (2001) 53 NSWLR 213 at 224 (citations of authority omitted) … " 80 After further discussion, his Honour concluded that the omission of "from his own monies" from s 95A removed an artificial restriction, and that - "116. … s.95A requires the Court to decide whether the company is able, as at the alleged date of insolvency, to pay all its debts as they become payable by reference to the commercial realities. If the Court is satisfied that as a matter of commercial reality the company has a resource available to pay all its debts as they become payable then it will not matter that the resource is an unsecured borrowing or a voluntary extension of credit by another party." 81 His Honour then said - "117 In the present case, I have regard primarily to the following facts in determining Constructions' solvency as at 31 October 1994: - there is no evidence that, as at that date, Constructions had not been paying all of its debts as they became payable;
127 As I have found in paragraph 65, the purpose of the Restructure was to segregate the property holding activities of the Group from the construction activities so that it would be easier to obtain finance for the property holding activities. But, as is evident from the advances made by Holdings to Constructions after 1 November 1994, money coming into Holdings from borrowings could be made available to Constructions if required.
128 In my opinion, having regard to Holdings' role as banker to the Doran Group, it could be seen as reasonably in the interests of Constructions to facilitate the Restructure so that Holdings could find it easier to borrow.
129 Similarly, because Holdings was unarguably solvent as at 1 November 1994 and would be ready to provide money to Constructions or to DCA thereafter, if needed, I do not think that Constructions suffered an unreasonable detriment in that the Restructure replaced the debt from Holdings with the debt from DCA. I do not accept that DCA must have been seen at that time as incapable of repaying its debt to Constructions. There is no reason to suppose that if Constructions had required repayment of the DCA debt shortly after the Restructure and DCA itself had insufficient funds, Holdings would not have advanced the necessary funds to DCA." 84 Finally, his Honour returned to breach of the directors' duties. He said - "131 It will have become clear from the foregoing reasons that I am not satisfied that Constructions was insolvent, near to insolvent, or at any risk of insolvency as at 1 November 1994.
132 Accordingly, in considering whether to enter into the Restructure, the Directors in exercising their statutory and fiduciary duties as directors of Constructions, had no duty, or even occasion, to consider the effect which the Restructure might have on the rights of Constructions' creditors: see e.g. Equiticorp at 144-146 and the cases there cited.
133 As I have held, the Directors did not enter into the Restructure for the purpose of replacing a valuable asset of Constructions with a worthless one, in order to deprive the University or Beresfield of the fruits of their litigious success, if that should be the outcome. The purpose which I have found motivated the Directors was not ulterior to the interests of Constructions nor was it unreasonable having regard to the interests of Constructions.
134 Further, I take into account the fact that the Directors expressly sought the advice of the Group's auditor and of its solicitor, neither of whom advised that what was proposed in the Restructure was wrong.
135 In all of these circumstances, I am unable to find that, in effecting the Restructure, the Directors did not act in good faith in the interests of Constructions or with lack of appropriate care and skill in the discharge of their duties as directors of Constructions."
Was there the purpose of defeating creditors? 85 The Liquidator submitted that the directors had never advanced a "clear and coherent" explanation for the debt restructuring. He said that although they had denied that the purpose was to remove assets from the reach of Constructions' creditors, the judge had found that Paul, and probably Peter, were aware that the University was making a substantial claim against Constructions, and that Paul and Mr Joyce foresaw a "major litigation battle" with the University, with concomitant expense. His Honour regarded the impending litigation as providing "a sense of impetus and focus", but in the Liquidator's submission had given too little weight to that part of the evidence of Mr Linz in his examination in which he said that Mr Joyce wanted to tidy up the loan accounts because the company was about to take action against the University and he wanted the group "in a secure position" before it did so; in particular the evidence - "You can recall being discussed at this meeting the possibility of a negative result from the university claim, can't you? ~~ I can remember - well, I can - I can remember the awareness that there was some risk attached to the litigation that they were about to embark upon. Indeed, the whole conversations about these transactions was predicated, was it not, on the basis of a desire to separate Holdings from Constructions because of this claim? ~~ Yes." 86 The Liquidator's submission was rather selective within Mr Linz's evidence. Mr Linz remembered Paul telling the other directors that "he thought the University would be a positive result for them". He was vague about what the group was to be secure against, but did not accept that there had been any "definitive" reference to the claim going against Constructions, rather that there was risk attached to any litigation. He recalled the directors discussing the transaction as part of the ongoing rationalisation of the group, wanting a simpler presentation to financiers which Paul and Mr Joyce had "always pushed for", which in Mr Linz's mind was "given some urgency" because Constructions was about to embark on litigation against the University. 87 Mr Freeman's evidence was squarely that the discussion was of simplifying the loan accounts within the group so that the construction companies and the property companies were responsible for their own transactions, under pressure from the group's banks to simplify the group structure. He said that Paul explained to those present that the banks wanted two separate groups "so that when processing a loan for one group, they only need concern themselves with that group's accounts". Mr Freeman said he gave advice as to the need to ensure that the debt restructuring did not put any of the participants into present or future insolvency, and suggested the debt restructuring which in fact took place. He was not cross-examined. 88 Although the judge did not refer to it, Mr Joyce described tidying up the loan accounts as part of an ongoing process of rationalisation, discussed with the directors, auditors and financiers. He said that the process of disconnecting the Holdings group and the Constructions group began in the late eighties and "it continued all the way through during my time at the company". Mr Joyce's general recollection is of some significance, although he could not recall the meeting of 1 November 1994 in any detail. 89 The objective matters to which the judge referred were these. First, Holdings still owed $1.189 million to Constructions, and advanced $1.225 million to Constructions after 27 July 1995; his Honour considered that this was not consistent with "a preconceived plan by the Directors to shield Holdings' assets from claims by Constructions' creditors" (at [61]). Secondly, the directors and other companies in the group, including Holdings, had given unlimited guarantees to Constructions' banks Barclays and Westpac to secure its financing liabilities; his Honour considered that through the guarantees, the assets of Holdings remained exposed. In evaluating his Honour's regard to these matters it should not be forgotten that on 18 July 1995 Holdings took a charge over Constructions' assets and undertaking; but it did commit its assets to funding Constructions. The matters do tend against a purpose of defeating creditors. Although the judge did not refer to it, that the debt restructuring included DPS's debt tends the same way - there was no suggestion that DPS was at risk from claims against it. 90 Importantly, the judge specifically accepted the directors' evidence, which included that, although they had little recollection of the particular circumstances in which the debt restructuring came about, they denied the purpose alleged by the Liquidator. Paul said that it "never entered his head" that a liquidator might be appointed to Constructions who could call in Holdings' debt, and that he believed Constructions was solvent at the time. He and Peter were express in their denials, and the judge noted that Peter said "with some warmth" that he considered it a wrong thing to do and "We just wouldn't do that". 91 The judge's conclusion was in part credit-based, upon the view he took of the directors in giving evidence. I do not think it was contrary to incontrovertible facts or uncontested testimony, or glaringly improbable or contrary to compelling inferences: in this I take up the well-known principles of appellate restraint more recently expounded in Fox v Percy (2003) 214 CLR 118. In my view, the Liquidator has not established that the judge was in error in finding that the directors thought that Constructions was solvent and did not have the purpose of defeating its creditors by removing Holdings' assets from their reach. 92 Whether the directors were in breach of their duties on the alternative basis alleged by the Liquidator is best left until after consideration of Constructions' solvency.
Did Constructions become insolvent as at 1 November 1994 as a result of entering into the transaction? 93 The Liquidator did not submit that the judge was in error in the view he took that s 95A called for regard to the "commercial realities", or in the view he took, earlier expressed in Southern Cross Interiors Pty Ltd (in liquidation) v Deputy Commissioner of Taxation (2001) 53 NSWLR 213 at 224 and repeated at his [106] in this case, that insolvency is a question of fact - " … to be ascertained from a consideration of the company's financial position taken as a whole. In considering the company's financial position as a whole, the Court must have regard to commercial realities. Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security, and when such realisations are achievable". 94 The Liquidator's submissions were to the following effect. As at 1 November 1994, Constructions' principal current assets were trade debtors of $1.872 million, a debt of $1.189 million payable by Holdings and a debt of $4.1 million payable in six years time by DCA. Its principal current liabilities were trade creditors of $2.063 million and a bank overdraft of $1.812 million. (These excluded the unliquidated claims of Beresfield and the University, which were correctly not brought to account in the balance sheet at that time. Mr Pascoe had taken trade creditors of $2.661 million, but the judge accepted Mr Bryant's figure of $2.063 million; I have substituted this figure in the submission.) Constructions had sustained a trading loss for the year to 31 October 1994 of nearly $300,000, and Paul acknowledged in his evidence that it could not meet the demands of its creditors from its cash flow from its building activities. It had been dependent on recoverability of the Holdings debt in order to pay its creditors, it was said, and after the debt restructuring was dependent on recoverability of the DCA debt; but DCA had had no operating revenue in 1993-1994 year, its principal assets were its shareholdings in Constructions and DPS, and it had no realistic capacity to repay the debt which in any event was not repayable for six years. So, it was said, the judge correctly noted in his [83] the concession that Constructions could only pay its debts by means of advances from other companies in the group. The Liquidator submitted that the judge erred so far as he reasoned that, because it in fact paid its debts for three years after 1 November 1994, Constructions was solvent as at that date, and that the judge's further and more fundamental error was that Constructions was not solvent when its ability to pay its debts required voluntary assistance from related entities. 95 The judge did not simply reason that, because it in fact paid its debts for three years after 1 November 1994, Constructions was solvent as at that date. Such simple reasoning would have involved error, consider a hopelessly insolvent person who wins the lottery. His Honour took account of a host of matters in coming to his conclusion, prominent in which was that Constructions' debts had been paid for the three years but not as sufficient in itself; rather, as proof "that the funds of the other companies in the Group were a resource available to Constructions as a matter of commercial reality", see his [118]. 96 The directors submitted that they did not concede, as the judge noted in his [83], that as at 1 November 1994 Constructions could only pay its debts by means of advances from other companies in the group. They acknowledged Paul's evidence that Constructions could not meet the demands of its creditors from its cash flow from its building activities. But they said that it remained that Constructions could meet the demands of its creditors from its assets, and pointed to their counsel's statements, in answer to questions from the judge, that their contention was that Constructions' liabilities as at 1 November 1994 were satisfied from Constructions' cash flow together with repayment of loans by other companies in the group, and that at no stage did Constructions have to depend on voluntary payments "for" (I think meaning "from") Holdings. With respect, it may be that the judge misunderstood their position. 97 The directors submitted that as at 1 November 1994 Constructions was able to pay its debts from its cash flow and repayment of loans by other companies in the group, but that in any event regard to the commercial reality of repayment by DCA and provision of funds by Holdings was permissible and determinative in establishing its solvency. 98 As at 1 November 1994, the directors said, Constructions was owed $1.189 million by Holdings and $1.21 million by Dyspane. The worth of the Holdings debt was not in question, and in fact it was repaid by 17 July 1995. There was no reason to doubt the worth of the Dyspane debt, which was also repaid by 24 December 1997. In addition, Constructions was entitled to payment from the Department under the Gosford Hospital contract, a payment which in mid-January 1995 crystallised as a payment of $1.005 million and put its bank account in credit for $0.479 million, at which time it also had an undrawn overdraft facility of $0.59 million, increased on 13 February 1995 to $0.8 million. (Paul gave evidence to the effect that at all times the group's banks were content with the conduct of its accounts and were not pressing for reduction in overdraft accommodation.) 99 Further, the directors said, DCA did have a realistic capacity to repay its debt. They said that its balance sheet as at 30 June 1994 showed net assets of $658,761, which would remain after balancing adjustments in the debt restructuring; and that the directors' evidence that they believed it was able to repay the $4.1 million had the reasonable basis that it could sell its shares in Constructions and DPS and could expect provision of funds by other companies in the group. 100 So far as the directors contended that DCA could have paid the $4.1 million from its own resources, they had the difficulty that Paul agreed in his evidence that, from its 1994 accounts, "unless funded in some way by Doran Holdings, there was no chance in the world that Doran Constructions Australia Pty Ltd would be able to repay such a debt". Paul thereafter asserted an expectation of repayment, but his explanation involved provision of funds by Constructions and DPS. Palmer J did not find that DCA could pay the DCA debt independently of provision of funds by other companies in the group, and in fact the part repayment was with funds of Holdings via DCA. In my opinion, when considering Constructions' solvency and otherwise it should be accepted that DCA could not have paid the $4.1 million from its own resources. 101 That notwithstanding, after the debt restructuring Constructions could call in $1.189 million from Holdings and $1.21 million from Dyspane, and was entitled to expect receipt of what proved to be over $1 million from the Department. It was necessary to consider when the amounts due to trade creditors were payable according to their terms of trading, see the judge's [80]-[81], and also whether the overdraft was immediately repayable; it was not suggested that the banks required reduction. Many companies would be insolvent if the test was whether they could immediately pay all their debts, but it is not. The Liquidator's submissions on appeal did not rely on a cash flow analysis of Constructions' position as at 1 November 1994 which took account of when debts were payable. The Liquidator's balance sheet comparison as at 1 November 1994, even given unprofitable trading, did not establish insolvency when there were available resources (Holdings' and Dyspane's debts, the claim on the Department), unless it was shown that as a matter of cash flow creditors could not be paid as and when payment fell due. 102 The Liquidator said that the $1.005 million from the Department could not be taken into account as funds available to Constructions unless there was also taken into account "the corresponding liabilities, such as the amounts from the $1.005m payable to subcontractors (including Beresfield Aluminium)". His submissions did not descend to identification of the corresponding liabilities. Assuming the Beresfield claim of $449,100, there remained some $0.65 million available to Constructions. But that claim was at the time an unliquidated claim, and Constructions had a counterclaim for a greater sum. The net indebtedness was only established more than three years later, and even then the Liquidator seems to have thought that outcome sufficiently doubtful to warrant years of further litigation, up to the High Court. 103 The full $1.005 million was in fact available for Constructions' cash flow. Solvency or insolvency is a state on which directors and others act in current conduct, for example if the issue is trading while insolvent. Section 95A speaks of objective ability to pay debts as and when they become due and payable, but ability must be determined in the circumstances as they were known or ought to have been known at the relevant time, without intrusion of hindsight. There must of course be "consideration … given to the immediate future" (Bank of Australasia v Hall (1907) 4 CLR 1514 at 1528 per Griffith CJ), and how far into the future will depend on the circumstances including the nature of the company's business and, if it is known, of the future liabilities. Unexpected later discovery of a liability, or later quantification of a liability at an unexpected level, may be excluded from consideration if the liability was properly unknown or seen in lesser amount at the relevant time. The Beresfield claim was only established as a liability some years later, and then only with rejection of Constructions' counterclaim. In my opinion, the $1.005 million could be taken into account as funds available to Constructions. 104 The Liquidator pointed out that, according to its balance sheet as at 30 July 1995, Constructions still had trade creditors of $1.10 million. He said that by that date the balance of Holdings' debt had been repaid and the bank overdraft stood at $1.37 million. This, however, does not show that Constructions was insolvent as at 1 November 1994. It is still consistent with ability as at that date to pay debts as they fell due. 105 In my opinion, the Liquidator did not establish insolvency as at 1 November 1994, quite apart from the question of availability of funds of other companies in the group. 106 Palmer J found positively that Constructions was solvent, considering it sufficient that as a matter of commercial reality a company had available as a resource to pay its debts the voluntary extension of credit by another company, see his [116] above. His Honour was satisfied that the funds of other companies in the group were a resource so available to Constructions, see his [118]. 107 Even when the test of insolvency referred to payment out of the debtor's own money, funds which could be gained from the use of the company's assets were a resource available to it: Sandell v Porter (1966) 115 CLR 666 at 670 per Barwick CJ - "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 entirely 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." 108 The directors submitted that there was more than voluntary assistance from other companies in the group, and that Constructions raised money on the security of its assets because Holdings held the charge granted on 18 July 1995. The charge was executed when the balance of Holdings' debt had almost been eliminated, with the result that future provision of funds would be by way of loan. There are difficulties in the submission. The payment of $1.449 million by DCA, in fact by Holdings via DCA, was not secured by the charge, and the provision of funds by Holdings does not seem to have been with regard to the security provided by the charge, which was not sound security. The charge was incidental, no doubt thought to be for the benefit of Holdings but not determinative in the provision of funds. The commercial reality of provision of the funds included that they were not of the nature of which Barwick CJ spoke. 109 Particularly when the limiting words are no longer part of the test, there is no compelling reason to exclude from consideration funds which can be gained from borrowings secured on assets of third parties, or even unsecured borrowings. If the company can borrow without security, it will have funds to pay its debts as they fall due and will be solvent, provided of course that the borrowing is on deferred payment terms or otherwise such that the lender itself is not a creditor whose debt can not be repaid as and when it becomes due and payable. It comes down to a question of fact, in which the key concept is ability to pay the company's debts as and when they become due and payable. 110 Even before the wording of s 95A, in re RHD Power Services Pty Ltd (1991) 9 ACLC 27 McPherson SPJ was prepared to pay regard to ability to borrow without security. Kearney J in re Adnot Pty Ltd (1982) 1 ACLC 307 took into account that the company "instead of having to resort to some outside lender, is in the fortunate position of having its fellow member of the group of companies to which it belongs, available in effect as banker to provide funds required to meet any shortfall" (at 311; the shortfall was until completion and sale of a shopping centre). In re a company (1986) BCLC 261 Nourse J declined to find that a company was unable to pay its debts as they fell due although it was being "propped up by loans made to it by associated companies and possibly by others" (at 262; his Lordship noted at 263 that he had evidence from a director to the effect that there was no question of the loans being withdrawn, the loans not being repayable for some eighteen months). 111 The Liquidator's emphasis on voluntary assistance from other companies in the group was rather off the point. Provision of funds by a third party on the security of the company's assets is voluntary - the third party can decline. Voluntariness is material to whether the company is able to acquire funds, as part of ability to pay its debts as and when they become due and payable, but if the evidence establishes that the company is able to obtain funds, albeit they are voluntarily provided, that can suffice. 112 This approach is consistent with the acceptance that creditors may voluntarily defer payment whereby solvency is promoted. An illustration is re Kerisbeck Pty Ltd (1992) 10 ACLC 619. An unsecured debt was payable on demand to the company's director. The director gave evidence that he did not intend to demand repayment in the immediate future. The debt was therefore not regarded as due and payable. This was determinative of solvency. In substance, voluntary continuance of an unsecured borrowing brought solvency; it is difficult to see why the result would have been different if there had been acceptable evidence of voluntary provision of an unsecured borrowing. 113 In the present case, there was ample support for Palmer J's regard to availability of funds from other companies in the group, relevantly Holdings, additional to the $1.189 million balance of Holdings' debt and Dyspan's $1.21 million, sufficient to establish Constructions' ability to pay its debts as and when they fell due. Importantly, I do not think it was suggested that the funds made available, apparently repayable on demand, were to be regarded as immediately repayable so that Holdings itself was a creditor whose debt could not be repaid as and when it was due and payable. Nor was it suggested that regard could not be had to the availability of the funds because their provision by Holdings was in breach of the directors' duties owed to Holdings. 114 It was clear that Holdings had acted and continued to act as "banker to the Doran Group" (the judge's [128]). Mr Joyce said in terms in his affidavit that "Whilst I worked for the Doran Group of Companies DH acted as the 'banker' for the Group. It lent money out to other members of the Group, including DC, as and when monies were required by that member." In cross-examination it was put to him, and he accepted, that money "moved back and forth between Holdings and Constructions throughout the whole of the time that [he was] with the Group". 115 A snapshot in time is Holdings balance sheet as at 30 June 1995, in which a schedule set out receivables for 1994 and 1995 all involving group entites- 1995 1994 Loan - JC ML PJ PA Doran 20,836 20,836 Loan - Wharf Road Unit Trust 515,534 780,334 Loan - Wharf Road Unit Trust No 2 1,935 843 1,837,003 Loan - Wharf Road Unit Trust No 3 1,165,978 2,025,548 Loan - Doran Property Trust 100 100 Loan - Elermore Tavern Pty Limited 740,413 967,074 Loan - Doran Constructions (Australia) Pty Limited - 4,592,146 Loan - Doran Health Care Pty Limited 2,461,055 1,443,146 Loan - Doran Nominees Pty Limited 100 100 Loan - Daytona Pty Limited - 540 Loan - Aldo Unit Trust 355,832 832 Other loan - Grantlex Pty Limited 149,829 189,189 Other loan - Denprime Pty Limited 149,829 189,189 116 In July 1992 Holdings had lent to DCA the money for the alteration of the group composition. As Mr Joyce accepted, the traffic was not one-way, and as at 31 October 1994 Holdings owed Constructions a significant sum; at least prior to 1 November 1994, there had been intra-group support as necessary. After 1 November 1994 Holdings did act as banker in that, after repayment of the $1.189 million balance of its debt, it paid $1.225 million to Constructions and $1.449 via DCA, and only ceased to do so upon withdrawing its support on 16 December 1997. At least on appeal, the Liquidator accepted that Holdings was capable of supporting Constructions so long as its directors were minded to do so, and that Holdings provided support until 16 December 1997. 117 As to intra-group support as necessary, Paul's affidavits included a description of arrangements with Westpac over the period 1992-1996 in which other companies in the group provided security and guarantees for facilities provided to Constructions. He specifically asserted, "As at 1 November 1994 I say, as a director of the other members of the Doran Group of companies, that the assets and revenue of those companies were also available to provide whatever financial assistance may have been required by DC." Peter's affidavit included that as at 1 November 1994 he was aware that from 1990 onwards Constructions had borrowed from and lent to other companies in the group and that other companies were "in a financial position to provide further assistance to [Constructions] as and when required". Michael and John gave evidence to the same effect. 118 None of the directors was cross-examined to the contrary of these states of mind, which together with the evidence of what had occurred amply founded an expectation that, if Constructions needed money to pay its creditors, the money would be made available from within the group. The directors had the control whereby they could put the expectation into effect, and they did so until late in 1997. 119 I do not overlook the Liquidator's submission that the withdrawal of support in December 1997 showed the frailty of Constructions' position. The Liquidator said that it was at the mercy of Holdings and the other companies, and that the withdrawal of support showed that the funds of the other companies in the group were really not a resource available to Constructions. As a finding of fact, however, the ability as at 1 November 1994 was real, notwithstanding that in the latter part of 1997 circumstances changed and, with the withdrawal of support, the ability was lost. 120 In my opinion, error has not been shown in Palmer J's finding that Constructions was solvent.
Was posting the journal entries an act done for the purpose of giving effect to the transaction? 121 The judge appears to have accepted that it was, see his Honour's [122] referring to September 1995 "when the book entries giving effect to the Restructure was made" and to "giving effect to the Restructure by the book entries". The directors' written submissions on appeal did not contend to the contrary. 122 In the hearing of the appeal there was some debate on the matter. The second minutes for Holdings recorded that the "method of payment" by Holdings to Constructions was to be by journal entry. The same intent may be inferred for the other limbs of the debt restructuring. If the method of payment had been by cheque, at first sight the negotiation of the cheque would have been an act done for the purpose of giving effect to the transaction. The journal entries altered the loan accounts in the companies' books, and there was the equivalent of the passing of money by negotiation of a cheque. On the other hand, if the resolutions evidenced enforceable agreements, then it could be said that the entries were only formalities; were there enforceable agreements, and were the formalities acts done for the purpose of giving effect to the transactions? 123 As a late oral submission, the directors said that what mattered was the purpose, and posting the journal entries did not have the purpose of giving effect to the transaction: they were unnecessary because "the transaction was effective, it could have been sued on if it hadn't been performed". The directors were invited to develop the submission, but did not do so. 124 I consider it sufficient that posting the journal entries was doing what had been agreed should be done, maybe sufficient even if the resolution(s) had not stipulated the method of payment. Attaching legal significance, in the present context, to an act done for the purpose of giving effect to a transaction seems to have been intended to catch an agreement entry into which was an uncommercial transaction if the company was insolvent when the agreement was performed. This is consonant with the view taken in the Full Federal Court in Demondrille Nominees Pty Ltd v Shirlaw (1997) 25 ACSR 535. It was agreed that a residential unit should be sold for $180,000 with $120,000 payable as the deposit and an acknowledgment that the deposit had been paid. The $120,000 had not been paid, and the agreement was found to have been an uncommercial transaction. The company was not insolvent at the time, but was insolvent at the time of a later deed which rescinded the agreement but recited the deemed payment of the $120,000. The Court held that the deed was for the substantial purpose of giving effect to the uncommercial transaction "because it gave effect to the 'credit' in favour of Demondrille which the agreement created" (at 549).
Was Constructions insolvent as at 4 September 1995? 125 Palmer J was not satisfied that Constructions was insolvent in September 1995, see his [122] above, for the reasons he had earlier given. The reasons must have been those leading to his opinion that Constructions was solvent because the funds of other companies in the group "were a resource available to Constructions as a matter of commercial reality" (his Honour's [119]). 126 The Liquidator submitted that, whatever Constructions' solvency as at 1 November 1994, by 4 September 1995 its position had changed for the worse. He said that by 4 September 1995 Constructions had "exhausted its loan from Holdings", meaning that the balance of $1.189 million had been repaid, and that Constructions had ceased to trade (this is uncertain); that it had trade creditors as at 30 September 1995 of $765,396 and a bank overdraft as at that date standing at $1.14 million; and that its only substantial asset was the debt of $4.1 million payable by DCA. Constructions' management accounts balance sheet as at 30 September 1995, showed net assets of $2,060,060, but it was said that that depended on recoverability of the DCA debt. 127 The directors contended that adjustments should be made to the balance sheet whereby Constructions' net assets were not $2,060,060 but $2,566,896. The adjustments were questionable, but not particularly material because they did not meet the Liquidator's contention that the positive net assets depended on recoverability of the DCA debt. 128 Again, the Liquidator's submissions did not rely on a cash flow analysis of Constructions' position as at 4 September 1995. Of the trade creditors, for example, only $405,000 was due and payable as at 30 September 1995. Putting less significant matters aside, Constructions' balance sheet as at 30 September 1995 included, albeit as a non-current asset, the debt from Dyspane of $1.21 million. (The debt from DCA was included as a current asset, albeit in terms not payable for another five years). Although the balance of Holdings' debt had been repaid, Constructions could call in $1.21 million from Dyspane. Trade debtors stood at $128,639. There was no reason to regard the bank overdraft as immediately due and payable, and the liabilities ultimately established to Beresfield and the University were no more or less real than they had been as at 1 November 1994. While the DCA loan, then standing at $4.01 million, underpinned the excess of assets over liabilities, again I do not think inability to pay debts as and when they fell due was proved. 129 In any event, on like reasoning to that earlier described I do not think error has been shown in Palmer J's conclusion that it had not been shown that Constructions was insolvent. Peter's evidence included the assertion that he believed Constructions was able as at August 1995 to pay its debts when they became due and payable because it was still trading, there were no problems with the payment of its creditors and "it had the backing of the Doran Group". The other directors were not so specific, but John said that he believed Constructions was able to pay its debts because "the Doran Group was financially sound". The finding of Holdings continuing as the banker of the group, and that Constructions had the resource of access to its funds and was able to pay its debts as and when they fell due, was readily available for 4 September 1995.
Was Constructions' insolvency as at 24 December 1997 because of, or because of matters including, entering into the transaction? 130 Palmer J held in his [120] that the Liquidator had "failed to prove that Constructions became insolvent as a result of the Restructure". The context in the reasons was insolvency as at 1 November 1994 and 18 July 1995, the latter being the date of the charge. His Honour said in relation to an insolvent transaction that he was not satisfied that Constructions was insolvent as at 1 November 1994 or in September 1995, or that it "became insolvent by reason of the Restructure" (at his [122]). It is not entirely clear whether his Honour was referring to insolvency on 1 November 1994 or in September 1995 by reason of the debt restructuring, or whether he meant that the debt restructuring was not the or a cause of insolvency thereafter. 131 For a time in the appeal it was in dispute, but eventually the directors agreed that the Liquidator had contended at the trial that Constructions had ultimately become insolvent because of the debt restructuring. Palmer J did not more expressly deal with that matter. 132 The Liquidator submitted that, if Constructions had not earlier been insolvent, it became insolvent on 16 December 1997 when Holdings resolved to cease making funds available. It was soon placed in administration, and the creditors resolved that it enter voluntary liquidation. But for the debt restructuring, the Liquidator said, withholding financial support "would not have been an option available to the directors of Holdings" The DCA debt was only repaid in part, $2.651 million remaining payable, and it was said that it followed that Constructions' insolvency arose "because of matters including the loss of its ability to recover the full amount of the loan from Holdings as at 31 October 1994". 133 This was an application of the "but for" approach to causation. In March v E & M H Stramare Pty Ltd (1991) 171 CLR 506 Mason CJ, with whom Deane, Toohey and Gaudron JJ relevantly agreed, favoured a "common sense" approach over the "but for" approach, referring to the part played by "value judgments and the infusion of policy considerations" (at 515-6). The but for approach played an important role "as a negative criterion of causation", but was not an exclusive criterion (ibid). 134 It has been recognised that the common sense approach itself requires that the purpose of the inquiry into causation be identified, see for example Environment Agency (formerly National Rivers Authority) v Empress Car Co (Abertillery) Ltd (1999) 2 AC 22 at 29 per Lord Hoffman and Allianz Australia Insurance Ltd v GSF Australia Pty Ltd (2003) 57 NSWLR 321 at 330-1 per Santow JA; on further appeal (2005) 215 ALR 385 at 394-5 per McHugh J and 406 per Gummow, Hayne and Heydon JJ. Indeed, in the lastmentioned case Gummow, Hayne and Heydon JJ endorsed the doubt expressed by McHugh J in March v E & M H Stramare Pty Ltd at 532 that there is "any consistent commonsense notion of what constitutes a 'cause'." Causation in the law involves the attribution of legal responsibility, and a value judgment must be made having in mind the occasion for the enquiry into causation. 135 In Demondrille Nominees Pty Ltd v Shirlaw at 548 Foster, Lindgren and Madgwick JJ said that ss 588FB and 588FE of the Law were "the current attempt of the legislature to balance the interests of the unsecured creditors of a company being wound up and those who would otherwise be the beneficiaries of pre-winding up transactions entered into by the company". Their Honours said that their purpose was - " … to prevent a depletion of the assets of a company which is being wound up by, relevantly, "transactions at an under-value" entered into within a specified limited time prior to the commencement of the winding up (see Explanatory Memorandum, para1014)" 136 Transactions at an undervalue were no doubt the primary target of the provisions, but the description of an uncommercial transaction in s 588FB(1) was not limited to such transactions. The description directed primary attention to a balancing of benefit and detriment, only in the broadest sense involving undervalue. A transaction could conceivably be one a reasonable person in the company's circumstances would not have entered into although for full value; or it could be one a reasonable person in the company's circumstances would have entered into although at an undervalue, for example a forced sale to overcome temporary illiquidity. For s 588FB(1), in addition to regard to benefits and detriments to the company, regard was to be had to the benefits to the other parties to the transaction. It appears to have been contemplated that a transaction detrimental to the company but beneficial to other parties to the transaction might not unreasonably be entered into. If, for example, there were no creditors and no prospect of creditors, it may be that the controller of the company could reasonably sacrifice its interests to the interests of other parties to the transaction. 137 Section 588FC added to the nature of the transaction the company's insolvency, either at the time the transaction was entered into or (put shortly) at the time it was given effect, or because the transaction was entered into or given effect. An uncommercial transaction was permissible, at least so far as the avoidance provisions were concerned, if the company was solvent at those times and did not become insolvent because of those happenings. 138 Directors should be in a position to conduct their company's affairs without running foul of the avoidance provisions, and I do not think an expansive notion of causation is consistent with their purpose. Where s 588FC(b) looks to an act or omission causing or contributing to insolvency, the insolvency should be quite closely related to the entry into or giving effect to the transaction; if it were not so, the provisions would not guide conduct towards validity, but would avoid transactions because of the turn of later events. The purpose cautions that, in the common sense approach, Constructions' circumstances as at 1 November 1994 and the passage of events after that date are important. 139 The directors said that Holdings had paid $2.674 million to Constructions, $1.225 million directly and $1.449 million via DCA. As well, $1.210 million was paid by Dyspane. In substance, they said, Constructions was funded to the extent of $5.1 million in the three years after 1 November 1994, and there was no reason to conclude that, if Holdings had been left owing the whole debt of $5.239 million as at 1 November 1994, the same funding would not have been provided by repayment of the debt almost in full. It was insufficient, they submitted, to postulate inability to recover the full amount of the loan as at December 1997, when Constructions was solvent after the debt restructuring; three years had passed; $5.1 million had in fact been paid to Constructions; all creditors as at 1 November 1994 had long been paid; the major creditors in the insolvency (Beresfield and the University) were yet to have their debts established; and the later occasion for Holdings withdrawing support for the future was the prospect of extended and expensive litigation. The directors emphasised that none of the directors had been cross-examined to the effect that the debt restructuring changed the way in which Holdings funded Constructions' activities or affected the decision to withdraw support. 140 No bright line can be drawn in many questions of causation; this is one of them. It is by no means determinative to say that, but for the debt restructuring, withholding financial support would not have been an option. It is likely that, but for a number of transactions in its life, Constructions might have had more money or an entitlement to receive payment of more money. Nonetheless, and whatever the reasonable expectation of provision of funds by Holdings or other companies in the group, as a result of the debt restructuring Holdings could withhold funds. It had provided only $2.674 million, and if Beresfield and the University be put aside the external unsecured creditors of the order of $350,000 could not be paid unless it provided more funds. The debt restructuring need only have been one of a number of matters because of which Constructions became insolvent, see s 588FC(b), and if the debt restructuring was an uncommercial transaction I do not think it inconsistent with the purpose of the avoidance provisions that the directors exposed it to avoidance in the event of insolvency when there had not otherwise been made available to Constructions the amount of Holdings' debt. In my opinion, there was the necessary causation.
Was the debt restructuring in breach of the directors' duties on the alternative basis? 141 In addressing breach of directors duties Palmer J considered that, Constructions being solvent as at 1 November 1994, there was no occasion for the directors to consider the interests of creditors when undertaking the debt restructuring; his Honour considered that their purpose of achieving separation of the financial affairs of the property holding companies in the group (Holdings and subsidiaries) and the construction companies (DCA and subsidiaries), to make it easier to obtain finance for the property holding activities, was not "ulterior to the interests of Constructions" or "unreasonable having regard to the interests of Constructions" (see his [132]-[133] above). 142 This negatively expressed view must be seen together with his Honour's views, stated in addressing an uncommercial transaction, that money coming to Holdings could be made available to Constructions if required and (I repeat his [128] - [129]) - "128 In my opinion, having regard to Holdings' role as banker to the Doran Group, it could be seen as reasonably in the interests of Constructions to facilitate the Restructure so that Holdings could find it easier to borrow.
129 Similarly, because Holdings was unarguably solvent as at 1 November 1994 and would be ready to provide money to Constructions or to DCA thereafter, if needed, I do not think that Constructions suffered an unreasonable detriment in that the Restructure replaced the debt from Holdings with the debt from DCA. I do not accept that DCA must have been seen at that time as incapable of repaying its debt to Constructions. There is no reason to suppose that if Constructions had required repayment of the DCA debt shortly after the Restructure and DCA itself had insufficient funds, Holdings would not have advanced the necessary funds to DCA." 143 The Liquidator challenged his Honour's reasons on both fronts. He said that the debt restructuring substituted for a debt owed by a company with significant resources a debt owed by a company with no realistic capacity to pay, and that, even if Constructions was solvent as at 1 November 1994, there was a "realistic possibility" that the interests of creditors would be prejudiced by the debt restructuring, because if Constructions failed successfully to resolve its disputes with Beresfield and the University it was unlikely to have sufficient funds to meet its liabilities to them. Further, he said, Constructions did not gain a commercial or financial benefit from the transaction. Thus, he submitted, a reasonable director acting in the interests of Constructions and considering the interests of creditors would have taken account of the possibility that the loan to DCA would prove irrecoverable, of the risk of relying on voluntary assistance from Holdings, and of the possibility that Beresfield and the University would make out their claims against Constructions, and would not have undertaken the debt restructuring. 144 Neither side's submissions explored any differences between or the intricacies of the various statutory duties and the overlapping fiduciary duties. I do not think it is necessary to do so. 145 In Nicholson v Permakraft (NZ) Ltd (in liq) (1985) 3 ACLC 453 Cooke J's statement of principles included (at 459) - "The duties of directors are owed to the company. On the facts of particular cases this may require the directors to consider inter alia the interests of creditors. For instance, creditors are entitled to consideration, in my opinion, if the company is insolvent, or near insolvent, or of doubtful solvency, or if a contemplated payment or other course of action would jeopardise its solvency. The criterion should not be simply whether the step will leave a state of ultimate solvency according to the balance sheet, in that total assets will exceed total liabilities. Nor should it be decisive that on the balance sheet the subscribed capital will remain intact, so that a capital dividend can be paid without returning capital to shareholders. Balance sheet solvency and the ability to pay a capital dividend are certainly important factors tending to justify proposed action. But as a matter of business ethics it is appropriate for directors to consider also whether what they do will prejudice their company's practical ability to discharge promptly debts owed to current and likely continuing trade creditors." 146 In Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722 Street CJ, with whom Hope and McHugh JJA agreed, said (at 733) - "I hesitate to attempt to formulate a general test of the degree of financial instability which would impose upon directors an obligation to consider the interests of creditors. For present purposes, it is not necessary to draw upon Nicholson v Permakraft as authority for any more than the proposition that the duty arises when a company is insolvent inasmuch as it is the creditors' money which is at risk, in contrast to the shareholders' proprietary interests. It needs to be borne in mind that to some extent the degree of financial instability and the degree of risk to the creditors are inter-related. Courts have traditionally and properly been cautious indeed in entering boardrooms and pronouncing upon the commercial justification of particular executive decisions. Wholly differing value considerations might enter into an adjudication upon the justification for a particular decision by a speculative mining company of doubtful stability on the one hand, and, on the other hand, by a company engaged in a more conservative business in a state of comparable financial instability. Moreover, the plainer it is that it is the creditors' money that is at risk, the lower may be the risk to which the directors, regardless of the unanimous support of all of the shareholders, can justifiably expose the company." 147 For the reasons I have given, I consider that Constructions retained the ability to pay its debts as and when they fell due, and that as at 1 November 1994 the directors were justified in not seeing Beresfield and the University as creditors whose interests would be put at risk by what was done. On the judge's findings, while the expense of litigation was in prospect, liability to Beresfield and the University was not. His Honour's implicit finding that at the time they were not likely creditors was well open. I do not think his Honour has been shown to have erred in concluding that there was no occasion to consider the interests of Constructions' creditors. 148 It was necessary for the directors to consider the interests of Constructions, as a separate legal entity, in deciding whether to participate in the debt restructuring: Walker v Wimbourne (1976) 137 CLR 1 at 6-7. It has nonetheless been recognised that a transaction benefiting one company in a group may have derivative benefits for another company in the group, even if the companies are not parent and subsidiary. In Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146 Brennan J observed (at 183) that "it may be for the benefit of solvent companies in a group to guarantee the liabilities of a holding company in order to benefit the guarantor companies as well as other members of the group". In Equiticorp Finance Ltd (In Liquidation) v Bank of New Zealand Clarke and Cripps JJA said (at 146-7) - "It may be accepted, therefore, that actions carried out for the benefit of the group as a whole may, in particular circumstances, be regarded as benefiting as well one or more companies in the group. This may occur even where, for instance, a company is providing a guarantee for its holding company or another company in the group. Similarly a transaction carried out for the benefit of one of the companies in the group, company A, may be seen to be for the benefit of another company in the group, company B." 149 In Linton v Telnet Pty Ltd (1999) 30 ACSR 465 it was said (at 472) that a loan to a director from the funds of company A, in order to secure his services for company A and company B, could be seen as for the benefit of company A "both directly and derivatively to the extent to which [the director's] services to [company B] ensured the supply of computers and otherwise the successful conduct of [company A's] retailing business". In Equiticorp Finance Ltd (In Liquidation) v Bank of New Zealand it was held that use of the funds of companies A to discharge the debt of the wholly owned subsidiary of related company B was in the interests of companies A, essentially because it was necessary to retain the support of the bank the loss of which would be detrimental to, amongst others in the group, companies A. Clarke and Cripps JJA noted (at 147-9) the necessity for consideration of the interests of companies A as distinct from the group as a whole, so that companies A were not "sacrificed for the good of the other companies in the group", but accepted that the protection of the group as a whole was for the benefit of companies A. 150 The Liquidator contended that more ready finance for the property holding activities of the group gave no benefit to Constructions, it being engaged in the construction activities which were intended to be kept separate in the group composition. The directors responded that, when Holdings was to act and acted as banker to the group (by which I take up the more detailed discussion earlier in these reasons), its enhanced access to finance was for the benefit of Constructions. 151 The submissions did not address whether Holdings or its subsidiaries in fact experienced enhanced access to finance. Holdings' accounts showed a bank overdraft of nil as at 30 June 1995, $92,817 as at 30 June 1996 and $155,530 as at 30 June 1997. From Paul's evidence, it seems that the facilities held by Constructions were left in place. There is some tension between intended financial separation of the property holding activities and the construction activities, on the one hand, and Holdings thereafter acting as the banker to the group, on the other hand. Holdings' exercise of enhanced access to finance was not extensive. But it remains that increased financial capacity in Holdings could have been and to some extent may have brought funds to Constructions. The transaction was for the benefit of Constructions. 152 The interests of Constructions involved a balance of benefit and detriment, and there was also detriment. Instead of a debt of $4.1 million payable by Holdings on demand, Constructions held a debt of $4.1 million payable by DCA in six years time. DCA did not have the same financial substance as Holdings, quite apart from the deferred payment, and as to the deferred payment it may be noted that the unsigned DCA minutes recorded concern about "borrowing money, albeit inter group, without the provision of a reasonable time for repayment". I have earlier noted that it should be accepted that DCA could not have paid the $4.1 million from its own resources. 153 Palmer J said that there was nonetheless not an "unreasonable detriment" (at [129]) to Constructions, because Holdings would put DCA in funds if it were necessary; implicitly, also that the deferral was not an unreasonable detriment because of the expectation that Holdings would provide funds before the strict time for payment of the DCA debt. His Honour plainly enough found that the directors had considered the interests of Constructions and that, on balance, the debt restructuring was in its interests. 154 It is established that courts "have traditionally and properly been cautious indeed in entering boardrooms and pronouncing upon the commercial justification of particular executive decisions": Kinsela v Russell Kinsela Pty Ltd (in liq) at 733. This is not a case of a straightforward comparison of the value of an asset with the consideration received, or the values of an original and a substituted asset. It is a case of a balance of commercial benefit and detriment in the light of the conduct of the group's businesses as "one family business" (the judge's [125]), with Holdings as the banker to the group. The caution is particularly pertinent in such a case. 155 For those reasons, I am not satisfied the primary judge was in error in holding that the Liquidator did not establish that the directors' decision was in breach of their statutory or fiduciary duties.
Was the debt restructuring an uncommercial transaction? 156 The definition of an uncommercial transaction in s 588FB(1) of the Law raises considerations similar to those material to breach of the directors' duties. The question is objective, whether a reasonable person in the company's circumstances would not have entered into the transaction, and free from the subjectivity involved in some of the directors' duties, compare Equiticorp Finance Ltd (In Liquidation) v Bank of New Zealand at 147-8. The curious introductory words, "it may be expected that a reasonable person …", were said in Tosich Construction Pty Ltd (in liq) v Tosich (1997) 78 FCR 363 not to qualify what a reasonable person would have done, but to emphasise the objective nature of the inquiry (at 366-7). 157 It must positively appear that the reasonable person would not have entered into the transaction see Tosich Construction Pty Ltd (in liq) v Tosich at 367 - "What the Court must do is consider each of the matters to which reference is made in s 588FB(1) and, having regard to them, reach a conclusion as to whether a reasonable person in the company's circumstances would not have entered into the transaction. The company's circumstances must include the state of its knowledge, that is, of the knowledge of those who were relatively its directing mind. Only if the Court can conclude that a reasonable person in the company's circumstances would not have entered into the transaction does the section make that transaction uncommercial." 158 The parties applied the submissions concerning breach of the directors' duties also to an uncommercial transaction. The Liquidator emphasised that payment of the DCA debt depended on the "whim" of the directors in providing funds, in comparison to a right in Constructions to demand payment from Holdings, and said that in the result not only was that the debt was left unpaid in full but its balance was purportedly forgiven in November 1997. He said that benefit through Holdings' enhanced access to finance should not be accepted, and that "[i]n the absence of a real benefit no reasonable person in the company's position would have entered into the transaction". The directors said that it was not a case of whim, but of reality at the time that funds would be provided as and when necessary. 159 What the reasonable person would not have done must be judged according to the circumstances at the time, including proper perception of the future, but without the influence of hindsight. It is not necessary to repeat earlier portions of these reasons for the matters to which regard is to be had for the purposes of s 588FB(1). 160 In my opinion, Palmer J is not shown to have erred in not being satisfied that the debt restructuring was an uncommercial transaction.
Orders 161 I propose that the appeal be dismissed with costs. 162 HODGSON JA: I agree with Giles JA. 163 McCOLL JA: I agree with Giles JA. **********
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Lewis (as liquidator of Doran Constructions Pty Ltd (in liq) & Anor
Doran & Ors
Lewis (as liquidator of Doran Constructions Pty Ltd (in liq) & Anor v Doran & Ors [2005] NSWCA 243 CITATION: This decision has been amended. Please see the end of the judgment for a list of the amendments.
re a Company (1986) BCLC 261; re Adnot Pty Ltd (1982) 1 ACLC 307; Allianz Australia Insurance Ltd v GSF Australia Pty Ltd (2003) 57 NSWLR 321; Allianz Australia Insurance Ltd v GSF Australia Pty Ltd (2005) 215 ALR 385; Bank of Australasia v Hall (1907) 4 CLR 1514; Demondrille Nominees Pty Ltd v Shirlaw (1997) 25 ACSR 535; Doran Constructions Pty Ltd v Beresfield Aluminium Pty Ltd [1999] NSWSC 499 (Brownie AJ, 21 May 1999); Doran Constructions Pty Ltd v Beresfield Aluminium Pty Ltd (2001) 17 BCL 215 (Brownie AJ, 8 February 2001); Doran Constructions Pty Ltd v Beresfield Aluminium Pty Ltd (2002) 54 NSWLR 416 (CA, 8 May 2002); Environment Agency (formerly National Rivers Authority) v Empress Car Co (Abertillery) Ltd (1999) 2 AC 22; Equiticorp Finance Ltd (In Liquidation) v Bank of New Zealand (1993) 32 NSWLR 50; CASES CITED: re Kerisbeck Pty Ltd (1992) 10 ACLC 619'; Kinsela v Russell Kinsella Pty Ltd (in liq) (1986) 4 NSWLR 722; Lewis v Cook [2000] NSWSC 191; (2000) 18 ACLC 490; Linton v Telnet Pty ltd (1999) 30 ACSR 465 March v E & M H Stramare Pty Ltd (1991) 171 CLR 506; Nicholson v Permakraft (NZ) Ltd (in liq) (1985) 3 ACLC 453; Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146; re RHD Power Services Pty Ltd (1991) 9 ACLC 27; Sandell v Porter (1966) 115 CLR 666; Southern Cross Interiors Pty Ltd (in liquidation) v Deputy Commissioner of Taxation (2001) 53 NSWLR 213; Tosich Construction Pty Ltd (in liq) v Tosich (1997) 78 FCR 363; Walker v Wimbourne (1976) 137 CLR 1.
Thursday 18 August 2005 LEWIS & ANOR v DORAN & ORS Judgment 1 GILES JA: Doran Constructions Pty Ltd ("Constructions") was a wholly owned subsidiary of Doran Constructions (Australia) Pty Ltd ("DCA"). DCA and Doran Holdings Pty Ltd ("Holdings") were related companies, not in a parent/subsidiary relationship but with common effective shareholdings, in the Doran group of companies ("the group"). The directors of all the companies in the group were Messrs Paul, Peter, Michael and John Doran (collectively, "the directors"). 2 In a debt restructuring, by resolutions passed by the directors on 1 November 1994 DCA agreed to pay $4.1 million to Holdings in part repayment of its then indebtedness; Holdings agreed to pay $4.1 million to Constructions in part repayment of its then indebtedness; and Constructions agreed to lend $4.1 million to DCA. In the result, in place of a debt of $4.1 million payable by Holdings on demand, Constructions held a debt of $4.1 million payable by DCA in six years time. 3 Constructions went into liquidation on 24 December 1997. DCA had gone into liquidation shortly beforehand. DCA had repaid $1.449 million, but the balance of the DCA debt was worthless. The liquidator of Constructions, Mr Alan Lewis ("the Liquidator"), alleged that the debt restructuring was entered into in breach of the directors' statutory and fiduciary duties and was voidable under the Corporations Law ("the Law") as an insolvent transaction. He claimed $4.1 million from the directors and from Holdings, plus interest. (On appeal the Liquidator recognised that, at least for breach of the duties, account should be taken of the partial repayment by DCA.) 4 Palmer J held that the Liquidator's claims failed (Lewis v Doran [2004] NSWSC 668). This appeal by the Liquidator raised, but was not confined to, questions of intra-group support in determining solvency as at and after the debt restructuring and of causation of Constructions' insolvency at the time it went into liquidation.
(2003) 57 NSWLR 321
(2005) 215 ALR 385
(1907) 4 CLR 1514
(2002) 54 NSWLR 416
(1993) 32 NSWLR 50
(1986) 4 NSWLR 722
(1991) 171 CLR 506
(1990) 170 CLR 146
(1966) 115 CLR 666
(2001) 53 NSWLR 213
(1997) 78 FCR 363
(1976) 137 CLR 1
(2003) 214 CLR 118
Appeal dismissed with costs.