Owners Strata Plan 70294 v LNL Global Enterprises Pty Ltd [2006] NSWSC 1386 | Case summary

3894/06 OWNERS STRATA PLAN 70294 v LNL GLOBAL ENTERPRISES PTY LTD; LIANA LEONDAS and LYALL GORMAN - APPLICANTS JUDGMENT 1 The applicants, Ms Leondas and her husband Mr Gorman, are the only shareholders of LNL Global Enterprises Pty Ltd. Ms Leondas is the sole director. On 11 September 2006, the court made a winding up order in respect of the company. By an interlocutory process filed in the winding up proceedings, the applicants now seek an order under s.482 of the Corporations Act 2001 (Cth) terminating the winding up. 2 The winding up order was made on the insolvency ground. A presumption of insolvency arose via s.459C(2)(a) by reason of the company's failure to comply with a statutory demand based on a judgment debt in respect of a default judgment for $4,793.87 related to unpaid strata levies. It appears that the court process initiating the debt action and the originating process in the winding up proceedings were both served at an address recorded as the registered office of the company, being a former home of its principals. For this reason, it seems, the documents did not come to the notice of the human beings behind the company. 3 The evidence adduced in support of the application for an order terminating the winding up consists of two affidavits of Ms Leondas, one affidavit of Mr Gorman and an affidavit of the liquidator going to limited matters to which I shall refer presently. 4 The question of the company's solvency is, of course, crucial to the present application. I therefore turn immediately to that matter, noting as I do so that no attempt has been made by the applicants to adduce evidence of a qualified accountant regarding the company's financial position. As I have mentioned, the liquidator's affidavit is confined to limited matters. The applicants have apparently seen fit to ignore the guidance as to proof of financial position recently reiterated by White J in QBE Workers Compensation Pty Ltd v P Russell Enterprises Pty Ltd [2005] NSWSC 1128 at [26]: "It has been said on a number of occasions that the Court is unlikely to be persuaded to act on the evidence of a single director/shareholder without external confirmation. That confirmation is typically obtained either from the liquidator of the company, if he has carried out sufficient investigations so as to put himself in a position to express an informed opinion, or from the evidence of an external accountant." 5 As the Court of Appeal emphasised in Expile Pty Ltd v Jabb's Excavations Pty Ltd (2003) 47 ACSR 711, a party bearing the onus of proof of solvency must lead the "fullest and best" evidence of the company's financial position. The same task confronts someone who seeks to show that solvency will be achieved if a particular course of conduct is followed. 6 According to the evidence of Ms Leondas, the company has assets consisting of a strata title property at Camperdown and "shares of approximately $35,000.00 in value". It is not clear how the latter matter is borne out by a balance sheet as at 30 June 2006 put into evidence by Ms Leondas. That balance sheet is signed by Ms Leondas and is accompanied by a "compilation report" of Mr Covell, a chartered accountant, who says that he has not conducted "verification or validation procedures" or any "audit or review", so that "no assurance is expressed". 7 The balance sheet refers to current assets of $190,000, being cash assets of $24,571, receivables of $18,410 and investments of $147,207. It shows and non-current assets of $381,620, being "property improvements" of $383,117 and plant and equipment of $77 net of accumulated depreciation of $1,574. A note to the accounts explains that the "investments" item refers wholly to shares in listed companies. The figure of $147,207 must be presumed to be the cost of the shares in the listed companies, given that it is the same at both 30 June 2006 and 30 June 2005. Ms Leondas' reference to "shares of approximately $35,000 in value" may indicate that the market value now is substantially less than the cost; or there may be some other explanation (or none). Mr Gorman's affidavit merely says that the above investments "are currently valued at $147,207.00 in the balance sheet of the company" - a statement that begs the question of their real worth. 8 The balance sheet shows current liabilities of $252,006 (designated "Lyall Gorman: $251,234" and "Liam Gorman: $772") and non-current liabilities of $344,489 designated "Loans-Bank". There is no indication that Ms Leondas is herself a creditor. 9 If the balance sheet as at 30 June 2006 contains a fair depiction of the company's financial position at that date (itself a significant question in light of Mr Covell's compilation report), that position was such that current liabilities were some 133% of current assets. If the true worth of the "investments" is $35,000 and all other matters are accepted as presented, current liabilities would be some 323% of current assets. 10 Ms Leondas' affidavit contains an explanation of the company's debt of $772 to Liam Gorman who, she explains, is the five year old son of Mr Gorman and herself. Ms Leondas says that the "debt" to the child "is a deferred distribution to which he was entitled under the terms of the trust". From this it will be inferred that the company is a trustee. In fact, it seems that its sole activity has been to act as the trustee. The balance sheet to which I have referred is expressed to be a balance sheet of the trust, but is obviously intended to reflect the assets and liabilities of the company as trustee, that is, omitting its own shareholders' funds. 11 The trust was created by an apparently undated trust deed (stamped by the Office of State Revenue on 10 April 2000) constituting a discretionary trust entitled "LNL Global Trust". The trust deed provides that on the "vesting day" (expressed, in the apparently undated deed, to be the day which is 80 years "from the date of this deed"), the corpus shall be held for persons selected from a defined group and, in the meantime, the income of each "accounting period" is to be paid, applied or set aside to or for the benefit of persons selected from a defined group and, in default of such selection, the income is to be accumulated. 12 When Ms Leondas speaks in her affidavit of a debt having become owing to the child by way of "deferred distribution", she is presumably referring to the result of a process which saw the company, as trustee, resolve to pay, apply or set aside income to the extent of $772 to or for the benefit of the child, with the result that the company, as trustee, thereby became liable to account to the child for $772. 13 The debt of $253,234 to Mr Gorman, by contrast, appears to relate to a loan. I say "appears" because of the following passage in one of Ms Leondas' affidavits: "The debt which is described as a debt due to Lyall Gorman is in fact monies which Lyall Gorman and I provided to the company and which I did not regard as a debt or loan but which I am now informed by the accountant was treated as a debt due by the company to Lyall Gorman." 14 This is a curious statement. The sole director of the company seems to be saying that she did not regard the moneys paid by Mr Gorman (and, she says, Ms Leondas herself) to the company as giving rise to a debt or loan. Despite being the sole person in whom management of the company is vested, Ms Leondas is apparently content to be "informed by the accountant" that the money in question "was treated as a debt due by the company to Lyall Gorman". The sole director has presumably overlooked or discarded the possibility that Mr Gorman (and perhaps she herself) paid money to the company with the intention that it should be an addition to the trust fund, a possibility that the trust deed itself clearly contemplates, although with possibly adverse by-products through its clause 11.2. At all events, the sole director has now embraced the proposition that the relevant payments to the company were by way of loan. 15 With the evidence in this state, I proceed on the footing that the company is indebted to Mr Gorman in the sum of $253,234. Nothing in the evidence indicates the terms of the loan, except for its classification as "current liabilities" in the balance sheet. I therefore infer that it is payable in the short term - probably on demand. Because that $253,234 item significantly exceeds the cash resources available in the short term (reflected by the current assets of $190,000 - subject to a query whether the investments are realisable at the apparent cost of $147,207 or the $35,000 to which Ms Leondas refers) and no evidence is given to suggest that there is any commercially realistic prospect of the company's obtaining sufficient cash resources from other sources in a way that does not exacerbate its financial difficulty, I must proceed on the basis that the company is insolvent. 16 I have mentioned the affidavit sworn by the liquidator. He deposes to steps taken to locate assets and liabilities. He says that, subject to approval for the payment of his remuneration and costs (which he quantifies), he has "no objection to" termination of the winding up. The liquidator does not give any comprehensive picture of assets and liabilities or comment on cash flow. Nor does he offer an opinion on solvency. 17 The liquidator's affidavit is dated 10 November 2006. It does not refer to the substantial debt owed by the company to Mr Gorman. It appears likely that the liquidator was not aware of that debt. I say that because Ms Leondas, in her affidavit of 12 October 2006, did not mention the debt owing to Mr Gorman, saying that there were no creditors other than the secured creditor and herself. It was only in her subsequent affidavit of 6 December 2006 (from which I have quoted at paragraph [13] above) that she referred to the debt owed to Mr Gorman. 18 The foregoing brief analysis of the somewhat unsatisfactory account of the assets and liabilities of the company assumes - according to the view of matters most favourable to the applicants' case - that all assets shown in the trust balance sheet, being trust assets, are available to support an operative right of the company as trustee to exoneration and indemnity; in other words, that the company is not, because of breach of trust, denied the ability to resort to the whole of the assets to meet its debts and obligations. 19 The applicants apparently accept that there is a situation of insolvency. In the absence of evidence from an accountant on the financial position, the court can make no real attempt to quantify the extent of the inability to pay debts as they fall due. The applicants nevertheless seek to persuade the court to make an order terminating the winding up. They do so by proffering undertakings to the court. Each of them (Ms Leondas and Mr Gorman) proffers a written undertaking in this form: "I [name] hereby undertake to the Supreme Court of New South Wales that I will not require LNL Global Enterprises Pty Limited (in liquidation) to repay and [sic] money due to me until all other creditors in the company are paid in full." 20 If Ms Leondas is a creditor (something that does not appear from the evidence), adherence to each of these undertakings, where both are simultaneously given, will mean that neither Ms Leondas nor Mr Gorman is ever free to require payment by the company. Ms Leondas will be precluded from requiring payment until Mr Gorman has been paid in full and Mr Gorman will be precluded from requiring payment until Ms Leondas has been paid in full. The result will be perpetual paralysis. But if, of course, Ms Leondas is not a creditor and her undertaking is meaningless, the paralysis does not arise. It will also be observed that the undertaking is an undertaking not to "require" payment. It follows that, if it is open to the company, according to the loan or debt terms, to pay without demand or being "required", the undertaking will not preclude acceptance and receipt by the creditors. 21 These points aside, however, there is a question of policy as to whether the court should accept undertakings of this kind in circumstances such as the present. In other words, should the court allow an insolvent company to be re-launched into the mainstream of commercial life when an associated creditor for a substantial amount whose debt is due immediately or on demand offers to the court an undertaking of indefinite duration not to require payment of the creditor's debt until all other debts have been paid? 22 I approach that question from the standpoint described by McLelland CJ in Eq in Re Nature Springs Pty Ltd (1994) 13 ACSR 50 at p.51: "It is a long established principle that it is contrary to the public interest to terminate the winding up of a company if after the termination the company would remain insolvent in the sense that its liabilities will substantially exceed its assets, even if there is a contractual subordination of all existing debts to future debts. The principle is explained and relevant authorities cited in Collins v G Collins & Sons (1984) 9 ACLR 58; 2 ACLC 595." 23 In Collins v G. Collins & Sons Pty Ltd (1984) 9 ACLR 58, McLelland J reviewed the earlier cases. Among the passages he quoted was the following from the judgment of Mason JA in Re Data Homes Pty Ltd [1972] 2 NSWLR 22 at p.27: "The question here is whether the court should grant a stay in circumstances where, although the company will not be insolvent in the sense that it will be unable to pay its debts as they fall due, and there may be no prejudice to future creditors because they will receive a priority over existing creditors, the liabilities of the companies (including those which are contingent) will substantially exceed its assets. In my opinion that question should be answered in the negative and it matters not whether the reason for that answer is expressed in terms of commercial morality or public interest." 24 This court accepted an undertaking of the kind now contemplated in Brolrik Pty Ltd v Sambah Holdings Pty Ltd (2001) 40 ACSR 361. The Federal Court recently adopted the same course in Re De Groot and Sydney Dive Centre Pty Ltd [2006] FCA 159. In GIO Workers Compensation (NSW) Ltd v Advance International (Australia) Pty Ltd [2002] NSWSC 261, this court again accepted an undertaking but on the express footing that it would be replaced by a subordination of the debt owing to the associated party by means of "an appropriate subordination arrangement, by which I mean that the contractual basis of the debt should be varied so that, as between the parties, restrictions will apply equivalent to those in the undertaking to the court, with the subordination so structured that a simple amending contract of the parties cannot undo it." 25 Neither an undertaking by the associated creditor to the court of the kind now proposed nor a contractual subordination (designed, in each case, to preclude payment to the associated creditor while other creditors are unpaid) represents a sound basis on which to order termination of the winding up of an insolvent company. Purely contractual subordination is unsatisfactory because it can be reversed by the same kind of contractual conduct that created it. An undertaking by the associated creditor to the court that the creditor will not require or accept payment while other creditors are unpaid is unsatisfactory because there is no effective means of monitoring compliance. On occasion, the court may be disposed to order termination of a winding up upon an undertaking being given by an associated party to take some action in the short term - for example, an undertaking to cause tax returns to be lodged (Deputy Commissioner of Taxation v Star Building Formwork Pty Ltd [2005] FCA 1939) or to procure the making of a payment to a certain person by a certain date (Jain v Deojill Pty Ltd [2005] FCA 1938). An undertaking given to the court by an arm's length party involving some short-term action may also be acceptable (cf Singleton v Andreones Pty Ltd [2005] NSWSC 730). Where some action of the company itself is necessary to put it into a state where termination may safely be ordered, the alternative generally preferable is for leave to be granted under s.471A(1A) for the directors to take the necessary action while the winding up subsists, so that the s.482 order can be made after that action is complete. 26 Where short-term undertakings of the kind I have mentioned are proffered, the court may be disposed to accept them because some person beyond the company and its controllers and associates has an interest in the due performance of the undertaking. As a result, any breach of the undertaking is most likely to become the subject of complaint which, in turn, gives rise to a distinct possibility of moves towards early sanction by way of charge of contempt of court. That, of itself, may represent sufficient assurance of likely compliance in the near term to make the undertaking acceptable. 27 In the case of an undertaking of the kind proposed here, however, that analysis does not hold good. There is no party at arm's length with an interest in due observance of the undertaking. The person giving the undertaking not to demand or accept payment by the company is the person (or a close associate of the person) whose decisions determine the actions of the company. One human brain is therefore capable of both causing the company to pay moneys that the giver of the undertaking has undertaken not to demand or accept and receiving (or acquiescing in the receipt of) money in breach of the undertaking. There is, furthermore, no reason to expect that any breach would ever be acted upon, assuming it were detected - unless, perhaps, the company were again wound up and the new liquidator both discovered the undertaking (which, being a matter entirely between the associated creditor and the court, need not appear in any records of the company) and had funds sufficient to pursue a contempt charge. Even then, there is no apparent reason why such a new liquidator would see it as beneficial to the insolvent estate to expend funds on action which, at most, might see the contemnor subjected to fine or imprisonment. And, of course, the advent of the second winding up would be the very thing that the dishonoured undertaking was intended to forestall. 28 It was submitted that the court should regard the undertakings as sufficient in this case because the expedient of capitalising related party debt is, as a practical matter, unavailable. A recent example of resort to that procedure will be found in Re Directorcorp Pty Ltd (2006) 58 ACSR 398. Capitalisation may be employed to remove a situation of insolvency, in that the claim of the related party creditor as a creditor, which represents the difference between solvency and insolvency, comes to be replaced by an interest of that person in the share capital. The debt claim is converted into the inferior claim of a shareholder. The reason why such a ceding of position might be thought to have less radical consequences now than previously was referred to in Sutherland v Rahme Enterprises (2003) 46 ACSR 458 at p.465: "Since 1998, the corporations legislation has made available simplified procedures for the reduction and repayment of share capital. The legislature has drawn what it considers to be an appropriate balance between the interests of shareholders and the interests of creditors in that sphere. Sanctions for contravention by repayment of share capital effected inconsistently with the statutory provisions may be visited upon officers and others involved. Capitalisation of related party debts in contexts of the present kind does not today see funds in any sense irretrievably locked up and, at the same time, ensures safeguards for creditors if any proposal to release such funds comes under consideration. Capitalisation of that kind avoids altogether the kind of difficulty at issue in this type of case." 29 It is said that this method of proceeding is, as a practical matter, unavailable in this case because the company is a trustee. That is simply not so. The method is clearly available. The unwillingness to pursue the possibility really comes from the circumstance that profits and accretions accruing to the company as trustee accrue not to the benefit of shareholders but to the benefit of the trust beneficiaries. The objection is not one of impossibility, practical or otherwise. It is the product of commercial unwillingness to invest in shares that will always be of limited worth. If the persons concerned have chosen to put their company into a position where all the property owned by it is held on trust so that the company's interest (beyond the legal estate) is limited to the "preferred beneficial interest" that is the product of the trustee's right of exoneration and indemnity (Chief Commissioner of Stamp Duties v Buckle (1998) 192 CLR 226 at p.247), they must live with the consequences. By causing a company to become a trustee and to engage in commercial activity, those persons profess themselves content to confront the dilemma described by the late J R F Lehane in "Trading Trusts", a paper in the University of Sydney's series entitled "The Companies Bill 1980 - The Revised Draft": "The use of trusts for this purpose [that is, trading and commerce] may fairly be described as a distortion, a distortion which probably would never have occurred but for the difference in treatment for tax purposes between trusts and companies. In general terms, company law - both statutory and general - proceeds on the assumption that it is normal and appropriate for a trading concern to be organised as a company incorporated under the Companies Act. It is not unfair to say that the whole of trust law - both statutory and general - proceeds on the contrary assumption about trusts." 30 Commercial unwillingness of the creditor to accept equity in the form of shares in a company having only a limited "preferred beneficial interest" in the property held by it (plus whatever independently generated shareholders funds may exist) does not represent any reason why the court should accept an undertaking having the deficiencies to which I have referred. 31 I have observed that the evidence of the company's financial position in this case is deficient. The extent to which the capacity to pay debts as they fall due is impaired cannot be reliably judged by the court. But even if a clear picture were presented and it could be seen that solvency would exist if Mr Gorman's debt were left out of account, the court would, for the reasons stated, not regard Mr Gorman's undertaking (and any like undertaking of Ms Leondas) as any foundation for an opinion that a state of insolvency would no longer exist after the undertaking was accepted by the court. 32 It was indicated upon the hearing of the application that if the court was not disposed to make a termination order on the basis of the undertakings proffered, the applicants would wish to see the application adjourned rather than dismissed. I shall stand it over accordingly. **********

Owners Strata Plan 70294 v LNL Global Enterprises Pty Ltd

At a glance

Court

Decision date

Before

Source

Judgment (11 paragraphs)

Parties

Legislation Cited (1)

Cases Cited (7)

Cited By (15)