Supreme Court of SA|2001-03-08

POWELL & DUNCAN (NOELEX YACHTS AUST) v FRYER & ANR No. SCGRG-98-431 [2001] SASC 59 (8 March 2001)

INSOLVENCY -- DEBTS DIRECTORS AND OTHER OFFICERS -- CRIMINAL AND STATUTORY CIVIL LIABILITY OF OFFICERS -- OTHER MATTERS -- CORPORATIONS -- INCURRING OF DEBT -- S 588G Appeal - appellants were company directors - appeal against judgment entered against them for loss or damage suffered by creditors due to contraventions of s 588G(2) and/or s 588G(3) of the Corporations Law - claim against directors with respect to debts said to be incurred while company insolvent - debts incurred included taxes, levies, employee entitlements, penalties for late payment of taxes and Workers Rehabilitation and Compensation Act penalties - consideration of meaning of the word "debt" - consideration of when a "debt" is "incurred" - whether learned trial judge erred in concluding that the appellants were in contravention of s 588G of the Corporations Law, so as to give rise to liability pursuant to s 588M of the Corporations Law - whether the learned trial judge erred in finding that the appellants had not made out any statutory defences pursuant to s 588H and that it was not appropriate to excuse them pursuant to the discretionary power conferred by s 1318.

Corporations Law s 9, s 85A, s 95A, s 513B, s 513D, s 588E(3), s 588E(9), s 588G, s 588G(1)(c);
Corporations Law s 588G(2), s 588G(2)(b), s 588G(3), s 588H, s 588H(2), s 588M, s 588M(2), s 1318;
Corporations Law Part 5.7B, Par 5.3A;
Companies (New South Wales) Code s 556, referred to.
Tourprint International Pty Ltd (In Liq) v Bott [1999] NSWSC 581; (1999) 32 ACSR 201;
Sheahan v Hertz Australia Pty Ltd (1995) 16 ACSR 765;
Re Mike Electric (Aust) Pty Ltd (In liq) 1983 7 ACLR 600;
Sands & McDougall Wholesale Pty Ltd (In Liq) & Anor v Commissioner of Taxation (Cth) [1998] VSCA 76; (1999) 1 VR 489;
Hawkins & Ors v Bank of China (1992) 26 NSWLR 562;
Commissioner of State Taxation (WA) v Pollock (1994) 12 ACLC 28, applied.
Castrisios v McManus (1991) 9 ACLC 287;
Standard Chartered Bank of Australia Ltd v Antico [Nos 1 & 2] [1995] NSWSC 31; (1995) 38 NSWLR 290;
Shepherd & Ors v Australia and New Zealand Banking Group Ltd & Anor (1996) 20 ACSR 81, discussed.
Sandell v Porter (1966) 115 CLR 666;
Pegulan Floor Coverings Pty Ltd v Carter (1997) 24 ACSR 651;
Deputy Commissioner for Corporate Affairs v Caratti (1980) 5 ACLR 119;
Flavel v Day (1984-1985) 9 ACLR 502;
Calzaturificio Zenith Pty Ltd (In Liq) v NSW Leather & Trading Co Pty Ltd [1970] VicRp 80; [1970] VR 605;
Carrier Air Conditioning Pty Ltd v Kurda & Ors (1993) 11 ACSR 247;
Re Newark Pty Ltd (In Liq): Taylor v Carroll & Anor [1991] FCA 469; (1991) 9 ACLC 1,592;
Lee Kong & Ors v Pilkington (Australia) Ltd (1997) 25 ACSR 103;
Metropolitan Fire Systems Pty Ltd v Miller & Ors (1997) 23 ACSR 699;
Group Four Industries Pty Ltd v Brosnan [1991] SASC 2986; (1991) 56 SASR 234;
Credit Corporation Australia Pty Ltd & Ors v Atkins & Anor [1999] FCA 335; (1999) 30 ACSR 727;
Marchesi v Barnes [1970] VicRp 56; [1970] VR 434;
Dominion Insurance Co of Australia Ltd (In Liq) v Finn (1988) 7 ACLC 25;
Australian Growth Resources Corp Pty Ltd v Van Reesema (1988) 13 ACLR 261;
Grove v Flavel (1986) 43 SASR 410;
Macquarie Dictionary, Second Revision ;
Australian Securities Commission v Marlborough Gold Mines Ltd [1993] HCA 15; (1993) 177 CLR 485;
Sutherland v Liquor Administration Board (1997) 24 ACSR 176;
FAI Traders Insurance Co Limited v Ferrara (1996) 41 NSWLR 91, considered.

Counsel: PROF J O'DONOVAN WITH MR D COLOVIC - Solicitors: KELLY & CO

Judgment No. [2001] SASC 59

POWELL & DUNCAN as joint liquidators of NOELEX YACHTS AUSTRALIA PTY LTD (In Liquidation) (Respondents)

1 The appellants in this matter were defendants at first instance. They separately appeal against a judgment entered against them in this Court on 14 April 2000, as amended on 28 June 2000. That judgment required them, jointly, to pay to the plaintiffs a total sum of $277,342.23 plus $62,657.77 for interest.

2 The notices of appeal each raise similar issues. They are expressed at some length and do not here require recitation in extenso. Suffice to say that they seek to join issue with the conclusions of the learned trial judge that the appellants were in contravention of s 588G of the Corporations Law, so as to give rise to liability pursuant to s 588M of that statute, that they had not made out any statutory defences pursuant to s 588H, and that it was not appropriate to excuse them pursuant to the discretionary power conferred by s 1318.

3 The respondents are the joint liquidators of Noelex Yachts Australia Pty Ltd (In Liquidation) ("Noelex").

4 It was common ground between the parties that Noelex carried on the business of a manufacturer and wholesaler of yachts from 28 August 1987 to 2 April 1995 on premises which it owned at Goolwa. On 9 June 1995 a resolution for winding up was passed by a meeting of creditors.

5 The present liquidators were appointed on 27 March 1997. They replaced a single liquidator, one Irving, previously appointed at the time of the winding up resolution.

6 Irving had earlier, on 2 April 1995, been appointed as administrator of Noelex. On 4 April 1995 the National Australia Bank appointed a receiver and manager of Noelex. The latter ceased to act on 20 April 1996. Noelex was plainly insolvent as at the date of appointment of Irving as administrator.

7 By virtue of the provisions of s 588E(3) of the Corporations Law, read in conjunction with s 513B, s 513D and the definition of "relation-back day" in s 9, if it is proved or presumed that Noelex was insolvent at a particular time during the period of 12 months ending on 2 April 1995, it must be presumed that it was insolvent throughout the period beginning at that time and ending on that day. That presumption is, of course, rebuttable by virtue of s 588E(9).

8 The appellant Fryer ("Fryer") was a non executive director of Noelex during the period from 10 May 1989 until 2 April 1995. He is in practice as an oral surgeon. The appellant Perry was, at all relevant times, the managing director and responsible for the detailed conduct of the operations of the Noelex at Goolwa.

9 The present proceedings were commenced on 26 March 1998. By the statement of claim, the respondents alleged that, subsequent to 23 June 1993, Noelex incurred a series of debts which remained unpaid as at time of action brought. As to these it was averred that:-

. Noelex was insolvent at the time when each of the debts was incurred;

. At the time at which each debt was incurred there were reasonable grounds for suspecting that Noelex was insolvent; and

. At those times the directors of Noelex were aware that there were grounds for suspecting that it was insolvent.

In the alternative, it was pleaded that a reasonable person in a like position to the directors in a company in the circumstances of Noelex would have been aware that, at the time when each of the debts in question was incurred, there were grounds for suspecting that Noelex was insolvent.

10 The foregoing pleas were, of course, based on the provisions of s 588G of the Corporations Law.

11 In essence, the respondents' claim invoked the provisions of s 588M against the appellants. The liquidators sought to recover from the latter an amount claimed to be equal to the loss or damage said to have arisen by virtue of alleged contraventions of s 588G(2) and/or s 588G(3) of the Corporations Law.

12 The total amount claimed was based on a number of separate categories of debt alleged to have been incurred between June 1993 and 2 April 1995. In broad terms these were:-

Accrued leave, superannuation and wage entitlements due to employees;

Assessed penalties for non payment of WorkCover levies

13 The learned trial judge did not have a great deal of direct evidence before him concerning the early years of the Noelex operations.

14 Reports tendered in evidence, as amplified by oral and documentary evidence, indicate that Noelex was established in 1987 to build and market in Australia a range of Noelex brand trailer yachts. These are of New Zealand design. Construction rights were procured from the original designers. Similar rights were also obtained to construct the Australian designed "Challenger" fixed keel yachts, and also the "Sabre" 25 trailer yacht. In general, these seem to be vessels at the top end of the trailer/sailer market.

15 The evidence suggests that the business did not ever attract a large number of orders and appears to have been somewhat under capitalised from the outset.

16 At any event it was very adversely affected by the economic recession experienced in the early 1990s.

17 The financial summary set out at AB Vol 8 p 548 indicates that, in its first four years of operation, Noelex made very substantial operating losses in all but the year ended 30 June 1989, when it made a profit of $9,642. In each of those years current liabilities greatly exceeded current assets. By 30 June 1991 that excess was no less than $312,762.

18 It is significant that successive financial accounts for periods from the commencement of 1992 to the end of 1994, disclose substantial accumulated trading losses, which grew to $690,390. On only two occasions were net profits reported - $55,686 for the four months ended 31 October 1992 and $9,406 for the eight months ended 30 June 1993 (AB 757).

19 Successive balance sheets for the corresponding periods all disclosed an excess of liabilities over assets, albeit of varying amounts. These increased from as little as a deficit of $24,177 as at 31 October 1992, by steadily escalating amounts, to a sum peaking at $339,649 as at 31 December 1994. As early as mid 1991 it was apparent to the appellants that an infusion of at least about $300,000 was needed for working capital, but this was never forthcoming.

20 Statements had not been prepared in respect of periods subsequent to 31 December 1994 and up to the date of appointment of Irving as administrator.

21 The respondent Powell both prepared a formal report as liquidator and also gave evidence before the learned trial judge. As I read his reasons, the learned trial judge appears to have accepted the substance of what was advanced by Powell. He preferred Powell's methodology to that propounded by an expert called by the appellants.

22 It was Powell's opinion that Noelex was certainly unable to pay its debts as and when they fell due and payable from its own money (and was thus insolvent) from and after 23 June 1993 (the date on which s 588M and other relevant sections of the Corporations Law came into operation), and was likely to have been insolvent for some time prior to that date. It was his assessment that Noelex encountered significant financial difficulties from the outset and that these became increasingly acute from 1992 onward. But a glance at the financial statements reveals the accuracy of that judgment.

23 In the course of his reasons the learned trial judge seems to have taken, as a convenient commencement point for present purposes, the minutes of a special meeting of directors of Noelex held at Goolwa on 8 April 1992.

24 Those minutes, inter alia, contain these statements:-

"Noelex Yachts Australia Pty Ltd ... has continued to trade in the expectation and hope that there would be a revival in the trailer boat market and that orders would flow. This was noted as not having been realised and, in fact, for the first time ever, there are no forward orders on the books.

No interstate sales have been recorded in recent months.

A review of the Balance Sheet as depicted by Mr Tonkin made it apparent that in its present position, Noelex is insolvent. The various approaches discussed were:-

(3) Approach the National Australia Bank with the problem.

(5) Approach Shareholders for injection of capital.

It was agreed that (1) could be achieved but it was not appropriate to make our own determination on the Development and Technology loan.

Further agreed that (3) be undertaken but not until Stephen Tonkin discussed various matters with an insolvency expert. The advice to the Bank Shareholders and Creditors should all be held off until an opinion could be obtained.

The reason for withholding the various actions is that there is a likelihood that by Easter the Company could have at least three orders. In addition a marketing campaign, commenced last week was showing some signs of success.

The sale of any or all of these units would revive the business substantially.

It was agreed that in the absence of immediate revenue receipts there will be no possibility of the company continuing to trade.

It was noted that this meeting was called as soon as it was realised that there was likely to be no cash flow after the end of April unless orders were received and that as a result the company could not hold itself out as being capable of meeting its debts."

25 The minutes indicate that the directors resolved on a variety of strategies designed to overcome the difficulties which had arisen.

26 On 6 May 1992 a meeting of directors was held. The minutes of this indicated that, "[a]s of now there are no orders" and that the Company was in "a critical position re finance".

27 A special general meeting of shareholders was held later in the day. The minutes of this state that:-

"To keep business going we need an input of cash of $80,000 for finance charges, wages and creditors.

Two Avenues (a) Rights issue of Shares on one for one discount to 50 /$1.

(b) Ask shareholders to lend money to company using four stock boats as security."

28 Neither of the proposed strategies was truly productive.

29 On 1 July 1992 the directors resolved to issue shares at a 90 cent discount. In the event entities controlled by the two appellants purchased 261,898 shares for $26,189.80. One other shareholder took up rights to a value of $800.

30 On 25 October 1992, Mr I M Ironside resigned as a director (effective as of 27 October 1992), saying that he had assumed control of operations during absences of the Managing Director on leave. He commented that, on both occasions, he found the financial position different to that which had been indicated to him; and that, on the most recent occasion, he had had to fund the operation from his own resources.

31 In his report to a shareholders' meeting dated 9 June 1993, the Chairman of the Board pleaded with shareholders to consider financial assistance to enable Noelex to complete a restructuring and continue in business for the following six months.

"Presently the company situation is desperate. Your decision this evening will determine the continued viability of the company. Unless we receive an immediate substantial cash commitment, the Board will recommend the winding up of the company.

The efforts of the Board to keep the company afloat for so long will have been in vain."

33 The report indicated that there were then only two boats under construction, with no firm additional orders.

34 On 10 August 1993 winding up proceedings were initiated by the Australian Taxation Office. Its claim was paid out and another creditor became a substituted plaintiff. It was, in turn, also satisfied and the winding up claim was dismissed.

35 On or about 21 March 1994 further winding up proceedings were instituted by the Workers Rehabilitation and Compensation Corporation ("WRCC"). Following certain arrangements made with it the proceedings were dismissed on 13 September 1994.

36 Mr Powell's analysis of the Noelex financial statements indicated that, at 30 June 1992, Noelex had only approximately 20 cents of current assets with which to meet every dollar of current liability. This increased to 38 cents as at 30 June 1994, but decreased to 18 cents as at 31 December 1994.

37 He reported that the "quick ratio" (ie a ratio which measures an entity's ability to pay off short term obligations without relying on the realisation of certain current assets such as inventory or stock) revealed a depressingly illiquid situation. As at 30 June 1992 Noelex had approximately 4 cents of quickly convertible assets for every dollar of current liability. This increased to 14 cents as at 30 June 1994, but diminished to 3 cents by the close of that year.

38 Mr Powell said that he considered that he had not received all of the records related to cash payments and supplier invoices. From the material available he inferred that, over a long period of time, Noelex was not meeting its trade and operating debts as and when they became due and payable, in accordance with normal trading terms. He exhibited indicative copies of correspondence received by Noelex from creditors in both 1993 and 1994 related to defaults in due payment.

39 A summary of aged balances dated 13 January 1993 indicated that, at that time, 58.77% of creditors were outstanding over 90 days and 76.84% were aged over 60 days. Normal credit terms require payment within 30 days. It was Mr Powell's assessment that Noelex was generally trading well outside its agreed terms of trade from at least 31 October 1992. In the course of his evidence Fryer accepted that, during the year ended 30 June 1994, aged creditor balances had increased from $167,303 to $237,227.

40 As to the ability of Noelex to raise additional finance to meet its current debts, Mr Powell reported in these terms:-

"5.10 I have considered the ability of Noelex to obtain shorter or longer term funding from financiers or working capital from other sources by offering available current and non-current assets as security.

5.11 I have calculated that in order to alleviate the ongoing and substantial liquidity shortfall having regard to the level of current liabilities (refer to Annexure H), the additional working capital that was required by the Company was a minimum of approximately $848,896 as at 30 June 1992 increasing to $1,446,499 as at 31 December 1994. These figures are based on total current liabilities of $472,162 as at 30 June 1992 and $793,072 as at 31 December 1994. For the purposes of these calculations, I have assumed an acceptable current ratio of 2:1. In regard to an appropriate current ratio, Mr Tonkin, in an examination conducted pursuant to s 596A of the Law on 13 September 1996, and in answer to a question from Mr John Wilkinson regarding whether he agreed that the current ratio for Noelex should be in the order of 1.8 to 2.0 answered:-

Even based on a current ratio of 1.5 : 1.0 the additional working capital required would have been $612,815 as at 30 June 1992 increasing to $1,049,961 as at 31 December 1994."

41 There can be no doubt that the learned trial judge accepted the substance of all of the foregoing conclusions.

(1) In September 1992, the appellant Perry was drawing post-dated cheques in part payment of some creditors. At that time the Company simply did not have the money to pay creditors. Perry conceded in evidence that, later in that year, the situation worsened; and

(2) Although funds were found to satisfy the creditors who prosecuted the winding up proceedings in August 1993 (dismissed in March 1994) and the subsequent proceedings brought by WRCC, Perry was constrained to issue a series of post dated cheques to creditors over that period.

43 The learned trial judge went on to summarize the effect of the evidence related to mid 1993 in these terms:-

"I think that the evidence clearly establishes that Mr Fryer, though appearing to be optimistic in his report, was by no means convinced about the company's solvency at that time. I find that when a debt included in those pursued in these proceedings was incurred on 1 July 1993 the company was insolvent and that there were reasonable grounds for suspecting that the company was then insolvent. I find that both defendants were aware that there were reasonable grounds for suspecting that the company was then insolvent and that a reasonable person in a like position in a company in the company's circumstances would be so aware. Neither defendant has proved that at that date he had reasonable grounds to expect and did expect that the company was then solvent and would remain solvent, even if it incurred that debt and any other debts then.

Things did not really improve. In March 1994 WorkCover commenced a separate winding-up action against the company. In June, the company was struggling to make even reasonably small payments to its creditors. A cheque for $400 to WorkCover was referred to by Mr Tonkin as having been referred to drawer. Mr Perry admitted to not being surprised about that at the time. On 24 June, the company's bankers issued a Notice of Demand, calling up its facility of $327246. Payment within three days was demanded. Aged creditors had increased by some $70000 during that financial year. The company had made an operating loss of $24509.

Current liabilities where shown at $539783, with current assets but $207207. Soon after the demand for payment of $327246 the company's bank commissioned a report to it from Chua Crase. The accountants' subsequent report to the bank was dated 14 September 1994. The bank referred to its concern with the present conduct of the business and the lack of progress in servicing and reducing the company's debt. Within the report to the bank there was reference to the company's liquidity position being severely strained, with the majority of outstanding creditors as at 31 August 1994 already well overdue for payment. The accountants described the company's position as serious. A cash flow annexed to the report was not achieved. I think it is correct to say that that cash flow was never ever likely to be achieved. Of significance is the fact that within that cash flow the bank's debt would only have decreased by $12000 within 12 months.

The bank invited the directors to consider the issues arising from the report. This included the deficiency shown on the balance sheet of the company, the position of trade creditors, the company's liquidity position, monthly management reports and a finance proposal. Any confidence asserted to be gained by any director from this letter must be described as misplaced."

44 A copy of the Chua Crase report was supplied by the Bank to the directors on or about 27 September 1994.

45 The learned trial judge adverted to a directors' meeting held on 12 October 1994, during which it was recorded that cash flow remained critical, there only being sufficient money to pay wages for the current and the following week.

46 By the close of 1994, no accommodation had been arrived at with the Bank and post dated cheques were still being issued. A cheque to Riviera Nautic was dishonoured.

47 The learned trial judge noted that, in giving evidence, the appellant Perry contended that he was always able to proceed on the basis that most creditors would not press for payment, or that he would ensure payment of creditors by making some further loans to Noelex himself or through companies associated with him, or by persuading other directors to do likewise.

48 The learned trial judge made an express finding in this regard, based on his assessment of Perry's credit. He said that he was not satisfied that that was the truth. He specifically concluded that the situation "was as Mr Perry put it to the directors in July of 1992". (He was there referring to minutes of a meeting held on 1 July 1992 in which it was recorded that the financial position was still serious, creditors had increased, with WorkCover and group tax due, and that Perry had "stopped purchasing as he believes he cannot legally do so").

49 It was observed by the learned trial judge that, in cross examination, Perry accepted that, over a long period of time, trade creditors were often not being paid on time, contrary to normal terms of trading. As to this he said:-

"At the end of his cross-examination, Mr Perry agreed that at best, there was an understanding that creditors would not take action against the company provided it paid within a reasonable time after 30 days. I think that is closer to the truth. However, I am not satisfied that any particular creditor has been shown to have actually agreed to take no action against the company with respect to payment of debts beyond the usual commercial period of 30 days. The fact that proceedings were not issued against the company by many of its creditors only served to encourage Mr Perry and his fellow director to take advantage of that position and continue to trade notwithstanding the company's insolvency. Injection of funds did occur on some occasions, but never really to the point where the company could be seen as solvent against its assets and liabilities. I do not accept that it has been properly proved that particular creditors had agreed not to seek payment of debts. Rather, the evidence identifies nothing more than what has been described as hesitation on the part of creditors to take immediate steps to enforce their rights against the company. I think the liquidator was entitled to consider the usual trading terms of creditors to be 30 days. The schedule prepared indicates the enormity of unpaid creditors at relevant times."

50 The learned trial judge pointed out that what was in issue was not some short term, temporary lack of liquidity, but a chronic, ongoing situation, which persisted over a very long period of time.

51 He did not accept that either of the appellants had any reasonable belief that Noelex was solvent when debts were incurred. He rejected as unreal and, at best, false optimism, the suggestion of Dr Fryer that, in about July 1994, the prospects of Noelex improved because of orders coming in. He found that there were no reasonable grounds to base a reasonable expectation of solvency on an increase in sales at that time. He pointed out that the 1993 "profit" was, in fact, based on the sale of plant.

52 As he stressed, the financial year ended 30 June 1994 ended in a loss, despite a reported first quarter profit. There were no orders from December 1994 to March 1995; and two of the six boats referred to in the Chua Crase report as being under construction were in fact being built for directors at cost.

53 The National Australia Bank demand, on 24 June 1994, for payment of the liability to it in three days was not honoured. Accordingly, s 588E(3) of the Corporations Law gave rise to a presumption that Noelex was insolvent throughout the period from then up until 2 April 1995.

54 But, as His Honour emphasised, this presumption did no more than reflect the compelling inference which necessarily arose from the whole of the evidence, in any event.

55 It comes as no surprise that the learned trial judge concluded that:-

"The company was insolvent. There were reasonable grounds for suspecting that the company was insolvent. Both defendants were aware at those times that there were grounds for so suspecting. Equally, a reasonable person in a like position in a company in the company's circumstances would be so aware."

56 The provisions of the Corporations Law relevant for present purposes are somewhat convoluted. It becomes necessary to trace the scheme of them with some care.

57 The logical commencement point is s. 588G. This stipulates that the section applies if:-

"(a) a person is a director of a company at the time when the company incurs a debt; and

(b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and

(c) at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent as the case may be; and

(d) that time is at or after the commencement of [Part 5.7B of the Corporations Law (ie 23 June 1993).]"

58 The section goes on to provide that, by failing to prevent the company from incurring the debt, the person contravenes it if:

(a) that person is aware, at that time, that there are such grounds for so suspecting; or

(b) a reasonable person in a like position in a company in the company's circumstances would be so aware.

59 It is at once apparent that three particular concepts immediately arise for consideration in relation to those provisions.

60 The first is what constitutes a "debt" for the purposes of the section. The second is to when a debt is "incurred". The third is as to when a company may be said to be insolvent, within the meaning of the section.

61 The word "debt" is not defined by the statute. It appears in a series of sections. Prima facie one would expect that it is used in a constant sense and according to its natural and ordinary English meaning.

62 It is pertinent to note that the normal meaning of the word is simply "a liability or obligation to pay or render something; that which one person is bound to pay to or perform for another" (Macquarie Dictionary, Second Revision). As Professor O'Donovan, of counsel for the respondents put it - "a debt is simply an obligation of one party to pay a sum of money to another". The obligation may be present and absolute, or contingent.

63 There is nothing in the Corporations Law to suggest that any other special meaning is intended. That is the meaning attributed to the word, as it appeared in the context of the former s 556 of the Uniform Companies Code, by Gleeson CJ in Hawkins & Ors v Bank of China (1992) 26 NSWLR 562 ("Hawkins") at 572. Indeed, I did not take Mr Randle, of counsel for the appellant Fryer, to contend to the contrary. The essential focus of his submissions was on the issue of when it could be said that a debt had been incurred, within the meaning of s 588G. I therefore next turn to that question.

64 In speaking of the concept of incurring a debt, in the setting under consideration in Hawkins, Gleeson CJ made the point that the words "incur" and "debt" are not words of precise and inflexible denotation ... they are to be applied in a practical and common sense fashion, consistent with the context and with the statutory purposes. That dictum is no less apposite to the construction of s 588G.

65 In Commissioner of State Taxation (WA) v Pollock (1994) 12 ACLC 28 at 41 ("Pollock") Ipp J, as a member of the Full Court, took, as his commencement point, that the normal meaning of the word "incur" is to become liable to, or subject to, through one's own action. He stressed that this did not exclude rendering oneself liable through acts of omission. Wallwork J agreed.

66 So it was that that Full Court held that it was fairly arguable that a liability to pay tax was a "debt" and that a Company could, in various circumstances, "incur" such a debt. Thus, for example, the engaging of a person at a time when there were reasonable grounds to expect that the Company would be unable to pay its debts, or in circumstances in which the Company knew that it could not pay future wages or payroll tax, was "incurring a debt" in the relevant sense. (See also Charles JA in Sands & McDougall Wholesale Pty Ltd (In Liq) & Anor v Commissioner of Taxation (Cth) [1998] VSCA 76; (1999) 1 VR 489 at 504 ("Sands"). He there concurred in the view that a tax liability constituted a "debt" in the relevant statutory sense and, by inference, that it could be incurred.)

67 It must be recognised that the reasoning of Cox J in Castrisios v McManus (1991) 9 ACLC 287 is to a contrary effect, in that he there concludes that sales tax is not a debt incurred, because there is no act on the part of the relevant company which can be identified as one which brought the debt into existence.

68 Moreover, in Standard Chartered Bank of Australia Ltd v Antico [Nos 1 & 2) [1995] NSWSC 31; (1995) 38 NSWLR 290 at 314, Hodgson J expressed the view that a company incurs a debt when, by its choice, it does or omits something which, as a matter of substance and commercial reality, renders it liable to a debt for which it otherwise would not have been liable. He considered that such a formulation potentially threw up three factors for consideration, namely:-

. whether the company has a choice whether to do (or omit) the act or not;

. whether it is the act or omission, or something else, which renders the company liable for the debt; and

. whether the company would otherwise (in any event) have been liable for the debt.

69 This line of reasoning did not find favour with Bryson J in Shepherd & Ors v Australia and New Zealand Banking Group Ltd & Anor (1996) 20 ACSR 81 at 89 ("Shepherd"). He was of the opinion that the relevant statutory expression does not, in any way, express an element of choice; and that "the practical implications to which Hodgson J referred ... do not require any limitation of the language so as to apply only to the consequences of acts or omissions of the company's choice or to obligations which the company chose to be involved in." It was his opinion that obligations imposed by law, including revenue law, can be debts for this purpose, whether or not acts or omissions which the company chose to be involved in brought them into existence. He felt that the issue fell to be decided by reference to the test enunciated in Hawkins; and that this plainly led to the conclusion that a revenue liability which arose from a company's activities was a debt incurred.

70 A proper resolution of these differing approaches must reflect what fell from the High Court in Australian Securities Commission v Marlborough Gold Mines Ltd [1993] HCA 15; (1993) 177 CLR 485 at 492.

71 It is the clear duty of this Court not to depart from an interpretation already placed on the relevant provisions of the Corporations Law by another Full Court unless convinced that it was plainly wrong. I would accordingly adopt the approaches espoused in Hawkins, Pollock and Sands, with which Shepherd is consistent.

72 In my opinion, not only is it well established that a statutory impost is capable of constituting a debt, but it is also the situation that, if, by reason of the normal, ongoing operations of a Company (including the mere passive retention of existing staff or premises) it is rendered liable to pay a statutory impost, then it may properly be said that such impost has been "incurred", as a debt, by the entity in question. Such an approach is reflected in the reasoning of cases such as Sutherland v Liquor Administration Board (1997) 24 ACSR 176 at 179.

73 Moreover, as Gleeson CJ pointed out in Hawkins, a debt is taken to have been incurred when, by its conduct or operations, a company has necessarily subjected itself to a conditional, but unavoidable, obligation to pay a sum of money at a future time. So it is that, in FAI Traders Insurance Co Limited v Ferrara (1996) 41 NSWLR 91 the Court of Appeal had little difficulty in concluding that ongoing, accruing worker' compensation premiums payable after the occurrence of insolvency were debts which had been incurred within the meaning of s 556 of the former Code.

74 The concept of insolvency, for the purposes of most provisions of the Corporations Law, is spelt out in s 95A. This stipulates 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. ("Person" is defined, by s 85A, to include a body corporate.) The former section goes on to provide that a person who is not solvent is insolvent.

75 There are numerous authorities bearing on this topic but, for present purposes, those which are most pertinent establish these propositions:-

(1) Whether or not a Company is insolvent at a given point in time is a question of fact to be determined by the trial judge. Expert evidence may be of assistance, but it is not conclusive. (Sandell v Porter (1966) 115 CLR 666 ("Sandell").)

(2) The conclusion of insolvency must be derived from a proper consideration of the Company's financial position, in its entirety, based on commercial reality. Generally speaking, it ought not to be drawn simply from evidence of a temporary lack of liquidity. (Sandell, Pegulan Floor Coverings Pty Ltd v Carter (1997) 24 ACSR 651) Regard should be had not only to the Company's cash resources immediately available, but also to moneys which it can procure by realization by sale, or borrowing against the security of its assets, or otherwise reasonably raise from those associated with, or supportive of, it. It is the inability, utilizing such resources as are available through the use of assets or which may otherwise realistically be raised to meet debts as they fall due which indicates insolvency (cf Sandell at 670, Deputy Commissioner for Corporate Affairs v Caratti (1980) 5 ACLR 119, Flavel v Day (1984-1985) 9 ACLR 502).

(3) It is legitimate to take into account any indulgences extended to a Company by its creditors as to trading terms. (Calzaturificio Zenith Pty Ltd (In Liq) v NSW Leather & Trading Co Pty Ltd [1970] VicRp 80; [1970] VR 605 at 609.) However, absent a firm arrangement with all of its creditors for an extension of terms of trade, the Court will usually apply the normal terms of trading when assessing solvency. It is not normally proper to base an assessment on a mere failure of creditors (or of some creditors) strictly to enforce payment obligations at a given point in time. (Carrier Air Conditioning Pty Ltd v Kurda & Ors (1993) 11 ACSR 247 ("Kurda") at 253-254.) I do not read Re Newark Pty Ltd (in liq): Taylor v Carroll & Anor [1991] FCA 469; (1991) 9 ACLC 1,592 as an authority to the contrary. (See Derrington J at 1,601.) The point made in the latter case was that, on the facts, there had been a well established pattern of trading indulgences established over a long period and extended by the creditors generally - to the point that commercial reality required proper cognizance of it. The evidence in the instant case falls far short of such a situation.

In this regard, what fell from Debelle J in Kurda at 254-255 is pertinent. He said:-

"A reasonable and prudent company director would assess whether a company is in a position to pay its debts as and when they fall due by reference to the legal obligations of the company not by reference to any indulgences which the company might have received from its creditors. He would have regard to the fact that the credit policy of any particular creditor might suddenly change and require any outstanding debts to be paid forthwith. The possibility of such a change could result from any one of a number of factors including the fact that the creditor is itself experiencing financial stringency or, as the circumstances of this case illustrate, a change in management. A reasonable and prudent director must found his expectations on reasonable grounds. An expectation that creditors will continue to permit late payment of accounts is founded on hope or optimism, not on reason. It is a policy fraught with danger and could only be reasonably adopted if the company was experiencing a temporary lack of liquidity. A reasonable and prudent director would acknowledge that, while his company might have enjoyed periods of grace in the payment of its debts, there could be no reasonable expectation that that situation would continue. Apart from these considerations, he would recognise that the very fact that the ability of a company to continue to trade depends on indulgences from its creditors points to the conclusion that it is unable to pay its debts as and when they fall due. In other words, a reasonable and prudent director will, generally speaking, be directing his attention to whether the company will be able to pay its debts on the date stipulated for payment."

The same conclusion was arrived at by the Full Court in Lee Kong & Ors v Pilkington (Australia) Ltd (1997) 25 ACSR 103.

(4) It is not appropriate to base an assessment on the prospect that the Company might be able to trade profitably in the future, thereby restoring its financial position. The question is whether it, at the relevant time, is able to pay its debts as they become due - not whether it might be able to do so in the future, if given time to trade profitably (Sheahan v Hertz Australia Pty Ltd (1995) 16 ACSR 765 at 769.)

76 The test to be applied in relation to s 588G(1)(c) is objective (Metropolitan Fire Systems Pty Ltd v Miller & Ors (1997) 23 ACSR 699 at 702-703). As Duggan J pointed out in Group Four Industries Pty Ltd v Brosnan [1991] SASC 2986; (1991) 56 SASR 234 at 238, the state of knowledge of a particular director and any assessment which he may have made as to the ability of the company to pay its debts is irrelevant. The Court must make its own judgment on the basis of facts as they existed at the relevant time and without the benefit of hindsight.

77 By reason of s 588G(2)(b) it is sufficient that a reasonable person in a like position in a company in the Company's circumstances would be so aware. Regard is to be had to the facts and circumstances that the director ought to have known, as well as to the facts and circumstances that were actually known to him (Credit Corporation Australia Pty Ltd & Ors v Atkins & Anor [1999] FCA 335; (1999) 30 ACSR 727 at 769).

78 Viewing s 588G in the foregoing light, it is also necessary to consider other interfacing provisions of the statute.

79 The present claim against the appellants was founded on the provisions of s 588M. Relevantly, that reads as follows:-

(a) a person (in this section called the director) has contravened subsection 588G(2) or (3) in relation to the incurring of a debt by a company; and

(b) the person (in this section called the creditor) to whom the debt is owed has suffered loss or damage in relation to the debt because of the company's insolvency; and

(e) the director has been convicted of an offence in relation to the contravention; or

(f) a civil penalty order has been made against the director in relation to the contravention.

588M (2) The company's liquidator may recover from the director, as a debt due to the company, an amount equal to the amount of the loss or damage.

80 The phrase "loss or damage" is not defined by the statute. Mr Randle strenuously contended that the relevant loss or damage is not the amount of the unpaid debt in each instance. It was, he said, necessary for the court to examine each individual debt and make various potential abatements of it.

81 First, he submitted, due allowance had to be made, by way of offset, for any dividends which the creditor would probably receive in the winding up in any event.

82 Second, he argued, in the case of a trade debt, it was necessary to look into the profit component of the debt. As I understood him, it was necessary to enquire as to what would have been the situation had the sale to the Company not taken place. If the supplier would not have had a ready alternative market (as, it was asserted, was the case on the Fleurieu Peninsula at the time) then it could not be said that the true loss was the full amount of the debt.

83 Third, he asserted that, in the case of revenue imposts such as rates, which constituted a statutory charge on the Company's land, due regard had to be given to the value of any security arising from that charge, as if it had actually been enforced.

84 Finally, he advanced the argument that, in any event, revenue penalties exacted did not constitute loss or damage, because there was no demonstrable loss or damage to the revenue, other than the primary statutory impost in issue. The amounts in question were mere penal exactions of a disciplinary or enforcement type.

85 Mr Randle further submitted that there was an inherent unfairness in simply looking at relevant unpaid debts globally, as contrasted with individually. This was because the effect of so doing was, potentially, to subsidise earlier creditors whose debts were not incurred in circumstances which may be impugned. He argued that it was necessary, in some fashion, to, as he put it, recognise "the opening position, in comparison with the closing figure when it comes to solvency, and saying that it's that difference which measures the overall outer limit of the directors' responsibility".

86 I pause to say that, with respect, I really do not comprehend either the legal logic or the inherent mathematics of the lastmentioned propounded approach.

87 With all due respect, these arguments, both individually and collectively are both novel and extraordinary. Moreover, they fly in the face of the plain intention of the legislation. All of the provisions to which reference has been made focus on the incurring of further debts when a company is insolvent and the consequential detriment to creditors by virtue of the non payment to them of the amounts of their claims.

88 I entertain no doubt that, read in context, the loss and damage adverted to is the amount of the unpaid debt due to the creditor in question. This is the view which was obviously taken by Austin J in Tourprint International Pty Ltd (In Liq) v Bott [1999] NSWSC 581; (1999) 32 ACSR 201 at 217 ("Tourprint"), and, in my experience, has always been applied to the practical administration of the statute. Whilst the provisions of the Corporations Law, so applied, may give rise to some practical consequences which could be said to be somewhat arbitrary and possibly inequitable in some respects, the insolvency law has always, as a matter of practicality and commercial expediency, had to adopt certain parameters which are arbitrary. There is nothing particularly novel in the approach here in question. By way of contrast, the adoption of the approach espoused by Mr Randle would render administration in insolvency virtually unworkable. The legislature could not possibly have envisaged creating the inevitable complexity and requirement for detailed examination of collateral issues which Mr Randle propounds.

89 I therefore reject his submissions and conclude that the "loss or damage" in question will normally be the quantum of relevant unpaid debts.

90 The Corporations Law provides various potential defences to directors, inter alia, to claims made against them pursuant to the provisions of s 588M(2). That which is particularly pertinent to the present proceedings is found in s 588H(2), which reads as follows:-

"(2) It is a defence if it is proved that, at the time when the debt was incurred, the person had reasonable grounds to expect, and did expect, that the Company was solvent at the time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time."

91 There are two critical elements which arise for consideration on the particular facts. First, it must be demonstrated that, at the relevant time, the particular director had an actual expectation that the Company was in fact solvent and would remain solvent. Second, it must also be shown that the grounds for that expectation were reasonable.

92 As Austin J pointed out in Tourprint at 215, the expectation in question must be a higher degree of certainty than a mere hope or possibility or "suspecting". Moreover, the director cannot hide behind any degree of ignorance of the true state of affairs which is either of his or her own making, or has been contributed to by his or her own failure to make further necessary inquiries.

93 When the statutory provisions to which I have referred are applied to the facts revealed by the evidence in this case the ultimate conclusions to be drawn are inevitable.

94 There cannot be the slightest doubt that, at least by mid 1992, Noelex was hopelessly insolvent and that its situation did not ever recover in a significant degree. The various extracts from the minutes which I have recited, considered in light of the progressive financial statements speak eloquently for themselves. As Dr Fryer conceded in evidence, it was realised by the directors that they were incurring debts which they were not in a position to pay (AB 436 Vol 7). Their attitude was that they "were confident, if we could survive the recession, we would be a successful company". When he was asked "But how could you possibly, given the situation that your managing director had stopped purchasing, as he believed he could not legally do so and give the situation that it had been recorded a couple of months earlier in the minutes that you had no orders, how could you possibly continue trading?", his response was "... we were looking for ways of raising further capital".

95 The compelling inference arising on the evidence was that the directors plainly adopted what, to any dispassionate observer at the time, was a quite unrealistic "Micawber" like stance - hoping against hope that something would turn up to resolve their difficulties. This persisted over a very long period of time and any honest appraisal by them of the situation must have caused them to realize that they were whistling against the financial wind.

96 I do not think it could ever seriously have been believed by any of them that there was ever any general agreement by their creditors for extended terms of trade. What was occurring was plainly a constant juggling of what funds were available to satisfy those creditors who pressed hard, leaving the less aggressive creditors simply to wither on the vine.

97 The action of the National Australia Bank in calling up its debt on 24 June 1994, really triggered the ultimate death knell of Noelex and confirmed its insolvency as at three days after that date. However, it is patent from the evidence that the Company was constantly insolvent long before then, and, as I have indicated, at least by mid 1992. Not only was it unable to pay its debts, as they fell due, from its own resources, there was never any realistic possibility of securing adequate funding support from elsewhere to enable it to do so.

98 In his submission, Mr Randle persisted in maintaining that the respondents had not proved that Noelex was insolvent at the time of incurring any relevant debt.

99 His argument placed considerable emphasis on the criticism by the accountant Kennedy of Powell's analytical methodology. However, it seems to me that this was largely a smoke screen. It is significant that Kennedy did not ever advance any suasive thesis to establish that Noelex was actually solvent at any relevant time. Plain common sense dictated a contrary conclusion on any realistic overview of the evidence led at trial. Mr Randle's suggestion that the failure of some creditors to press their claims indicated the probability of some concluded, positive arrangement for vastly extended terms of trade utterly lacks conviction.

100 In short, nothing has been put on behalf of the appellants which can successfully impugn the finding of the learned trial judge that Noelex was unable to pay its debts as and when they became due and payable, relevantly, from and after 23 June 1993, when Part 5.7B of the Corporations Law came into operation.

101 Equally, his conclusion that, as and when debts were incurred thereafter there were, patently, reasonable grounds for suspecting that the Company was insolvent is beyond reproach.

102 The analysis of the evidence further reveals that the appellants were plainly aware that, at the times in question, there were grounds for so suspecting. In any event it is beyond question that, given the evidence as to the situation as it existed from time to time, any reasonable person in a like position in a company in Noelex's circumstances would be so aware.

103 It follows that a conclusion by the learned trial judge that the appellants had contravened s 588G was inevitable.

104 In so saying, I do not ignore Mr Randle's contentions concerning the composition of the amounts claimed by the respondents as constituting debts.

105 My analysis of the authorities renders it plain that, insofar as the claim included debits related to statutory imposts, these clearly fell within the rubric of "debts". At one stage I entertained some doubt as to whether assessed or statutory late payment penalties in respect of both taxation liabilities or WorkCover levies can constitute debts incurred within the meaning of s 588G. Mr Randle strongly contended that they did not, because, even on a liberal interpretation of the statute, they had not been "incurred" in the relevant sense.

106 At the end of the day it seems to me that the answer to the stance adopted by Mr Randle must be that proffered by Professor O'Donovan.

107 There can be no question that each of the property items in question became a "debt" as of the date when, in law, it actually became payable. The "incurring" of the debt arose by virtue of the directors causing or permitting Noelex to continue to trade, knowing of its state of insolvency, knowing that there was a liability already extant and knowing that, if unmet, that liability might well attract imposition of a penalty. As Professor O'Donovan pointed out, it was open to the directors, prior to the imposition of any such penalty, to cause an administrator of the company to be appointed pursuant to the provisions of Part 5.3A of the Corporations Law. This would have activated the moratoriums provided for by the statute and would also have excused the directors from any relevant future accruing liabilities of Noelex.

108 By not adopting or participating in such a course the appellants failed to prevent the Company from incurring the penalties in question. Such penalties were, accordingly, properly included in the claim.

109 It is no cause for surprise that the learned trial judge summarily rejected any claimed defence pursuant to s 588H(2). The evidence strongly contra-indicated any possibility that either of the appellants had reasonable grounds to expect, and did expect, that the Company was solvent at any relevant time and would remain solvent even if it incurred the debt. The learned trial judge expressly rejected - as non credible - any suggestion that Perry ever told Fryer that he had "creditors in hand". It is small wonder that the learned trial judge remained in no doubt that, not only was there no actual expectation of the type contemplated by the statute, but also there could have been no reasonable grounds to have given rise to it. The brief summary of the evidence earlier set out in these reasons amply reveals how fanciful it was to even suggest the existence of the statutory defence.

110 The learned trial judge was constrained to reject an application to exercise the s 1318 power in favour of the appellants, on the basis that they had acted honestly and in the circumstances ought fairly to be excused from any s 588G contravention.

111 The authorities indicate that a director acts "honestly" (within the statutory meaning of that word) when he acts bona fide in the interests of the Company, including the unsecured creditors of that entity. (See Marchesi v Barnes [1970] VicRp 56; [1970] VR 434, Dominion Insurance Co of Australia Ltd (In Liq) v Finn (1988) 7 ACLC 25 at 33-34, Australian Growth Resources Corp Pty Ltd v Van Reesema (1988) 13 ACLR 261 and Grove v Flavel (1986) 43 SASR 410.)

"... I do not think either defendant can be said to have acted honestly in the ordinary sense of that word or in a manner consistent with the meaning given to it in other provisions of corporation laws but even assuming that, having regard to all the circumstances of the case, I do not think that either of them ought fairly to be excused for any of their contraventions of the civil penalty provisions of the Corporations Law. In my view, both defendants were negligent and, indeed, reckless with respect to the company's financial position and capacity to trade. They did not act fairly but took advantage of indulgent creditors by allowing the company to continue to trade."

113 All that need be said is that such a conclusion was demanded by the evidence.

114 Finally, there is a need to refer to that aspect of the appeals which joined issue with the inclusion in the judgment of the sum of $62,657.77 for interest. Both notices of appeal sought to place the allowance of interest from the date of liquidation of the Company in issue.

115 As Professor O'Donovan pointed out, the making of a demand is not a pre-requisite to a cause of action pursuant to s 588M. Further, unlike proceedings related to undue preferences (where the transaction remains valid unless and until it is avoided), s 588M gives rise to liability, as and when each debt is inappropriately incurred and is not satisfied according to its terms. Theoretically, interest ought, as a matter of logic, to be computed as from when each relevant debt fell due and was not met. As a matter of convenience, interest has been allowed to run from the date of appointment of a liquidator. This is consistent with Re Mike Electric (Aust) Pty Ltd (In Liq) (1983) 7 ACLR 600 and a series of authorities stemming from it. These cases all related to preference claims. There is an even greater reason to apply the practice to a claim such as that now before the Court.

116 There is, therefore, no point of substance in this aspect of the appeals.

117 In my opinion the various grounds of appeal advanced on behalf of the appellants cannot withstand serious scrutiny and are at odds with the indisputable evidence.

119 DUGGAN J I agree that the appeals should be dismissed for the reasons given by Olsson J.

POWELL & DUNCAN (NOELEX YACHTS AUST) v FRYER & ANR No. SCGRG-98-431 [2001] SASC 59

At a glance

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Decision date

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Judgment (180 paragraphs)

POWELL & DUNCAN (NOELEX YACHTS AUST) v FRYER & ANR No. SCGRG-98-431 [2001] SASC 59 (8 March 2001)

Parties

Cases Cited (8)