SCOTT v WILLIAMS & ORS No. SCCIV-98-1663 [2002] SASC 424

Supreme Court of SA|2002-12-20|Before: Lander J

For the reasons that follow, subject to any defence available to the plaintiff under s 588H, the plaintiff has established a contravention by the defendant of s 588G.

Only 5 witnesses were called in the trial. The parties relied mainly on documentary evidence.

All witnesses gave their evidence in chief by way of the tender of witness statements. Thus any impressions of the witnesses' demeanour were formed in their cross examination. The plaintiff, the defendant and the first third party each gave evidence in their respective cases.

The defendant also called Mr Alexander Marshall, a solicitor.[67] It would be convenient to deal with Mr Marshall's evidence at this time. The defendant tendered an affidavit sworn by Mr Marshall on 31 January 1997 in proceedings in the South Australian Registry of the Federal Court of Australia. The affidavit was allowed, by the defendant, to stand as Mr Marshall's evidence in chief.

In that affidavit Mr Marshall deposed to a number of conversations he had with Mr Sparks, then an employee of the third parties and later a partner in that firm, and Mr Sims.

In cross examination, Mr Marshall said that he had no recollection of matters contained in the affidavit but that the affidavit contained his recollection at that time.

I accept Mr Marshall's evidence that when he was called to give evidence in this trial he had no more than a vague recollection of some of the events and that his better recollection was contained in the affidavit.

Because he had no recollection independent of the affidavit, counsel for the third parties was placed at a disadvantage in challenging the matters contained in that affidavit.

However, in a sense, that does not matter much. Mr Marshall's evidence was at best peripheral to the issues between the parties. He was called to establish that Mr Sims had given an undertaking that in the event that Mr Sims became the voluntary administrator of the Company then he would not dispute Mr Marshall's client's right to possession of some equipment which had been provided to the Company, and which had been installed in one of the steel vessels built by the Company.

The third parties also called Mr Grant Sparks who has subsequently become a partner in the firm of Sims Lockwood.[68]

I accept the evidence of Mr Sparks and Mr Marshall.

The liquidator was called for the purpose of tendering a report which he had prepared in relation to the financial affairs of the Company. That report was tendered.[69] He also gave evidence that the debts pleaded in the statement of claim remained unpaid.[70]

He was cross examined by counsel for the defendant on other matters. The cross examination was somewhat unusual. Mr Lindsay SC, who appeared as senior counsel for the defendant, put statements made by other persons in other proceedings to the witness and asked him if he would admit those statements for the purpose of these proceedings.

For example he was shown an affidavit which had been sworn by Grant Sparkes in which Mr Sparkes had deposed:

"It was apparent to me from the beginning of my involvement with the company that the company was insolvent."

"Q And do you admit, for the purpose of the proceedings, that statement?

I think that such an admission means that the liquidator admitted for the purpose of the proceedings that Mr Sparks believed from the beginning of his involvement with the Company that the Company was insolvent. I think that is clear from later cross examination in relation to the matter.

I have therefore taken the admissions made by Mr Scott in his cross examination as being admissions that the deponents to the various affidavits, to which he was referred, either did make the observations referred to by them in their respective affidavits or held the opinions expressed in those affidavits. Initially, I think Mr Scott was uncomfortable with the form of the cross examination but as it developed he made his admissions in a straightforward manner and without any prevarication.

In my opinion Mr Scott was doing his best to assist me in arriving at my decision.

Mr Sims was called by the third parties. The plaintiff did not seek to lead any further evidence from him. He was cross examined by counsel for the defendant.

Mr Sim's evidence was in some respects somewhat defensive and his answers exhibited a certain wariness. He was less straightforward than Mr Scott. I have more hesitation in accepting Mr Sim's evidence because of both its content and the manner in which it was given. In two respects I do not accept his evidence.

The major witness in the trial was the defendant Mr Hercus. He was extensively cross examined by both counsel for the plaintiff and the third parties. His evidence occupied seven days nearly all of which was cross examination.

Mr Hercus was an excellent witness. I formed a very favourable impression of him. He had no trouble understanding the questions which he answered straightforwardly. He gave his evidence candidly and frankly. At no time did he prevaricate.

He did not attempt to exculpate himself. He was a credible witness. He is undoubtedly an honest and decent man. I accept most of his evidence.

However in some respects his evidence was wrong. Where I have not accepted his evidence I have said so. Otherwise it may be assumed that I accept his evidence.

However, accepting his evidence does not mean that his defence must succeed. Indeed, in some respects, both the plaintiff and third parties relied on his evidence for their submissions that the defendant's case must fail.

On 13 July 1994 the Company entered into an agreement with INCAT and HMD whereby INCAT and HMD granted the company the exclusive rights to construct and market marine freight vessels designed by HMD. This was for a period of two years commencing on 1 July 1994 with an option for a further two year period commencing immediately thereafter provided that the company had a fully executed contract in place to build a prototype marine freight vessel of the type referred to in the agreement.[72] The vessels referred to in the agreement were fast freight vessels being Wave Piercing Catamarans of up to 150 metres in length.

In late 1994 probably about September the Company commenced trading at Port Adelaide.[73] It had two shipyards, one 'Northarm', for the construction of steel vessels and the other 'Berth 25', for the construction of aluminium vessels.

Mr Thomas acted as Managing Director of the Company and was actively involved in the day-to-day management of the Company.

On 6 December 1994 Mr Hercus wrote to Mr Thomas confirming arrangements made between the company and INCAT for the design of fast catamarans to be built by the company.[74]

The arrangements were for a period of five years with an option to extend for a further five years and covered the design of all types of powered catamarans "... which are capable of a speed (in knots) equal to 2.5 times the square root of the overall length of the vessel (in metres)".[75]

It was agreed that the Company would have the right to build the vessels in South Australia and to sell them anywhere in the world except in Japan.

The fee payable for the use of the design data to build one vessel which was provided for in the letter is not important for the purpose of the decision in this case but the manner of payment maybe. The design fee was to be paid in a series of equal instalments spread through the construction period. The first instalment was payable at the commencement of work by INCAT and the last payable on completion of the vessel. The agreement contemplated that there would be four payments for vessels up to 50 metres in length and eight payments for larger vessels.

Thus, it was by the end of 1994 that the defendant had put in place two contracts between the Company and companies of which he and his wife were proprietors which gave the company the rights to build vessels referred to in the agreements of 1994 and 6 December 1994.

Dr Williams was Chairman of the Board and was also actively involved in the day-to-day management of the Company. On 3 July 1996 he assumed an even greater role by becoming Executive Chairman.[76] Mr Dirk Verboon (who was resident in Adelaide) was actively involved with Mr Thomas and another party in setting up the Company's shipyards.

The Company appointed the ANZ Banking Group as its bankers and they remained the bankers to the Company over the whole of the relevant period.

Paul Robinson was an accountant who carried on business under the name of Capital Strategies Pty Ltd.[77] Capital Strategies is a specialist chartered accountancy practice which provides financial consulting services with regard to major financial transactions, mergers, acquisitions, business sales and start up ventures. Mr Thomas suggested to the board that Capital Strategies Pty Ltd be retained. Indeed Mr Robinson was present at the first meeting of the directors held on 9 June 1994.[78]

Mr David Carver, an accountant, was retained as an independent consultant on a full time basis to act as the internal accountant and financial controller of the Company.

Mr Colin Dunford of Arthur Andersen and Co was appointed auditor of the Company.

Mr Nigel Winter acted as solicitor for the Company from incorporation until the appointment of an administrator.

The directors collectively subscribed $750,000 to capital. The Share Capital was paid up by 28 February 1995.[79]

The Government of South Australia provided two loans one through the Economic Development Authority (EDA) of $400,000 for a period of seven years and the other by the Government of South Australia in the sum of $100,000 for a period of 99 years interest free.

Having regard to the business that the Company expected to carry on it is clear that the Company was under-capitalised from the outset.

The Company contemplated a significant undertaking. It saw itself as a major builder of both steel and aluminium vessels. It proposed to engage a workforce in the order of 200 people. It entered into leases for the premises at which the shipbuilding was to be carried on for a period of 20 years.

If the Company were to conduct a shipbuilding operation of the kind it contemplated it needed significant capital to tide it over, its start-up operation and purchase the raw materials necessary to carry on its business.

A budget prepared, I think, in October 1994 contemplated a net loss for the period to 30 June 1995 of $70,000. That budget predicted that the Company would enjoy a negative cash flow for that period amounting to $1.97 million, which would be funded by the capital contributed to by the directors and two Government loans of $400,000 and $250,000 together with creditors of $85,000.

The budget anticipated that by 30 June 1995 the Company would have cash reserves in the order of $280,000.

It was clear by January 1995 that the budget was optimistic. A revised forecast was prepared in February 1995 by Mr Robinson. That forecast predicted a net loss for the period ending 30 June 1995 of $210,000 and a negative cash flow in the order of $3,680,000. Debtors were likely to be in the order of $2 million more by 30 June 1995 than expected in the budget. It was believed that the increased negative cash flow would be funded by the capital and loans to which I have referred together with bank facilities of $1.18 million. Further, the forecast assumed that there would be a reduction in capital expenditure as predicted in the earlier budget of $500,000.

Shortly after commencement the Company received orders for the construction of two steel prawn trawlers. In 1995 A Raptis & Sons Pty Ltd (Raptis) ordered a steel boat. That Company followed with orders for seven further steel boats. Other customers ordered other steel boats in 1995 and 1996.

On 7 March 1995 the directors resolved to build a 46 metre aluminium catamaran (the aluminium ferry).[80] At that time there had been some discussions with overseas companies, especially in India and China, relating to the purchase of such a vessel but nothing had been resolved. However, Berth 25 required work. The directors believed that if construction commenced on the aluminium ferry it was likely that a buyer would be found. The construction of such a vessel was the real reason for the defendant's involvement in the Company. He was the designer of the vessel.

At the same meeting as the directors resolved to build the aluminium vessel "on spec" the directors discussed the possibility of securing a "Strategic Partner" and "... the requirement for existing shareholders to contribute a further $250,000 if a partner was not secured ...".[81]

On 8 May 1995 Mr Robinson reported to the board that difficulties were being experienced with EDA who were insisting that a further $250,000 be immediately subscribed as share capital in accordance with the loan agreement which had been entered into between the Company and EDA.[82]

At that board meeting, Dr Williams listed the options which EDA had put to the Company which were either to subscribe a further $250,000 in share capital, return to EDA proportionately $167,000 until such time as capital was subscribed or broaden the board with an EDA-appointed independent director until such time as the new strategic partner was introduced.

After discussion, the following resolution was passed:

"It was resolved the Directors arrange for a loan of $250,000 to be sought from Westpac Bank guaranteed by all Directors to be paid into the Company as a subordinated loan until such time as a strategic partner was introduced. All costs and interest associated with the loan is to be met by the Company. It was further resolved that this subordinated loan would be supported by an underwriting agreement signed by the Directors." [83]

The directors instructed Mr Thomas and Mr Robinson to advise EDA of the resolution.

The minutes also disclose that Mr Robinson reported the Company's financial statement in detail to the board. He said the Company had suffered a significant negative cash position which would prevail until significant aluminium construction occurred.

He further advised the board that it was necessary to advise EDA and the ANZ bank that it was likely the Company would incur further losses of between $100,000 to $150,000 before it began to trade in a profitable manner.

It is not clear from the minutes to which financial statements Mr Robinson was referring. However, the documents tendered in this trial include a report of 21 April 1995 by Mr Robinson to Mr Thomas the Managing Director of the Company.[84]

"Further to our recent meeting of Wednesday, 19 April 1995 with yourself and Dr Don Williams, please find attached various financial information for circulation to the Board with respect to the financial performance of the Company for the above period..."

I think it can be inferred, and I find, that the financial statements to which Mr Robinson was referring in the board meeting of 18 May 1995 were those contained and enclosed in his letter to Mr Thomas of 21 April 1995.[85]

A revised forecast for the year ended 30 June 1995 predicted a negative cash flow in the order of $2.83 million.

"At the time of writing this report EDA remains adamant that the Directors should subscribe an additional $250,000 in capital as a condition of the 99 year loan agreement from EDA. The original submissions to EDA and IDC were to the background and this capital should ideally be subscribed by a strategic partner who can assist the company with gaining acceptance and market penetration in the aluminium fast ships industry. We note that the Directors have offered EDA a legally binding director's underwriting agreement for this additional capital. This arrangement in our opinion should be endorsed by the EDA as it provides the company with access to an additional $0.25m if required for working capital purposes whilst leaving the opportunity open for the company to gain a further strategic partner."[86]

Mr Robinson forecast further negative cash flow for the period ending 31 December 1995.

On 27 June 1995 the board was advised by Dr Williams that he and Mr Dirk Verboon had arranged for subordinated loans of $125,000 to be deposited to the Company's account no later than 30 June 1995.

"The Chairman further stated that a letter needed to be circulated between the Directors setting out the obligations and risks involved in connection with this loan. It was further agreed Hercus Marine Design should invoice their current work on vessel 56 and that $125,000 should be applied to the deferred loan account of Mr P C Hercus on the same conditions as D P Verboon and D G Williams." [87]

I am satisfied, and I find, that EDA was not prepared to continue with its loan upon the basis that the Company would borrow a further $250,000, which would be guaranteed by the directors. It insisted that the directors contribute a further $250,000 by way of capital. This was done by way of a subordinated loan. Mr Hercus agreed to subordinate his charges for the work he was carrying out in relation to the design of the aluminium ferry in the same manner as Dr Williams and Mr Verboon.

The same minutes disclose that Mr Thomas reported that Tubemakers were prepared to provide aluminium for the construction of a 46 metre aluminium ferry on a delayed payment basis subject to a limit of $500,000.[88]

The Aluminium Ferry Contract with the YQ Company

On 25 November 1995 the Company signed a letter of agreement with a Chinese company Yue Qing High Speed Passenger Ship Company Ltd (the YQ Company) to sell a ferry to that company.[89] The letter of agreement provided that a formal contract would be signed before 30 December 1995. Delivery of the aluminium ferry would be on 30 June 1996.

6. Long term L/Cs for up to one and a half years as per the payment for last Two Million U.S. Dollars shall be issued to South Australian Ships Pty Ltd. The L/Cs shall be endorsed for all discount bank charges to Account of Joint Venture Yuequing High Speed Passenger Ship Co; Ltd.

8. The Buyer will grant to the Builder in the Ship Building Contract an option for a second vessel which will be taken up within six months of delivery of the contracted vessel.

The purchase price was less than the Company had sought to obtain. In an affidavit sworn by Mr Thomas on 23 January 1997 and tendered in these proceedings by the third party, Mr Thomas said:

"The end result was the signing of a binding Letter of Agreement to build a vessel for YQ Company at a cost of $US 7.55 million on the basis that a formal contract would be signed before 30 December 1995. ... Due to the significant discount against budgeted cost plus profit margin, YQ Company gave an undertaking to build a second boat on the understanding that a more commercial price would be negotiated for that vessel. Our budgeted price for the vessel was $US 8.4 million. We were able to re-cast our budget to $US 7.55 million after significant discounts were negotiated with our major suppliers and the substantial front end cash flows were taken into account." [90]

At the time the Company entered into the agreement with the YQ Company for the construction of the aluminium ferry it was experiencing significant negative cash flow. It was under-capitalised. It lacked a strategic partner. It entered into agreement with the YQ Company to sell the aluminium ferry at a figure in the order of $US 850,000 below its budgeted price. Such an agreement could have only aggravated its liquidity problems.

However, the problem was even more acute. From the day the agreement was signed with the YQ Company, that Company breached its contractual obligations for payment.

The letter of agreement provided for the execution of a contract before 30 December 1995.[91] Delays were experienced for a number of reasons, one of which was that the Company had to give a performance bond to the YQ Company. On 12 December 1995 a draft of an Export Finance Investment Corporation (EFIC) performance bond was sent to the YQ Company.[92] As an interim measure the Company requested the ANZ bank issue the first performance bond for $US 755,000 on the basis that the ANZ bank could hold those funds in escrow until that bond was replaced by an EFIC bond.

On 20 January 1996 a formal contract dated 26 November 1995 was signed between the two companies providing for a purchase price of $US7,550,000 to be paid by instalments during the continuing construction of the vessel.[93]

The contract provided the purchase price was to be paid in eight stages. The first payment was to be on the signing of the agreement or no later than 15 February 1996. Each of the other stage payments had to be made on production of an invoice, an interim stage certificate issued by the classification society, a performance bond, and in some cases photographs.

The contract further provided that the last $2 million of the purchase price could be required to be paid by long term letter of credit.

The contract provided that the Company would furnish the YQ Company with a series of seven performance bonds covering the principal amount of the relevant progress instalment payment plus interest.

The first payment of $US 755,000 was not made as the contract provided on 15 February 1996. The Company was advised by the YQ Company that the first payment would be made on 15 March. The YQ Company continued to delay payment. In the end a payment of half the first payment due under the contract was paid on 16 April. I shall return to that.

In the meantime the board had met again on 27 February 1996.[94] It resolved not to build any further aluminium vessels on spec and that any future building of aluminium vessels would be considered only where finance facilities in the form of construction finance with engine suppliers was first in place.

At that meeting, Mr Carver tabled two sets of financial statements. He tabled the financial statements for the period to 30 June 1995 for discussion.[95] Mr Dunsford, the auditor, was in attendance. The minutes report that enquiries were made of Mr Dunsford in respect of his view of these accounts and "... the going concern nature of the business and treatment of future tax benefits...".[96]

Note 16 of the 30 June 1995 financial statements said:

"The company commenced trading in September 1994 and is still in a startup phase of operations, and in the process of developing a diversified customer base. During the financial period, there was a level of dependence on the small customer base secured to date. The company therefore has an ongoing dependency on the ability to secure contracts for both its aluminium and steel vessels and growing its customer base." [97]

"The financial statements have been drawn up in accordance with the going concern principle, where it is assumed the company can realise its assets and extinguish its liabilities as and when they fall due in the normal course of business. Our opinion has been formed on the assumption it is appropriate to apply the going concern principle. If it were not appropriate to apply the going concern principle, then the realisability of the company's assets may not be adequate to extinguish all of the company's liabilities.

In determining the going concern principle to be appropriate, the company has projected profitability and positive cash flows in the foreseeable future. In addition to the economic dependency disclosure at note 16 to the accounts, the company requires the continued support of its members, bankers, customers and creditors in addition to future profitability and positive cash flows, to continue as a going concern." [98]

The auditors' qualification in certifying the financial statements to be true and fair and in accordance with applicable accounting standards should have alerted the board to the question of whether the Company was a going concern.

The directors resolved to accept the financial statements and in particular resolved that there were reasonable grounds to believe that the Company would be able to pay its debts as and when they fall due. It was resolved that the two directors should sign the accounts. The directors must have satisfied themselves that the accounts should be prepared on a going concern basis.[99]

It was reported at the meeting that the financial statements showed a net loss after taking into account an income tax benefit of $936,580. The income tax benefit was $523,782. Without taking into account that income tax benefit (which of course was only a benefit if the Company was a going concern and the Company was likely to be profitable in the future), the Company suffered a loss of $1,460,363.

The accounts which were approved by the directors on that day were not signed until 9 July 1996.[100] It is not clear to me why there was such a significant delay in the signing of those accounts. However, when they were signed, the directors were in possession of other financial information which was provided to them at a meeting to be held in July 1996. I will return to those accounts.

Mr Carver also tabled the November management results.[101]

The November accounts which were apparently printed on 22 February 1996 for the purpose of this meeting showed that the Company had made a loss for the period 1 July 1995 to 30 November 1995 before provision for income tax benefits, of $416,358. The financial statements also show the Company had a negative cash flow in that same period of $1,627,943.

The balance sheet attached to the November accounts is instructive. It shows total assets of $7,623,809, which comprise current assets of $5,850,000, and as part of the non-current assets a sum of $616,471 representing future income tax benefits.

The current liabilities totalled $6,939,576 and include a bank overdraft of $1,627,943. The bank overdraft had been $705,488 in October. Not only had the bank overdraft increased in the order of $900,000 but the commercial bills increased by a further $500,000.

The Company's total liabilities were $8,076,856. Its liabilities exceeded its assets by $453,047 but only after taking into account, as an asset, future income tax benefits. If future income tax benefits were ignored, the Company's liabilities exceeded its assets by $1,070,000.

The forecast profit and loss statement accompanying the financial statements predicted an income in the aluminium division of $1,331,446 in February. It was known as at the date of this meeting that the YQ Company had failed to honour its obligations pursuant to the agreement. The YQ Company was in breach from 15 February and had indicated it would not make the first payment until 15 March. The forecast also assumed a payment of $7,235,969 in March. On the agreement which had been executed by the Company with the YQ Company there was no possibility, even if the YQ Company observed its obligations, that the Company would receive a sum of that order in March.

As at the end of February 1996, the directors were aware:

1 That the Company had suffered a trading loss to 30 June 1995 of $936,581.

2 If income tax benefits were excluded then the trading loss for that period was $1,460,363.

3 The original capital subscribed for the Company was $750,000.

4 Two directors had advanced a further $125,000 each by way of subordinated loans.

5 Mr Hercus had agreed to subordinate the Company's debt to him in respect of the design of the aluminium ferry to the extent of $125,000.

6 The Company had commenced building the aluminium ferry on spec.

7 Budgeted cost for the aluminium ferry was $US 8.4 million.

8 The Company had entered into a contract for the sale and purchase of that aluminium ferry in the sum of $US 7.55 million.

9 The purchaser had failed to pay the first instalment due on 15 February 1996.

10 The Company had experienced a further trading loss for the period to November 1995 after excluding any income tax benefit of $416,358.

11 Leaving aside income tax benefits, which at that stage were illusory except in an accounting sense, the Company had lost nearly $2 million during the period between September 1974 and 30 November 1995.

In particular I find that the defendant was aware of all of those matters. It is clear from Mr Quick QC's cross examination of the defendant that the defendant was aware of the Company's financial position as at the date of the director's meeting on 27 February 1996.[102]

Assuming the subordinated loans to be available to the Company as quasi-capital, it had lost nearly $850,000 more than its own capital. It could have expected, as indeed it transpired, that the Government would convert the two loans to which I have referred, to grants. But even so, those grants would not restore the Company to a positive position.

The directors, no doubt in an endeavour to improve the Company's balance sheet, agreed to convert the three subordinated loans to which I have referred into $1 convertible preference shares. The resolution was subject to the Memorandum and Articles of Association being amended to allow the Company to issue preference shares.

The directors did not hold regular board meetings. The board meeting held on 11 December 1995 was closed without any date being set for the next meeting.[103] Minutes of the board meeting of 27 February 1996 show that the next board meeting was to be held on 16 April 1997.[104] No such meeting was held.

It is surprising that regular board meetings were not held particularly in the period between December 1995 and April 1996 when the Company was under so much strain.

The directors were not supplied with timely financial information at their board meetings. At the board meeting of 27 February 1996 the directors received the November management results which were already three months out of date.[105]

During the period between December 1995 and February 1996, there were other indications that the Company was under financial strain. On 3 January 1996 Mr Carver wrote, on behalf of the Company, to the Australian Taxation Office seeking deferral of payment of Group Tax amounting to $100,219.14 until 21 January 1995.[106] The reason given for the request was that cash inflow had been irregular. On the same day, he wrote to the State Taxation Office seeking deferral of payment of Payroll Tax of $22,313.76 and to WorkCover seeking deferral of the payment of the WorkCover levy of $29,044.16 until 21 January 1995.[107]

On 6 February 1996 he wrote again to the Australian Taxation Office, the State Taxation Office and WorkCover seeking deferral of payments of, respectively, $104,569.52, $24,321.22 and $30,490.08 until 21 February 1996.[108]

There is no record of the directors being advised of those requests at the meeting of directors on 27 February 1996.

The ANZ bank originally provided a facility by way of overdraft with a limit of $500,000. In March 1995 that was apparently increased to $750,000, although that may have only been on a temporary basis. In April 1995 the facility was increased to $827,000 but the facility was restructured to include an overdraft, an encashment facility, a variable rate commercial bill acceptance/discount facility, and a credit card facility. The limit approval fee was then fixed at $1,000,000.

On 24 November 1995 the ANZ offered additional facilities including a variable rate commercial bill acceptance/discount facility with a limit of $4,250,000.[109] That facility was in addition to the overdraft facility.

On 15 December 1995 the bank wrote to Mr Thomas drawing his attention to the pressure which was being placed on the bank's agreed overdraft limit of $500,000.[110] It extended the overdraft temporarily to allow the Company to meet its commitments.

On 8 January 1996 the bank advised the Company that it would increase the overdraft limit to $1,600,000 "... to assist your cash flow position".[111] However, the overdraft had to be reduced to $1,250,000 by 12 January 1996, to $600,000 by 19 January 1996 and to its original limit of $500,000 by 26 January 1996.

Dr Williams met with the ANZ bank on 18 January 1996 and asked the bank to consider relaxing the requirement to reduce the overdraft balance to $500,000. He also sought finance in relation to the bank guarantee to EFIC and for other matters.

On 18 January 1996 the bank wrote to Dr Williams in the following terms:

"We have previously advised that only wages and cheques that could jeopardise the trading of SA Ships should be paid until overdraft balance has reduced to within the approved overdraft limit of $500,000." [112]

However, the bank advised that it was prepared to honour cheques to pay payroll tax, group tax and other sundry cheques provided various deposits were made within a certain time.

On 1 February 1996, the ANZ confirmed that it would assist with the EFIC performance bond.[113] At the same time however, it advised that the overdraft limit must remain within the $500,000 agreed limit.

On 26 February 1996, the bank sent guarantees and indemnities to the Company for execution by the directors.[114]

On 29 February 1996, Mr Carver wrote to the bank in the following terms:

"At the Board Meeting held on Tuesday, it was resolved that the Directors would be prepared to sign guarantees in support of the overdraft facility subject to the following terms:

1. The guarantees were to be operative up to the date of receipt of the second of the contract eight payments on the Aluminium Vessel destined for China. i.e. SAS will have received as a minimum 20% of the contract price US$7.55 m.

2. Clearance of document for commercial reasonability by the company's legal counsel. I intend to use Johnson Winter Slattery for this review as Minter Ellison are advisers to ANZ Bank and are therefore not independent advisers as required by the Guarantee. I have already faxed a copy to Charlie Winter for this review to be commenced ASAP.

3. An overdraft limit of A$1.5 m is provided. The purpose of the limit is to provide some degree of flexibility within which to operate. It is not my intention to spend up to this limit unless absolutely necessary. Upon receipt of the second payment and termination of the Directors' Guarantees, the overdraft limit would revert back to $500,000." [115]

Mr Carver's letter was in accordance with the resolution of the board of directors passed on 27 February 1996.

On 29 February 1996, the bank confirmed it would make an overdraft facility to a level of $1.5 million available upon the basis that the directors would give the guarantees provided and that the overdraft would be reduced to $500,000 upon payment of the deposit from the Chinese in respect of the aluminium vessel. The bank agreed to cancel the guarantees when the overdraft was reduced.[116]

On 16 January 1996, Dr Williams wrote to the Manager Prudential Assessment of EDA in which he confirmed that the existing EDA loan agreement required that the issued capital of the Company be increased to at least $1 million on or before 31 December 1995.[117] In that letter he referred to a Malaysian investor who had undertaken to provide the necessary capital and an additional $.5 million subordinated loan on 22 January 1996. Dr Williams wrote that if that Malaysian investor should not eventuate the existing subordinated loans provided by Dr Williams, Mr Verboon and Mr Hercus would be converted to ordinary shares at par value.

On 29 January 1996, EDA extended the time within which the ordinary equity be increased to $1 million until 31 March 1996 on the proviso that the shareholders' loans of $375,000 would also remain.[118]

On 23 February 1996, EDA advised that the $250,000 99 year interest loan to the Company would be converted to a grant provided that the Company retain a minimum level of ordinary capital of $1 million.[119]

Between February and July the Company's financial fortunes did not improve.

Notwithstanding the Company's obvious financial problems in early 1996, no further board meetings took place until 3 July 1996.

Between 29 February 1996 and 3 July 1996 a number of matters occurred.

Whilst no board meetings took place during this time this period is relevant, because the plaintiff has asserted, and the defendant has admitted, that from 1 June 1996 the Company was insolvent.

It is necessary therefore to examine the Company's history during that time.

The Company continued to have difficulty paying its debts as and when they fell due. On 3 April 1996, Mr Carver wrote to Taylor Marine advising that the Company was not in a financial position to pay its January 1996 invoices until the deposit for the aluminium ferry was received.[120] He advised Taylor Marine that ANZ was only prepared to pay the employees' wages. Mr Carver advised that the Company had received information on 1 April that the deposit monies would be paid by 15 April. A similar letter was written to another creditor, Blast Master.[121] On the same day, he wrote to WorkCover seeking deferment of the payment of the WorkCover levy of $36,663.35.[122] He also wrote to the Australian Taxation Office seeking deferment of the March Group Tax payment of $134,815.17;[123] and to the State Taxation Office seeking deferment of Payroll Tax amounting to $30,543.84.[124]

As I have previously mentioned, the contract between the Company and the YQ Company required the YQ Company to pay 10 percent of the purchase price by 15 February. Notwithstanding the Company had sent the YQ Company a performance bond of US$755,000 the YQ Company unilaterally extended the time for payment until 15 March and then to 15 April.[125]

On 4 April 1996, Mr Thomas wrote to the YQ Company requesting the 10 percent instalment to be paid in full before 15 April 1996 and if it was not paid the contract would be terminated.[126]

On 4 April he received a reply advising that the best that the YQ Company could do was to pay 5 percent of the purchase price on 15 April 1996, with 10 percent on 25 April 1996. He replied to that fax on the same day pointing out that the YQ Company was 60 days in arrears "... which is causing problems for our Company".[127] On 9 April 1996, Mr Thomas wrote to the YQ Company advising that the Company would accept 5 percent before 15 April 1996 and the balance of that deposit, namely 5 percent, by 25 April 1996.[128] He said that the Company would also expect that all other progress payments would be made in accordance with the contract. Lastly, he advised the YQ Company that the delivery date for the ship would be 10 September 1996.

Since the signing of the contract the Company had continued with the building of the vessel and a number of claims had been made in accordance with the contract. In fact, progress claims 1 to 4 had been lodged for payment before 15 March 1996 and progress claim number 5 which amounted to $US 1.51 million was lodged on 17 April 1996.

In accordance with the terms of the contract the YQ Company should have paid 80 percent of the purchase price or $US 6.04 million on 25 April 1996.

The first 5 percent instalment was received on 16 April 1996.[129] No payment was made by the YQ Company on 25 April 1996.[130] That Company did pay $US 110,000 on 1 May 1996 and $US 267,500 on 9 May 1996.[131] At the end of May the YQ Company had failed to honour its obligation to pay the 10 percent deposit on 15 February 1996 and it failed to honour its obligations in accordance with the various claims made under the contract by the Company.

On 6 May 1996, Mr Carver wrote to the Australian Taxation Office in the following terms:

"As discussed over recent months, the sale of the high speed vessel to China has been putting this business under severe cash flow pressures - and continues to do so. In the last two weeks we have discovered that the Chinese buyer for the high speed aluminium fast ferry has turned out to have no financial backing whatsoever. We have however, managed to receive a total of 6.5% of the contract, where under the original contract terms, 80% is now due and payable."[132]

On 31 May 1996, Mr Carver again wrote to the Australian Taxation Office requesting deferment of the April 1996 Group Tax instalment deductions. He again complained that the YQ Company had not honoured its obligations.[133]

In March 1996, Mr Thomas met with the ANZ bank and requested an increase in the Company's overdraft from $500,000 to $2.2 million. He told the bank that the additional facility was required to assist with the payment of creditors and wages pending receipt of the Chinese deposit. The application was refused but the bank agreed to extend the overdraft to $1.5 million.

That extension was not sufficient and on 1 April 1996, Mr Thomas again attended on the bank seeking an extension of the facility to $1.75 million so as to allow the Company to meet wages due on 12 April ($120,000) and 19 April ($50,000). The bank refused that further request.

Mr Thomas again attended on the bank seeking assistance to pay pressing sub-contractors and the Bank agreed to extend the overdraft facility to $1.565 million.

On 10 April 1996, the bank wrote to the Company in the following terms:

"Michael, your company has not operated within its approved Overdraft facility since December 1995. The Bank has given you every support over the past 16 months but we must draw the line somewhere and limiting the Overdraft to $1.500,000 was intended to send you a clear message that we will not continue to provide cash flow to your group for the construction of the ferry, particularly as we made our position clear from day one that we did not see financing of this vessel as our role." [134]

The bank advised the Company that it would extend the overdraft to $1.5 million until the end of April 1996.

The bank insisted upon guarantees and on 30 April 1996 Mr Carver wrote to the defendant advising him that the directors' guarantee would expire on 30 April 1996 and that the bank had indicated that upon expiry of that guarantee they would demand repayment of $1 million of the $1.5 million overdraft facility unless new guarantees were in place.[135] Mr Hercus signed the further guarantee.[136]

In the meantime (16 April 1996) the company entered into a Recourse Deed with EFIC under which EFIC would issue performance bonds totalling US$7,172,500 in favour of the YQ Company but expiring on 31 August 1996.[137]

On 7 May 1996, Mr Thomas sought further accommodation from the bank.

The bank advised Mr Thomas that it would consider his request provided that the Company undertook to pay a fee for Mr Bruce Carter of Ferrier Hodgson to make an immediate enquiry into the following matters:

"• Efficacy of daily cash flow forecasts to 30th June 1996;

• Future cash flow projections beyond June 1996;

• Overview of your Assets and Liability position, including a current profile of the company's unsecured credits." [138]

A meeting was arranged, between representatives of the bank, Dr Williams, Mr Thomas and representatives of Mr Carter's office, for 8 May 1996.

On 15 May 1996, Mr Carver sent a facsimile to the bank seeking approval to pay a number of cheques to creditors of the Company, totalling $339,000 which would take the Company in excess of its overdraft limit. Mr Carver advised the bank that if payment of those cheques was authorised, and with other monies to be paid, the overdraft would increase to $2.014 million.[139]

On 27 May 1996, Mr Carver, Mr Robinson and Mr Kerr who was also employed by Capital Strategies met with the bank to discuss the temporary overdraft facility of $1 million which was due to expire on 31 May 1996.[140]

They advised the bank that they were presently working on a revised cash flow forecast for presentation to the bank for an additional temporary facility beyond May 1996.

On 27 May 1996, the bank advised that upon receipt of further deposit monies from the YQ Company or the close of business on 31 May 1996, the overdraft limit would return to a basic level of $500,000.[141]

The bank advised Mr Carver that it would consider further facilities provided certain information was provided.

On 31 May 1996, the bank advised that it was prepared to offer additional facilities that may be summarised as follows:

Variable Rate Commercial Bill Facility $2,500,000

Indemnity Guarantee Facility No. 1 - $US 755,000 $1,034,000

Indemnity Guarantee Facility No. 2 - $US 358,625 $491,267

Thus, by 1 June 1996, the liability to the bank had ballooned out to $6,038,017, although it must be admitted that part of the indebtedness included the indemnity guarantee facilities which were to be taken up by EFIC.

During the period between February 1996 and June 1996, the proportion of creditors aged 90 days and over, increased significantly. In March 1996, the proportion of creditors aged 90 days and over, was .62%; in April 1996, 9.72%; in May 1996, 8.55%; and in June 1996, 33.21%.

In cross examination Mr Hercus acknowledged that as at 31 May 1996 he was concerned about the solvency of the Company.[143] He was aware that accounts rendered by his companies to the Company had not been met.[144] He was aware that those accounts had not been met because the purchaser of the aluminium vessel had not paid instalments which had fallen due. In particular he was aware that the Company then had a cash flow problem.[145] He was also aware that the Company was undercapitalised.[146]

During his cross examination I asked these questions of the defendant:

"Q Did you have an appreciation, say at the end of 1995, that the company's balance sheet must have regard to whether or not the company is itself a going concern.

A I guess I knew that. One of the things that did bother me throughout the period was, while I knew the company had a cash flow problem, as I've said before, a cash flow problem doesn't necessarily mean that the company is insolvent. Now, I'm not an expert on when a company is solvent and when it's not solvent, and I needed to have advice from people who were expert in such a matter, whether the Company was solvent or not. Ultimately, that's why I raised the question at the early September board meeting, but prior to that point, I had been assured by people who were working for us continuously that the company was solvent. As I said, I don't remember exactly which meetings we talked about it, but the question of whether or not the company was solvent was a matter that was discussed a number of times, because we didn't want to have happen what has subsequently happened and we were watching very closely. By the same token we didn't want to say 'Oh, it might rain, therefore we better close the company up' - By '96 we had 200 people who were working there and I think it would have been irresponsible to prematurely close the company.

Q Was the question of the company's solvency discussed at the meeting of 27 February 1996. I ask that question having regard to the first paragraph and item 7.2.

A I would think it must have been, because it says here 'the question of the going concern nature was discussed.'" [147]

Moreover the defendant was aware that by this stage the Company had been holding back payments to trade creditors. He was aware of that because one of the companies which he controlled was a trade creditor and it had not been paid.[148]

As he said that was an indicator of the possibility of insolvency.[149]

The question of the Company's insolvency was discussed from time to time. Mr Hercus said he discussed the Company's ability to meet its future debts with Mr Carver, Mr Robinson, Mr Thomas and Dr Williams. He believed that the question of solvency was discussed at the February 1996 meeting. He was asked by Mr Quick in cross examination:[150]

"Q You actually inquired about insolvency because you suspected that there might be insolvency, did you not.

A I did not suspect - sorry, I did not expect that there was insolvency -

Q I didn't mean to cut you off, but you are not answering my question. I'm not asking you about expectation, I'm asking you about suspicion. Now, the fact that you were inquiring, I suggest to you, if you think about it and make your answer on oath, I suggest to you that the fact of that inquiry meant that at that time you had suspicions that the Company was, or might be, insolvent.

A I would have asked to - yes, there was a suspicion, but I didn't think it was.

Q When you had that suspicion, you knew it was part of your responsibility as the director to satisfy yourself about whether or not the Company would be able to meet its future debts as and when they became due. You knew that, didn't you?

The defendant said that he trusted the judgment of others as to whether the Company could pay its debts as and when they fell due. In particular he relied upon Mr Carver, Mr Robinson, Mr Thomas and Dr Williams because he believed those persons had a 'hands-on feel' which provided them with the ability to make judgments.[151]

He said he did not rely on any one of those people but relied upon information and advice from them all.[152]

He said that prior to 31 May 1996 he did understand that insolvency was measured by a Company's abilities to pay its debts as and when they fell due.[153] He remembered asking both Mr Winter and Mr Robinson about the Company's solvency position. However, on that matter he was somewhat vague and I am not satisfied that he has an accurate recollection at any time prior to 31 May 1996.

He also said he spoke to Mr Carver about that issue. Again I am not satisfied that at any time prior to 31 May 1996 he asked Mr Carver whether the Company was able to pay its debts as and when they fell due.

I am satisfied for reasons previously given that prior to 31 May 1996 Mr Hercus did suspect that the Company could not pay its debts as and when they fell due because the Company had not received the promised payments from the YQ Company in relation to the aluminium vessel. I am satisfied that prior to 31 May 1996 he suspected that the Company was suffering a negative cash flow, in that it was bearing the cost of the construction of the aluminium vessel without receiving the corresponding interim payments to cover those costs.

Mr Hercus said that as at 31 May 1996 he did believe that the Company was solvent.[154]

The liquidator has said in his report, which has been tendered in these proceedings, that an insolvent company would typically demonstrate some or all of the following characteristics:

At a glance

Court

Decision date

Before

Catchwords

Source

Catchwords

Judgment (1160 paragraphs)

Parties

Cases Cited (5)