Lewis, in the matter of Damilock Pty Ltd (In Liquidation) ACN 008 083 985 v VI SA Australia Pty Ltd ACN 002 433 267

Federal Court of Australia|2008-11-28|Before: Mansfield J

INTRODUCTION 1 Damilock Pty Ltd (In Liquidation) (Damilock) was incorporated in 1985. From 1987, it traded as a retailer, both domestic and commercial, of indoor and outdoor furniture under the business name "Casual Living". It operated only in South Australia until 2006. In about September 2006, it expanded via some new stores in New South Wales, and with a new and a relocated existing store in Victoria to larger premises. By early 2007, it had nine retail showrooms, three commercial showrooms, and three distribution centres, across the three States. 2 On 26 June 2007 Damilock's directors, David Hale and Peter Walkon, resolved to appoint administrators to Damilock pursuant to s 436A of the Corporations Act 2001 (Cth) (the Act). Then on 7 September 2007, Damilock's creditors resolved under s 439A of the Act to wind up Damilock. 3 Martin Lewis and Bruce Carter (the liquidators) were appointed administrators of Damilock on 26 June 2007, and subsequently its liquidators on 7 September 2007. 4 This action (and a series of other actions) is brought by the liquidators under Pt 5.7B Div 2 of the Act dealing with voidable transactions. Section 588FE(2) describes voidable transactions as those entered into, or acts done for the purposes of giving effect to a transaction, during the period of six months ending on the "relation-back day". That day is 26 June 2007: s 9 of the Act. Consequently, the relevant period for these actions is the period from 26 December 2006 to 26 June 2007, that is the relation-back period. 5 The defendant (and each of the defendants in the other actions) is alleged to have been an unsecured creditor of Damilock during the relation-back period. Each is alleged to have entered into an insolvent transaction, and therefore a voidable transaction, during the relation-back period, namely the receipt of money paid by Damilock to reduce its indebtedness to that defendant. 6 Section 588FF of the Act empowers the Court, on the application of a liquidator, if satisfied that a transaction is voidable under s 588FE, to direct the person the beneficiary of the transaction to pay the amount so received back to the company, so that the creditors of the company will then be able to prove in insolvency and to rate equally with other creditors in the allocation of available funds. One of the criteria for a voidable transaction is that it be an insolvent transaction. That is the criterion relied upon by the liquidators. 7 The defendant in this action (and certain of the defendants in the other actions) have put in issue that the moneys received by them from Damilock during the relation-back period were, or were all, insolvent transactions. Section 588FC defines an insolvent transaction in the following terms: A transaction of a company is an insolvent transaction of the company if, and only if, it is an unfair preference given by the company, or 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.

THE ISSUE 8 The one issue in this action, common to the other actions to which I have referred, is whether Damilock was insolvent at and from 26 December 2006 and during the relation-back period to 26 June 2007. Section 95A of the Act says that 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. The corollary, as that section says, is that a person who is not solvent is insolvent. 9 There are other defences available to persons who have been the beneficiary of an insolvent or voidable transaction: see s 588FG, including that there was in fact no benefit received by the counterparty to the transaction, or that the transaction was undertaken in good faith and at a time when the beneficiary had no reasonable grounds for suspecting that the company was insolvent and would become insolvent. In addition, secured creditors are protected from those provisions. That is not necessarily a comprehensive list of the defences raised in the various proceedings. Those matters will need to be addressed on a case by case basis, so it is not necessary in this decision to address the individual circumstances of the defendant or of each of the defendants in the other matters. 10 This judgment follows from a hearing in all the actions brought by the liquidators in which the defendants put in issue that Damilock was insolvent at 26 December 2006 and was insolvent during the whole of the relation-back period. The issue in those actions was heard together. I should note that, in the course of the hearing, one of the other actions in which the hearing was proceeding on that issue settled on terms which were not disclosed but, presumably, upon the basis of an overall resolution of the liquidators claims against it. In the other two actions in which insolvency was in issue, one defendant attended the hearing in part through counsel but did not otherwise participate in the hearing and adduced no evidence and made no submissions on the issue, and the other indicated that it would not attend the hearing but would be bound by the outcome. 11 In those circumstances, it is convenient to simply deal with this action and treat the present defendant as the defendant. I will refer to it as "the creditor". 12 In the event, the liquidators called only one witness, Mr Lewis who was one of the liquidators and an expert accountant, and the creditor called only one witness Gregory Keith also an expert accountant, addressing the issue of insolvency. There was no suggestion that each was not qualified to give evidence as to the insolvency or otherwise of Damilock at material times. The creditor's position was that Damilock was not insolvent until after 12 February 2007 and at some time during the succeeding month.

THE LAW 13 There was no serious issue between the parties as to the applicable law. Nor, indeed, was there any cross-examination of the two witnesses to suggest that they had misunderstood the concept of insolvency as it applies under the Act. The contested issue was as to their respective professional judgments, or as to the validity of the assumptions that were made by them, in addressing the question of the solvency of Damilock during the relation-back period. 14 Accordingly, it is convenient simply to note some principles which were commonly accepted in considering the issue. 15 The question of whether Damilock was insolvent at material times is to be determined objectively upon the whole of the admissible evidence: Emanuel Management Pty Ltd v Foster's Brewing Group Ltd (2003) 178 FLR 1 at [73 ff]. The decision is not necessarily about the directors' knowledge or the creditors' knowledge or their expectations or suspicions of insolvency. It is a matter to be determined objectively. It is to be determined on the circumstances as they were known or ought to have been known at material times, rather than with the benefit of hindsight: Lewis v Doran (2005) 54 ACSR 410 at [103]. 16 It is generally, but not necessarily, the case that an inquiry into the insolvency or otherwise of a company at material times is assisted by considering various indicia of insolvency. In Australian Securities and Investment Commission v Plymin (No 1) (2003) 46 ACSR 126, Mandie J at [386] referred to a number of indicia of insolvency. It is convenient to list them. I propose to consider those which are particularly relevant to the present circumstances. The indicia referred to by Mandie J were:

· continuing losses; · liquidity ratios below one; · overdue Commonwealth and State taxes; · poor relationship with bank, including inability to borrow further funds; · no access to alternative finance; · inability to raise further capital; · suppliers placing company on cash on delivery or otherwise demanding special payments before resuming supply; · creditors unpaid outside trading terms; · issuing of post-dated cheques; · dishonoured cheques; · special arrangements with selected creditors; · solicitors' demands, summonses and the like; · payments to creditors of rounded amounts not reconcilable to specific invoices; and · inability to produce timely and accurate financial information to indicate trading performance and financial position, and to make reliable forecasts. In any particular case, one or more of those factors, or other factors, may have particular significance and one or more of them may not exist. The absence of one or more of those factors does not, of itself, establish solvency. 17 In considering whether Damilock was able to pay its debts as and when they became due and payable, it is appropriate to have regard to its debts in the immediate future as well as its current debts. So much is clear from the use of the words "as they become due" in s 95A of the Act: see Lewis v Doran at [107] and Box Valley Pty Ltd v Kidd (2006) 24 ACLC 471 at [15], [59]-[67], and [68]-[74]. 18 The cash flow test of insolvency focuses on the liquidity of a business. A balance sheet test of solvency, addressing the excess of assets over liabilities, may include assets which are not readily realisable so as to permit the payment of all debts as and when they fall due. On the other hand, insolvency means more than a mere temporary lack of liquidity but, as counsel for the liquidators put it, involves "an endemic inability to pay debts as and when they become payable": see eg Sandell v Porter (1966) 115 CLR 666; Southern Cross Interiors Pty Ltd (in liq) v Deputy Commissioner of Taxation (2001) 53 NSWLR 213 at [54]. 19 Consequently, it is an appropriate starting point to look at the assets of Damilock which either represented cash or assets reasonably readily convertible into cash, and the amount of its debts then due and payable or to become due and payable in the fairly immediate future, in determining whether or not it was insolvent at the commencement of, or during, the relation-back period. 20 Counsel for the liquidators contended that Damilock's inventory or stock in trade was not an asset available to be realised (other than in the ordinary course of business) to meet its current debts. So much is self-evident. It does not follow that the inventory or stock in trade of what is in essence a retail trading company should not be taken into account at all in determining the solvency or otherwise of a retail trading entity. Much will depend upon the nature of the stock, the ability to realise its value, its turnaround time and the like. As Barwick CJ said in Rees v Bank of New South Wales (1964) 111 CLR 210 at 218: It is quite true that a trader, to remain solvent, does not need to have ready cash by him to cover his commitments as they fall for payment, and that in determining whether he can pay his debts as they become due regard must be had to his realizable assets. The extent to which their existence will prevent a conclusion of insolvency will depend on a number of surrounding circumstances, one of which must be the nature of the assets and in the case of a trader, the nature of his business. The treatment of inventory or stock in trade was a matter upon which the experts took a somewhat different view. 21 Another matter relevant to insolvency is the prospect of funds likely to be available from a third party, such as from a capital injection or a subordinated loan. The Court will generally be sceptical of a mere assertion of a third party's willingness to provide such support. Such asserted willingness should be cogently demonstrated as a matter of commercial reality, even if the evidence falls short of establishing a legal obligation to advance funds: see the discussion in Lewis v Doran (2004) 208 ALR 385 per Palmer J at [112], [113]. That topic, too, was a matter upon which there was some difference between the parties, but for reasons which are discussed below, I do not think it is significant in this instance because there is so little evidence of any real prospect of any third party capital funding becoming available. In the end result, senior counsel for the creditor did not place much weight on the prospect of an externally sourced capital injection of funds to show whether Damilock was insolvent prior to about 12 February 2007.

THE EXPERT WITNESSES 22 As I indicated, Mr Lewis' conclusion was that Damilock was insolvent from at least early December 2006 and certainly by 26 December 2006 and remained insolvent until 26 June 2007. He expressed that view because, in the whole of that period, Damilock had a deficiency in its cash flow needed to pay its debts which had become due and payable, based upon hypothetical bank balance assessments which he had prepared. He recognised that conclusion was based upon an assumption that Damilock's creditors were paid on 30 day terms. On that basis, he concluded that Damilock would have required an increase in its overdraft facility in excess of $6m, increasing perhaps to $8m plus by 26 June 2007, to meet its debts as and when they fell due during that period. He did alternative calculations based upon creditor payment terms of 60 and 90 days. They did not alter his conclusion, albeit that the increased overdraft facility required would have been considerably less. He also concluded on his balance sheet analysis that Damilock had a material deficiency in its working capital of $528,000 as at 31 December 2006 increasing to $4,896,000 at 30 June 2007, and that those figures were conservative as they did not take account of non-current employee entitlements such as long service leave, and depreciation. 23 Mr Keith's view was that Damilock was not insolvent prior to 12 February 2007, and became insolvent some time between that date and 14 March 2007. He identified the reasons for his conclusion, differing from that of Mr Lewis, as being: 1. Damilock was in ongoing discussions with potential equity investors at least in the period up to 12 February 2007; 2. Damilock had achieved a large net profit of $530,000 in January 2007, so as to have given Damilock's directors reason to expect that, at that time, its profitability and cash flow was improving significantly; 3. Damilock had engaged Korda Mentha, "highly regarded reconstruction and insolvency experts"; and 4. a report prepared by Korda Mentha as at 13 February 2007 did not state or express the opinion that Damilock was then insolvent, but indicated that Korda Mentha were in discussions with Damilock's directors so that Damilock was pursuing strategies to preserve the integrity of the continuing business. 24 He identified the significant changes in events between 12 February 2007 and over the succeeding month as being Damilock's poor trading during February and March 2007; the failure of discussions with potential equity investors on 12 February 2007; the "last ditch" unsuccessful efforts to seek other potential equity investors; the Korda Mentha further report of 14 March 2007 which expressed the opinion that Damilock was then insolvent, despite Damilock's execution of restructuring strategies; and that Equity and Advisory Limited (EAL) was engaged by Damilock in March 2007 for advice and gave Damilock advice that, in its opinion, Damilock was insolvent. 25 I will advert to those considerations in the course of considering the relative merits of the expert evidence. 26 I note that each expert, as required by the Court's Practice Direction, has identified the assumptions upon which each has formed his respective opinion and the material upon which he had done so. 27 In the case of Mr Lewis, his opinion was based upon primary business records of Damilock, and business records of Damilock's banker, Australia and New Zealand Bank Ltd (ANZ). There was one further document upon which he said he had placed reliance, namely an EAL report described as "Equity and Advisory Report dated March 2007" (the EAL Report). That is the same document upon which Mr Keith said that he had formed his view as to insolvency at least by 14 March 2007: see [23] above. Counsel for the creditor took objection to the receipt of the EAL Report as material upon which Mr Lewis could properly have formed his view. After submissions, I ruled that, even if it were a business record of Damilock because it had been in Damilock's records, I would not receive it in evidence under s 135 of the Evidence Act 1995 (Cth). It was a draft report, rather than a final report. It was unsigned. It was unclear, therefore, whether it represented a concluded view of any particular person. The status of the person whose draft view it was was not fully explained. It was a relatively superficial document. It depended to some extent upon a conditional proposed offer to fund a voluntary administration of Damilock which, so far as the evidence shows, was never accepted. All those features led me to conclude that, if it were received in evidence, it would carry very little weight on its own face, and that therefore its receipt was likely to cause or result in undue waste of time because of the need for the parties to address it. 28 I have carefully considered Mr Lewis' report and his evidence. In my view, he does not in any substantive way rely upon any of the information in the EAL Report, nor in any relevant way rely upon the conclusion which it reached. Consequently, as the balance of the material upon which he based his views and did his calculations was primary material received in evidence, I think his report contains opinions expressed upon admissible, admitted and cogent evidence. 29 The same does not apply to Mr Keith. In fairness to Mr Keith, it must be pointed out that he came into the picture rather late, and was asked merely to review Mr Lewis' report of 14 July 2008 in which he expressed the conclusions as to the insolvency of Damilock referred to above. He did not himself have the opportunity to undertake any primary investigation into the records of Damilock. 30 Mr Keith's report is based upon a number of facts which are not proved. 31 Firstly, he relied upon information provided by Mr Hale in a conversation with an officer or a member of Mr Keith's staff on 7 and 11 July 2008 regarding the prospect of an equity injection from an investor through Rundle Capital Ltd (Rundle), apparently engaged by Damilock in about December 2006 to source some $3m in equity capital. Those investigations ceased on 12 February 2007. He also relies upon that source of information to be satisfied that Damilock subsequently made "last ditch" efforts to identify other potential equity investors after that date. That material has not been proved as a fact. It is a foundation for Mr Keith's view that insolvency occurred only between 12 February 2007 and 14 March 2007 and that Damilock was solvent prior to 12 February 2007. That unproved foundation for certain of his views was further discussed in the body of his report. Mr Keith referred to information (based upon ANZ business records) that ANZ was not prepared to provide further overdraft facilities after September or October 2006. But he also took into account the views of Mr Hale that Damilock had a strong supply base; that ANZ was giving Damilock time to find a further equity partner; that Damilock had potential growth; and that it had a careful budget and forecast cash flow which accommodated some losses and shortfall in trading in the forthcoming period of 18 months. Mr Hale confirmed that Rundle was only formally engaged on 9 January 2007, and that Korda Mentha was engaged in January 2007 (in fact the evidence shows it was early February 2007) to provide "snap shots" of the business, high level strategic advice and to liaise with ANZ, and the like. All of that hearsay material was objected to. It was not independently proved through Mr Hale. 32 There is no cogent evidence of discussions with potential equity investors progressing to a point beyond mere discussions. Mere discussions may take place at a point when a company is quite solvent, marginally solvent, or insolvent. The mere fact of those discussions does not tend to prove solvency. Something more is plainly needed. There is no clear evidence identifying what was conveyed to the potential equity investor or investors. There is no direct evidence that the potential investor or investors fully considered that information, or had the resources to contribute capital, or had made any decision towards contributing capital. There is insufficient evidence to support any finding that a further capital injection was at least a realistic prospect, and so to support a conclusion as to the insolvency or otherwise of Damilock up to 12 February 2007. It may well be that the proposed capital investors had information about Damilock's affairs, and on the basis of it, decided not to invest having done some analysis. It may well be that, having received information about Damilock's affairs, they seriously considered investing capital. 33 Secondly, the EAL Report upon which Mr Keith placed weight in reaching his view as to the time of insolvency of Damilock was not received in evidence for the reasons given. If it had been, it would not have provided a sound foundation for Mr Keith's conclusion as to the period during which Damilock became insolvent for the reasons given. 34 Thirdly, as is apparent from the above discussion, the fact that Damilock had engaged Korda Mentha ("highly regarded reconstruction and insolvency experts") is not of itself a reason to conclude that Damilock was not insolvent prior to 12 February 2007. An insolvency practitioner or expert may be engaged prior to, about the time of, or subsequent to a corporation in fact becoming insolvent. The precise timing of such an engagement, in my view, cannot itself be an indicator itself of solvency or insolvency. That foundation for Mr Keith's view as to Damilock's solvency or otherwise at 12 February 2007 does not, in my view, support his conclusion. 35 Fourthly, Mr Keith relies upon the conclusion of Korda Mentha at 14 March 2007 that Damilock was insolvent and, on the other hand, the absence of a conclusion to that effect by Korda Mentha at 13 February 2007. Korda Mentha, or the author of those reports, was not called to give evidence. Any expert opinion, not being the subject of cross-examination, would have carried relatively little weight in any event where it was contested. In addition, the report of Korda Mentha of 13 February 2007 is a relatively slight document. It runs to five pages and two annexures, one dealing with assets and liabilities as at 31 January 2007 and as at 31 December 2006, and the other dealing with rent outstanding as at 31 January 2007. It does not, in my view, provide a basis for concluding that Korda Mentha had considered whether, and was of the view that, Damilock was solvent as at the date of that report. It simply does not discuss that issue in any specific detail. Its text indicates that a number of pieces of information are still being acquired. It did not have regard to the projected budget and cash flow statements prepared by Damilock, when it was embarking upon its interstate expansion in the latter half of 2006 and which would indicate that the trading profit in January 2007 would not give any real foundation for a forecast of satisfactory performance because the January 2007 outcome was so different from the projected trading cash flow and trading profit at that time. It does not advert to the trading profit in January 2007 discretely or compare it to budget. The net asset position has worsened, on the figures of Korda Mentha, by $1,307,735 in the period from December to January 2007. 36 Whilst addressing the foundations for Mr Keith's report, I note that he provided a further report also dated 16 September 2008 commenting, inter alia, upon a report of Paul Jorgensen of Kennedy and Co dated 11 September 2008. Mr Jorgensen's report had been filed apparently with the intent that he was to be called as a witness in another of the matters listed for hearing conjointly with the present matter (the matter which settled). It became apparent during the course of the hearing that Mr Jorgensen would not be called to give evidence. Consequently, the question arose as to the extent to which his report, if at all, should be received and if so on what basis. It was agreed, as recorded in the transcript, that Mr Jorgensen's report would be received only on the basis that it is evidence of matters to which Mr Keith had reference. It was not received as evidence of Mr Jorgensen's views, or of any of the facts upon which he expressed his views in that report. To the extent that Mr Keith's second report comments upon Mr Jorgensen's report, it is therefore commenting upon a document which has itself no evidentiary significance. It enables Mr Keith's report to be understood, but does not go further than that. Of course, there may be other matters in Mr Keith's second report which do have some evidentiary significance. 37 The end result, in my view, is that of the four reasons given in summary by Mr Keith as to why he held the view that Damilock was not insolvent prior to 12 February 2007, three of those four reasons for that opinion are not matters which are established in evidence. 38 That leaves one matter upon which Mr Keith relied and for which there is a foundation in the evidence to support his conclusion. That is as to Damilock's large net profit (which he erroneously describes as $530,000) for January 2007. However, his concomitant proposition that the profit "would have given Damilock's directors reason to expect that at that time, Damilock's profitability and cash flow was improving significantly" is speculative. I do not consider that the second or concomitant proposition flows from the first. To be able to draw that conclusion, in particular as to the significance of the January 2007 performance, the available measuring stick is Damilock's budget and cash flow forecast for the 12 month period ending June 2007. Accepting that there was a net profit in January 2007 of $416,000 (as Mr Lewis accepted, and as appears from Damilock's own financial records), that was some 50 per cent or thereabouts of the anticipated and budgeted net profit for that month. The budget and cash flow projections of Damilock indicated at best a very sensitive position for Damilock in the succeeding months, assuming that its budget and cash flow projections were satisfied. It recovered only half of what it expected in what appears to have been, on its own analysis, the major trading month of the year. That is not a cause to conclude that Damilock was not insolvent at 12 February 2007. Indeed, Mr Keith was not asked, and therefore did not say, whether that fact alone would have indicated solvency to him at 12 February 2007 (putting aside the other foundations for his view which I do not consider are established). 39 Consequently, in my view, Mr Keith's report does not provide sound expert evidence of solvency of Damilock at 12 February 2007, or at any particular time subsequent to 26 December 2006, because it is based upon foundations, three of which are not established on the evidence and the fourth of which, standing alone, does not in my view support the conclusion and which Mr Keith did not say that standing alone would support his conclusion. 40 Nevertheless, Mr Keith's evidence about the views of Mr Lewis is relevant to whether overall I should reach the conclusion that Damilock was insolvent by 26 December 2006 and remained so during the relation-back period.

CONSIDERATION OF INSOLVENCY 41 It is necessary to consider the whole of the evidence, including the cross-examination of Mr Lewis and the comments by Mr Keith about Mr Lewis' views, to determine whether Damilock was insolvent during the whole of the relation-back period. 42 Senior counsel for the creditor said that critical assumptions were wrongly made by Mr Lewis as the basis for his views. They were: (1) that stock in trade had been acquired on 30 day terms, when in fact the reality was the trading terms had been granted by suppliers extending to 90 days; (2) that stock in trade was not readily convertible into cash, and so Mr Lewis did not place much weight on the stock in trade in determining the solvency of Damilock, at least until 12 February 2007; and (3) that making payment arrangements with creditors and failing to comply with them is a firm indicator of insolvency, when in the circumstances it was not. 43 There are aspects of Damilock's relationship with its suppliers which need to be considered. Firstly, there is the issue as to its general trading terms with its suppliers. Secondly, there is the issue as to its trading terms with, and its current liability to, what was called the Chinese creditors or the Agio Group. 44 In considering the evidence on those issues, it is appropriate to have regard both to the contractual terms for payment of debts to suppliers, generally according to invoices 30 days, and to the attitude of the suppliers over time - provided the time is lengthy enough - to delayed payment of debts, as that may demonstrate some other arrangement between them and the debtor. I do not think that approach is inconsistent with the views of Palmer J in Southern Cross Interiors Pty Ltd v Deputy Commissioner of Taxation (2001) 53 NSWLR 213 at [54]. Nor do I think the creditor's emphasis on the "commercial realities" of the relationship between the company and its creditors is misplaced. What the arrangement was between Damilock and its creditors is a question of fact: see eg Iso Lilodw'Aliphumeleli Pty Ltd (in liq) v Commissioner of Taxation (2002) 42 ACSR 561; Re New World Alliance Pty Ltd (receivers and managers appointed); Sycotex Pty Ltd v Baseler (No 2) (1994) 51 FCR 425; and Taylor v Carroll (1991) 6 ACSR 255. 45 There is no indication that Damilock had other than a good relationship with its main suppliers, and with ANZ, at least up to early 2006. The aged creditors' analysis shows that, until early in 2006, Damilock paid its creditors at about 40 days or a little more after receipt of the invoice, so that - despite the invoices apparently specifying 30 day terms - the picture is that the suppliers were prepared to accord Damilock another 10-15 days for payment. 46 However, the picture worsens quite quickly thereafter. By April 2006, the ageing of creditors had extended out to 77 days, and by December 2006 to 149 days. Although there were no proceedings taken by creditors by 26 December 2006 - or indeed until March 2007 - there is evidence of certain of Damilock's creditors becoming concerned about the delay in payment of invoices by late 2006. I shall refer to that shortly. However, I am not prepared to infer from the fact of the change in ageing of creditors from April 2006 and from the absence of proceedings that Damilock's suppliers had agreed or accepted by 26 December 2006 to extend their trading terms to 90 days. 47 Indeed, subject to particular arrangements, the evidence does not lead to the conclusion that Damilock's arrangements with its creditors, as a matter of commercial reality, were for payment beyond a period of 40-45 days. The relatively rapid decline in the ageing of its creditors does not support a conclusion to the contrary, particularly with some evidence of concerns held by certain of Damilock's major creditors. 48 As to the second aspect, the issue is whether Damilock had agreed with a significant proportion of its supplier-creditors that their debts would not be repayable until after 30 June 2007, so they were not at material times current liabilities of Damilock. The submission was that the Agio Group (from time to time called "the Chinese creditors") had agreed to defer its indebtedness so that its debt was not due and payable either in December 2006 or at any time prior to 1 July 2007. 49 For that purpose, the creditor introduced into evidence a letter from the Agio Group dated 16 February 2007 to the directors of Damilock in the following terms: I wish to thank you for your continued retail support through what has been an exciting growth phase for your company. We are happy to be a part of your future growth and to this end we confirm payment arrangements for $1.2m of stock you are currently holding. This amount is to be paid over a 12 month period commencing 01/07/07. Peter we are very anxious to confirm your arrival dates in March to our Chinese factory to finalise selections for the ensuing season. 50 That document must be seen in the context of the other communications between the Agio Group and Damilock in the period of time leading up to 16 February 2007 and for a little time thereafter. 51 It appears that the Agio Group comprised two different entities or divisions, Dimension Industries and Agio Shan International (Distribution). After several phone calls and emails to discuss current payment arrangements, by email from the Agio Group of 13 December 2006 to Damilock, there is recorded an agreement that the Agio Group would release all shipping documents and continue shipping in accordance with Damilock's order schedule upon a certain arrangement. I infer that, by that time, the Agio Group was concerned about shipping further stock to Damilock because it was not being paid in a timely manner. The arrangement involved $US200,000 to be paid by the end of December 2006, and $US400,000 to be paid by the end of January 2007, to Dimension Industries, together with the outstanding amounts from previous years (including a reference to an outstanding amount from two years previously of $US75,303) to be paid by the end of March 2007. The email noted that, in addition, the amounts owed for goods currently in Australia or on the water was a further sum of $US366,946 and there was further shipping for an order of $US1,039,907 to be made. It also recorded that "funds owed to Agio Distribution for stock provided as per our agreement" $A1,213,770 would be payable by 30 June 2007. By return email Damilock confirmed that arrangement. 52 The next document in sequence is the letter of 16 February 2007 referred to. On the same occasion, however, an email was sent from the Agio Group to Damilock in the following terms: Letter as discussed with Peter in Sydney. Peter told me that it was the Bank only and that Casual Living would be making payments ($300k-$400k) off the $1.2m before the end of June. Also I reminded Peter that the payments for the factory around $US1m had to be made by March 30th, this is the agreement that Peter and David acknowledged to Oliver Wang. I have sent the original letter by mail. 53 The next communication is an email from the Agio Group to Damilock of 5 March 2007 recording an agreement to settle all outstanding payments to Dimension Industries by the end of March, and then a further email of 11 April 2007 recording the debt to Dimension Industries of $US1.1m and to Agio Distribution of $A1.2m, totalling some $A2.5m. It also recorded that further goods would be released on payment for them. By that time, the creditor does not dispute that Damilock was insolvent. 54 There is also included in the material a list dated 15 February 2007 entitled "Payment List for Casual Living" relating to the Agio Group. That payment list has some significant features. The schedule records in each case "terms / invoice numbers / shipped amounts / ETD / ETA / received amount / received date and balance". Counsel agreed ETD and ETA represented estimated times of departure and arrival of shipped goods. Under the column "terms" appears "T/T at site" in each instance. I take that to mean payment by telegraphic transfer of funds upon arrival of the shipped goods. The invoices for items shipped in September 2006 (11 show arrival times later in September and to about the middle of October 2006) show the payment dates on invoices varying between one and six weeks from the arrival time. There are 12 such invoices. There are eight invoices for goods shipped during October, of which payment was made for all but one within two to six weeks of arrival. The same applies in respect of goods shipped on departure dates in November, with payments up to 17 January 2007. There is no payment for shipments during December (totalling $128,896) and no payment for shipments during January apart from one shipment for which payment was made of $39,919 before the arrival of the goods on 26 January 2007. The balance of those shipments totalled $128,896. Nor is there any amount paid for shipments during February. 55 By the date of the document, 15 February 2007, there was said to be an outstanding payment of $952,633 apparently comprising outstanding shipments of $297,216 for 2005/06, $205,135 outstanding between July and August 2006, and $524,485 accumulated in the period from September 2006 to February 2007. 56 I do not consider that the letter of 16 February 2007 is an agreement by the Agio Group to defer recovery of all its indebtedness to a date from 1 July 2007. Indeed, senior counsel for the creditor accepted that it should not be accepted on its face. The letter seems to have been prepared on a particular basis, and on the basis of a private agreement which is not recorded or recognised in the letter. I place no weight upon it. More importantly, the picture seems to be that at least from the latter months of 2006 the Agio Group was pressing Damilock for payment of outstanding amounts, was concerned about payment, and was seeking to enter into arrangements to secure payment in a way presumably to maximise Damilock's survival prospects and so its prospects of full payment. It was nevertheless not reflective of an agreement to defer recovery of indebtedness for any particular time. I do not think there is evidence upon which it can be said that the Chinese creditors or the Agio Group agreed to defer recovery of all their invoices beyond 30 days, or beyond 90 days, or to 1 July 2007. The picture is of the Agio Group trying to enter into arrangements to secure as best it could the payment of its debts whilst Damilock continued trading. There are obvious reasons why it would do so, but they do not reflect agreement about Damilock's trading terms with the Agio Group involving deferral of its payment obligations. 57 That evidence also indicates, in my view, that the Agio Group was being paid on invoices within about 40 days (rather than the asserted 90 day terms) until late 2006. But Damilock was also being pressured to pay substantial sums outstanding to Dimension Industries, and in December 2006 made special arrangements to do so by three substantial lump sum payments in December 2006, January 2007 and March 2007. Agio Shan appears to have been prepared to defer recovery of its debt areas of $1.2m or thereabouts whilst the Dimension Industries debt was paid off, on the condition some $300k-$400k was paid before 30 June 2007. The total indebtedness arrears of the Agio Group was thus some $2m or more, and it was as a matter of commercial practicality trying to get that debt repaid over time whilst continuing to supply Damilock with stock on the basis of prompt payment for those further supplies. 58 I assume in the creditor's favour that the Agio Shan debt of $1.2m was not due until the middle of 2007. However, that does not mean that it is not relevant to Damilock's solvency or insolvency from 26 December 2006 and during the relation-back period. In the context of the arrangement for its deferral and the arrangement from December 2006 to pay progressively the substantial arrears of the Dimension Industries arrears, I consider it is part of the picture informing Damilock's insolvency as at 26 December 2006. The "deferral" of that debt was no more than as part of a wider arrangement with the Agio Group to keep its supplies going and to pay back the substantial accrued indebtedness as well. Mr Keith and Mr Lewis were agreed upon the relevance of that debt in that way. 59 For the reasons discussed below, in any event, if that part of the Agio Group debt were not regarded as a current liability of Damilock, and ignored when assessing its solvency at 26 December 2006 and thereafter, that would not affect my conclusion as to the date it became, and remained, insolvent. 60 There is also evidence that other creditors were pressing Damilock for payment in December 2006. I am mindful of not forming a judgment of solvency or insolvency with the wisdom of hindsight, so I do not have regard to evidence about creditors' attitudes during January 2007 (except in the case of the Agio Group, which by the letter of 15 February 2007 was raised by the creditor). Damilock entered into payment plans with three other creditors in December 2006. One creditor from 9 December 2006 pressed Damilock for weekly payments to ensure ongoing supply, and only released certain shipments upon payments which at least in one instance exceeded the price of that particular shipment. And in December 2006, Damilock failed to pay its statutory debts (superannuation, PAYG, payroll tax and WorkCover levy). 61 There was also some suggestion that HTL International (another Chinese company) had entered into an arrangement whereby it would give Damilock $2m extended credit. There is a bundle of communications between HTL and Damilock touching upon its trading terms. It does appear that for a time HTL was prepared to give Damilock 90 day terms to assist it in financing the establishment of its new stores. However, by 8 January 2007, HTL communicated to Damilock by email complaining that, notwithstanding having increased all current debts to 90 days, there were still significant amounts overdue beyond the 90 days, some extending well beyond 30 days overdue and into the 60 day overdue period totalling $318,773. It added: I must reiterate that 90 days term was requested by Casual in aid of its new store opening and that you promised that there will be no overdues if not we will revert back to 30 days. But it seems that this is not happening. You also mentioned that every week we will be receiving USD100k at least, but this is not happening as well. In addition, we have this exclusivity issue going on. I know you are busy with your new stores and have your own set of problems, but please consider my position as well. Please call me tomorrow to discuss. By email of 7 February 2007, Damilock indicated an acknowledgment that there was an amount of significance owing beyond 90 days, and that there was, at least for a period, an agreement to pay $100,000 per week in reduction of existing indebtedness. It continues: We at no stage ever made a commitment to pay $100 a week in February as February turnover is nowhere near as high as January and we felt we have broken the back (so to speak) of the situation at hand and we will continue to pay $50 a week in February and look to increase March to $75 a week. All the while heading towards a continual gradual reduction of the overall debt. … Subsequent communications indicate that the amount outstanding continued to increase substantially over time. 62 That material shows that, at some point apparently in about October 2006, HTL agreed to extend its trading terms to 90 days to enable Damilock to commence its interstate operations, but on the basis that there would be no further outstanding accounts beyond that time and that the indebtedness would further be reduced. In fact, that term was not met and, as the email of 8 January 2007 asserts, HTL were proposing to revert to 30 day trading. It may have nevertheless acquiesced in ongoing 90 day trading thereafter. There is a dispute as to whether the outstanding indebtedness was also to be reduced by the payment of $100,000 per week. In February Damilock was offering to reduce that amount by $50,000 per week and in March by $75,000 per week. That does not indicate an unlimited and unrestricted preparedness to allow existing indebtedness (whatever it was) to remain unpaid and to continue to trade on 90 day terms only. 63 I do not consider that evidence supports an assertion of any particular arrangement with that creditor as at 26 December 2006 or thereafter to grant $2m extended credit for any particular period. 64 For those reasons, I conclude that at 26 December 2006 and thereafter Damilock's trading terms with its suppliers were not agreed to be on 90 day terms, even though Damilock's payment of its suppliers in the latter months of 2006 in fact extended up to and beyond 90 days. The evidence indicates that (with the possible exception of part of the Agio Group debt) the delayed payment of suppliers was not agreed to and, in some instances, prompted certain suppliers to seek to impose and to impose special trading terms on Damilock. 65 In the light of those findings, I return to consider Damilock's status at and from 26 December 2006. Counsel for the parties, sensibly, did not distinguish between that date at 31 December 2006. I defer consideration of the two other matters referred to in [41] above to the course of my further consideration. 66 Mr Lewis' evidence analysed the status of Damilock at various dates, but relevantly for present purposes as at 30 June 2006, 31 December 2006, 31 January 2007 and 30 June 2007. I do not think it is necessary, beyond addressing Mr Keith's views, to look at the individual months beyond December 2006 and January 2007. The creditor's contention was that Damilock was not shown to be insolvent prior to 12 February 2007. The real issue was whether it was insolvent at 26 December 2006 (the commencement of the relation-back period) and remained insolvent despite the period of its profitable trading during January 2007 and up to about the end of February 2007. 67 Mr Lewis assessed at those dates Damilock's balance sheet, its cash flow analysis, its trading analysis, and he referred to other considerations. Mr Keith accepted his methodology was generally reasonable and appropriate. In other words, the dispute between them was as to the significance of particular facts which were available to each of them, to the extent to which they were proven (apart from the weaknesses in Mr Keith's assumptions to which I have referred). 68 The balance sheet analysis was broken up into a formal balance sheet analysis, a working capital analysis, a quick assets ratio and an analysis of the current creditors. The assessment of the current creditors is, of course, the matter in respect of which I have made the findings recorded above. 69 Mr Lewis' balance sheet picture, based upon Damilock's records, at those four dates was as follows:

30-Jun-06 31-Dec-06 31-Jan-07 30-Jun-07 $'000 $'000 $'000 $'000 Current Assets 5,173 8,617 7,778 6,426 Non Current Liabilities 803 1,975 1,975 2,411 Current Liabilities (4,403) (10,186) (9,760) (12,409) Non Current Liabilities (683) (934) (1,829) (1,324) Adjustments 0 0 870 0 Net Surplus (Deficiency) 890 (528) (966) (4,896)

70 Mr Lewis said that the balance sheet position of Damilock at 30 June 2007 was somewhat worse than the company records as at that date indicated, but it is not necessary to refer to that issue. Also, it is not necessary to refer to the positive adjustment of $870,000 to the balance sheet as at 31 January 2007. It was common ground between Mr Lewis and Mr Keith that that adjustment should have been made. 71 As noted earlier, all but the 31 January 2007 figures were based upon external or internal accounting financial statements, whereas the 31 January 2007 figures were based upon director's figures. 72 On that material, that is Damilock's own records, it is apparent that between June and December 2006, Damilock's net asset position deteriorated by $1.418m, and then between January 2007 and June 2007 by a further $4.368m. The position at 31 December 2006 is probably worse because it fails to account for depreciation for the six months leading up to those accounts, or for non-current employee entitlements during that period. 73 There was cross-examination of Mr Lewis suggesting that the records from which that summary was taken had some idiosyncratic features within them. In particular, there was no direct line comparison between the financial records of Damilock at 31 December 2006 and 31 January 2007 fully able to be made. He accepted that. He recognised that the primary records from which that summary was taken, to a degree, required some reconciliation. In my view, he satisfactorily explained the reconciliation, largely due to reallocation of items of assets and liabilities. Mr Keith did not criticise his analysis. 74 Mr Lewis' opinion then proceeded from the assumption as to the correctness of that balance sheet analysis, but focused upon the prospects of Damilock seeking an equity investor. I have previously found that, on the evidence, there was no foundation for anticipating in any meaningful way that an equity investor would be able to be introduced to Damilock in the reasonably proximate future from 31 December 2006. 75 Mr Lewis also analysed the adjusted bank statement balance which he had calculated, firstly to take into account some minor adjustments which he said were necessary, and secondly to take into account trade creditors terms if they were on 60 day terms rather than 30 day terms or if they were on 90 day terms rather than 60 or 30 day terms. He calculated the following: ADJUSTED BANK STATEMENT BALANCE (Balance beyond overdraft) Assumption 31.12.06 31.01.07 28.02.07 Trade Creditors and ATO and Super $ $ $

30 day trading (6,075,408) (5,501,506) (7,343,641) 60 day trading - trade creditors (4,508,817) (3,840,285) (5,807,325) 90 day trading - trade creditors (1,669,870) (2,273,694) (4,146,103)

30 day trading - trade creditors - (6,075,408) (2,501,506) (4,343,641) $3m capital injection January 2007

60 day trading - trade creditors - (4,508,817) (840,285) (2,807,285) $3m capital injection January 2007

90 day trading - trade creditors - (1,669,870) 726,305 (1,145,103) $3m capital injection January 2007

30 day trading - trade creditors - (6,075,408) (5,501,506) (4,343,641) $3m capital injection February 2007

60 day trading - trade creditors - (4,508,817) (3,840,285) (2,807,325) $3m capital injection February 2007

90 day trading - trade creditors - (1,669,870) (2,273,694) (1,146,103) $3m capital injection February 2007

76 However one looks at it, there was a significant shortfall of assets against liabilities on the balance statement analysis, even assuming 90 day trading terms for trade creditors, and even assuming a $3m cash injection, except if those two assumptions occurred together and the cash injection was in early January 2007. As I have found that there was no realistic prospect of a significant cash injection of $3m from external sources, and in any event it would not have occurred in January 2007 because Rundle appears not to have been engaged formally until about 12 January 2007, that combination of assumptions would not have occurred. 77 There was a dispute between Mr Lewis and Mr Keith as to the appropriate analysis or significance of the working capital ratio. That is the ratio of current assets to current liabilities. Using the figures which were common to each of them, Mr Lewis determined that the ratio of current assets to current liabilities of Damilock at 30 June 2006 was 1.17, at 31 December 2006 was 0.85, at 31 January 2007 was 0.80, and that it subsequently significantly deteriorated. The disagreement was whether a working capital ratio of 2:1, as Mr Lewis said, was a desirable indicator to demonstrate that a company is able to meet its current liabilities from its current assets. 78 Mr Lewis did not say that a ratio of 2:1 was necessary to demonstrate liquidity or solvency. Mr Keith made a few comments about that analysis. Firstly, he considered that a ratio of 2:1 or a ratio of less than 2:1 did not indicate per se that a company is insolvent. So much may be accepted. Secondly, he said that it had to be adjusted to take account of a potential equity investment, which, on the information he had he suggested would to have been by 31 January 2007 or shortly thereafter. That would have changed the working capital ratio. I have concluded that there was no realistic prospect of such a capital injection. Thirdly, he criticised the failure to take into account stock as likely to be sold for a value greater than cost in most instances, so its realisable value may be greater and should be adjusted for when stock is such a large component of the assets themselves above cost price. There was evidence that in normal trading the stock would sell significantly above its cost price. As Mr Lewis pointed out, and Mr Keith did not dispute, however, the relevant accounting standards require stock to be taken into a balance sheet at the lower of cost or net realisable value and he had proceeded on the basis of the accounting standard. 79 Those observations are also pertinent to the creditor's claims that Mr Lewis did not have sufficient regard to the fact that Damilock is in essence a retail trading company, so that its stock should have been given much more prominence in assessing its ability to pay its debts as and when they fell due. I accept that, depending on the evidence, trading stock may be relevant to assessing insolvency. Hence, I also accept the contention for the creditor that the decision in Rees v Bank of New South Wales (1964) 111 CLR 210 is to be understood in its particular circumstances. However, I consider the present circumstances are not dissimilar to those which were considered in Rees. 80 Clearly, by reason of its expansion interstate, Damilock had incurred very significant capital expense, and it had increased its trading stock. It had been unsuccessful in negotiating increased overdraft facilities with the ANZ to fund that expenditure. It did not have other sources of capital or deferred advances from its directors or (as I have found) externally. It appears to have funded those expenses by extending the period in which it paid its trade suppliers. It was keeping within its overdraft limits, but was not paying its trade suppliers in a timely manner. The evidence was that December and January in each year were its best trading period. That is reflected in Damilock's budget. The outcome of its trading in December 2006 and January 2007 is known. It achieved sales much less than it had budgeted in each month. There was, on its own budgeted projections, no reason to anticipate a windfall sales level in February or March 2007. Hindsight indicates that its budgeted sales in those months were also not achieved. Hence, in my view, there is no foundation to conclude that Damilock's trading stock beyond its actual sales in December 2006 and in January 2007 could have been realised in the reasonably foreseeable future to be available to meet its liabilities as and when they fell due. The short answer is that if the trading stock had that quality, it should and probably would have been realised to do so. The trading stock at cost held at 31 December 2006, excluding distribution costs, was in the order of $7.5m and by 31 January 2007 stock at cost was still of the order of $6.99m. The creditor says that at a gross profit margin of 58%, there were at December 2006 potential maximum sales of up to about $12.95m. A similar sum would be sold in November 2006. But the fact is that such sales were not made, and they were not made over the best trading period for the year. In my judgment, the commercial realities indicate that Damilock's trading stock, beyond that actually realised in December 2006 and in the latter months of 2006, and then in January 2007, was not in fact readily realisable to meet its ongoing liabilities as and when they fell due. 81 The creditor pointed out that Damilock always paid its trade creditors out of sales, rather than cash reserves, because it never had sufficient cash reserves for that purpose. That fortifies my understanding that its expansion in the latter months of 2006 was also largely to be financed out of sales, and that the increasing delay in paying its trade creditors illustrates that. If the sales levels were not achievable at a rate and at times sufficient to do so and when its debts fell due and became payable, then the point would be reached that Damilock was insolvent (in the absence of other resources being or becoming available). Its trade creditors had increased from $2.5m to $8.2m between June and December 2006. There was every reason why Damilock should, therefore, have made such sales as it could in December 2006 and in January 2007. There is also reason to conclude, as I did, that it did make such sales as it could over that period. The sales were not sufficient, as at December 2006 to meet its liabilities as and when they fell due. Nor were they in January 2007. 82 The next analysis Mr Lewis carried out in relation to the balance sheet is what is called a quick assets ratio, which describes or provides a measure of a company's ability to pay its debts as and when they fall due without liquidating stock and excluding any overdraft facility from current liabilities. He accepted that it is a stringent test of liquidity which requires a minimum ratio of 1:1. The calculation is current assets less inventory less pre-payments as a ratio to current liabilities less overdraft. On his analysis, the quick assets ratio at 30 June 2006 was 0.18, at 31 December 2006 was 0.04, and at 31 January 2007 was 0.07. Mr Keith did not dispute the quick assets ratio analysis, or its role. However, he considered that it was not an appropriate measure of Damilock's solvency as its main balance sheet component is its inventory, as it is in essence a retail and commercial business trading entity. Hence, he considered that it would provide a false measure of liquidity as it involves ignoring the business' main liquid assets (its stock) but treats the trade creditors as liabilities. In addition, he said that the ageing of Damilock's trade creditors which, he contended, demonstrated that Damilock did not have to pay its creditors at the times assumed by Mr Lewis, and in part and for some months after December 2006 and January 2007. 83 I have considered the latter of those two matters above. In addition, I note that Mr Keith's views in part depend upon information contained in the Korda Mentha report and in the Jorgensen report. Those views relate to the terms negotiated with Agio (which I have found not to have been satisfactorily established) or the Chinese creditors, and are based upon information ultimately provided by the directors, as well as his own analysis of the trading terms. It is unclear whether his analysis independently of the information which he took from those reports and which has not been proved as a fact would have been adhered to. His report (the second report) says that he has "now been made aware of the extended trading terms referred to by the directors" and conditionally then says that "in the event that the terms were as suggested by the Directors, then this information goes further towards supporting my view that Damilock was not insolvent as at 12 February 2007". He proceeds on the assumption that Damilock had arranged extended trading terms with its main supplier and may have been in the process of doing so with three other key suppliers. For the reasons given earlier, I do not accept that that was an appropriate assumption for him to proceed upon, simply because the facts upon which he has proceeded are not proved. Indeed, the second report tends to suggest that his opinion is based upon his assumption not from his own analysis but from information. It relevantly reads: If the extended trading terms suggested by the directors to the ANZ Bank on 24 January 2007 and to Korda Mentha prior to their preparing their report of 18 April 2007 are correct, then I would agree with Mr Jorgensen that this would need to be considered when looking at the dates on which the relevant debts were due. This information would have a material impact on the analysis as to when Damilock may have become insolvent. He notes that neither Korda Mentha nor the ANZ note refer to any documentation to confirm the director's assertion as to the extended trading terms. Whilst it may be appropriate to consider that the quick assets ratio, given the nature of Damilock and its trading system, and the evidence as to the trading margin between cost and normal sale price, is an unreliable indicator so that it may be accepted that a working capital ratio of less than 2:1 does not of itself tend to indicate insolvency, I do not think overall that Mr Keith's views, for the reasons I have given, significantly confronted those of Mr Lewis. They are based upon factual assumptions which have not been proved. 84 However, it is sensible to note that because Damilock was expanding its business in New South Wales and Victoria in late 2006, and because of the potential for increased sales over the Christmas and January period, its stock would have increased over that period and, to an extent, creditors would have increased over the period from October to December when stock was brought in for the Christmas and January selling season. That does not indicate solvency of itself. Nor, without being satisfied as to the capacity of Damilock to meet those increased liabilities, even if the directors informally were extending creditors' trading terms (as the evidence shows), does it tend to show that Damilock was capable of meeting those liabilities as they became due, or were likely to become due. 85 It was obviously a business decision of the directors of Damilock not to overextend its overdraft facility. Given the communications with ANZ, that was a sensible commercial decision. Any other decision was likely to have produced a significant adverse reaction from the bank. The alternative was to run out the trade creditors' terms, as appears to have occurred. 86 In my view, it is not a valid criticism of Mr Lewis' views to suggest that he did not have regard to extended trade terms. His views were formed on the basis of invoices. However, in his report he analyses the trade creditors based upon the company's records. That analysis does not provide itself evidence of any trade creditors' agreement to extended terms, either across the board or in relation to particular creditors. The percentage of trade creditors outstanding for more than 60 days increased progressively from about 60 per cent in December 2006. Those outstanding for more than 90 days increased from 23 per cent in December 2006 to 39 per cent in January 2006. In that period, superannuation payments remained unpaid for the December 2006 quarter, so that the company was not meeting its statutory obligations as and when they fell due. 87 Perhaps, more significant is Mr Lewis' cash flow analysis of Damilock's position. He looked at the financing available to the Damilock. It had two secured creditors, ANZ and a private financier Tincknell. Each held a debenture charge over all the assets of the company, ANZ having priority over Tincknell, and ANZ also held personal guarantees from the directors. 88 The ANZ banking records, and to the extent they are available Damilock's records, confirm that ANZ at June 2003 had agreed upon an overdraft of $0.5m, and subsequently agreed to provide guarantees for landlord's rights in respect of the new interstate premises of up to $1.93m. An increased overdraft facility of $2.3m for interstate expansion was requested in June 2006 but refused in August 2006. 89 In August 2006, the overdraft limit was increased to $1m on a temporary basis, to be reduced back to $0.5m from 31 December 2006. Although Damilock requested an extension of that increased overdraft facility, it was refused so that the overdraft facility returned to $0.5m from 31 January 2006. As I have noted, Damilock worked within its overdraft limit at all times by increasing the period of time it was paying its trading creditors. In fact, it was releasing cheques to its creditors from time to time to the level of its overdraft limit, indicating that there was some pressure from its trade creditors during that period. Moreover, during that period, there is no suggestion that the directors had any additional capacity to support Damilock by increasing their capital input or by lending to the company, and the directors had already provided guarantees in support of the company's indebtedness as well as to support its expansion interstate. And, as I have also found, there was no real prospect of increased capital from external sources at around that time. 90 Although I note that ANZ increased its risk assessment rating of Damilock both in October 2006 and in January 2007, I do not regard those ratings increases (downgrades), or the further rating increase (downgrade) in February 2007, as direct evidence of solvency. There is not sufficient evidence to explain the criteria used by ANZ for those purposes to give its internal ratings much weight. Moreover, its assessments are likely to have been made having regard to the security it held over the company's assets. More significant, in my view, is its attitude to the request for additional funding, the temporary increase of overdraft facilities, and then the re-imposition of the primary overdraft limit. 91 Mr Lewis looked at a hypothetical bank balance assessment to see on a cash flow basis whether Damilock was solvent or insolvent during the period of its trading from December 2006 to February 2007, and for longer periods. I have referred to that material above. In addition, as noted, he did a similar analysis taking into account the possibility that the Court may find that the "Chinese creditors" including Agio were not payable as at 31 December 2006 or until 26 June 2007. 92 Assuming 30 day trading terms for trade creditors, and that trade creditors had been paid as and when their debts fell due for payment, the hypothetical bank balance assessment shows Damilock was unable to meet its debts as and when they fell due. Allowing for 60 day trading period agreed by the creditors (despite there being no evidence of that) in any event it was unable to do so. 93 Mr Lewis also addressed the trading situation of Damilock. The table depicting the amounts discussed above is as follows: 30-Jun-06 31-Dec-06 31-Jan-07 30-Jun-07 12 mths 6 mths 7 mths 12 mths $'000 $'000 $'000 $'000 Sales 22,840 13,703 18,012 27,452 Cost of Goods Sold (11,295) (5,634) (7,931) (14,363) Current Liabilities (4,403) (10,186) (9,760) (12,409) Gross Profit 11,545 8,069 10,081 13,089 Gross Profit % 50.55% 58.88% 55.97% 47.68% Other Income 18 2 2 18 Other Expenses (11,790) (9,381) (10,970) (18,821) Adjusting Entries 0 (107) 0 0 Net Profit/(Loss) Before Tax (227) (1,417) (887) (5,714) Net Profit/(Loss)(%) (0.99%) (10.34%) (4.92)% (20.81%)

Mr Keith did not disagree with that assessment. He made the point that in January 2007, the company had apparently traded profitably to the extent of (he believed) $530,000 because the net loss before tax on an accumulated basis over the seven month period had diminished by that amount. In fact, the net profit in January 2007 was $416,000, as there was a need to make a $107,000 adjustment debit entry to reconcile the profit and loss sheet and balance sheet as at 31 December 2006. The trading statements show the profit of $416,000 during January. 94 As I have noted, Mr Keith placed significant emphasis on the trading profit in January as giving the directors reason to expect that at that time their profitability and their cash flow were significantly improving. In my view, Mr Lewis appropriately took that matter into account. The significant consideration is not that there was a profit in that month, but whether there was a profit of sufficient significance in what was assumed by both experts to be the major trading month for a business such as that of Damilock. Mr Lewis further makes the point that none of the significant expenses incurred by Damilock in setting up in Victoria and New South Wales in the latter months of 2006, approximately $1.9m, had not been expensed in the trading figures as they had been capitalised. He comments that the majority of those costs were never likely to be recoverable and should largely have been written off in Damilock's accounts. Consequently, he considers that the net losses in that table for the period subsequent to 31 December 2006 are significantly understated. 95 More importantly, in my view, Mr Keith did not take proper account of the profit and loss forecast in Damilock's 2006/2007 budget, designed presumably to accommodate its proposed development. It anticipated sales in January 2007 of $5,200,883 and a gross profit after cost of goods sold of $2,620,637. After allowing for other expenses, its net profit was estimated at $809,292. Each of the succeeding months from February to June 2007 (other than June) contemplated a significant net loss per month, and overall the anticipated net profit for the six month period from January to June 2007 was $65,026. Consequently, achieving the budgeted profit for January 2007 was a critical component of that outcome. A net profit of $416,000 was only about half of that which had been anticipated, and if carried forward would have led (assuming other forecasts were met) to a net loss during that period of some $330,000. Moreover, the projected cash flow forecast was structured to maintain the overdraft balance at a little less than the limit of $500,000, so that the shortfall on trading profit compared to budgeted profit would have meant an additional significant sum not available to pay trade creditors or statutory creditors. The progressive ageing of trade creditors suggests that was what in fact was occurring. As noted, Damilock appears to have had special payment arrangements with certain of its creditors by December 2006 including the creditor and HTL Manufacturing Pty Ltd, and was not meeting its statutory creditors at all. Anticipated profit was also necessary to convert the projected balance sheet (in fact, an incorrect balance sheet as it proceeds from net assets at 31 December 2006 of $527,565) shortfall to surplus net assets of $268,727 contemplated that level of net profit. A significantly lesser net profit would have maintained Damilock in negative net assets at 31 December 2006 and 31 January 2007 and increasingly so over the next succeeding several months. 96 I accept Mr Lewis' conclusion that, whether applying the cash flow test of insolvency, or the balance sheet test of insolvency, and by reviewing anecdotal evidence of insolvency, Damilock was insolvent from at least early December 2006 and remained so until the relation-back date. It had a significant deficiency in cash flow needed to pay its debts as and when they became due and payable based upon the hypothetical bank balance assessments. As I have noted, based on an assumption of 30 day terms for its creditors, from 31 January 2006 to 26 June 2007 the overdraft facility would have needed to increase by at least $6m to meet those debts as and when they fell due. Even if creditor terms for trade creditors were extended to 60 days or 90 days, the overdraft facility over that period would have needed to significantly increase over that time at a point when the overdraft had been limited by a decision of the bank. There was no other source of funds realistically available. On the balance sheet analysis, there was a material deficiency in working capital at the relevant dates. In fact, on the evidence, the creditor itself from about 9 November 2006 requested weekly payments to ensure ongoing supply, and at one point appears to have retained possession of shipping containers which it would only release upon payment of a lump sum exceeding the value of the container to reduce its indebtedness. Its shipping operations accounted for a large percentage of Damilock's imports. Finally, I note that Damilock did not make payment of its statutory obligations, that is superannuation, PAYG, WorkCover and payroll tax on time from at least November 2006. 97 I have reached that conclusion, notwithstanding the point made by the creditor in submissions that there is not a coherent picture of the deteriorating financial picture of Damilock between June and December 2006, but rather a "snapshot" only of its position as at 31 December 2006. There was material available to Mr Lewis about the position at Damilock as at 30 June 2006, and some material about aspects of its performance in that six month period. There was, from the creditor's viewpoint, no evidence adduced to show a picture of Damilock's position in the latter months of 2006. Mr Keith did not do so. Its approach was to rely on its cross-examination of Mr Lewis in an endeavour to expose weaknesses in his assumptions or analysis. I have had regard to the various points made in its submissions. 98 In my judgment, despite the matters raised by the creditor, the evidence points firmly to the conclusion that Damilock was insolvent at 26 December 2007 (and 31 December 2007), and remained so during the relation-back period. There is sufficient in the comparison of the picture at 30 June 2006 and 31 December 2006 of the state of affairs of Damilock, together with such information as there was of the intervening period of six months, to confirm that conclusion.

CONCLUSION 99 For those reasons, I find that by 26 December 2006 Damilock was insolvent and remained so during the whole of the relation-back period. 100 It will now be necessary to determine whether the creditor, or any of the other creditors the subject of other proceedings by the liquidators, may resist the respective claims of the liquidators by one of the available defences. In that regard, although I have made findings about the special arrangements between the creditor (and other creditors) and Damilock for the payment of Damilock's trade debts, the evidence on those matters was not particularly detailed and no oral evidence was given. It may be that further evidence will throw a fresh light on the nature and significance of any such arrangements. I do not intend this decision to indicate that, in the light of any further evidence, my views on matters relevant to the potential defences may be foreclosed. I certify that the preceding one hundred (100) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Mansfield.

Counsel for the Plaintiffs: Mr SJ Doyle with Mr B Renfrey

Counsel for the Defendant: Mr P Slattery QC with Mr M Burnett

Solicitor for the Defendant: HWL Ebsworth Lawyers

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