Woodgate (Liq of Fairlight ESP) v Commissioner of Taxation & Ors

• Australian Securities and Investments Commission Act 2001 (Cth) - s.30 LEGISLATION CITED : - Corporations Act 2001 (Cth) - s.95A, s.588FA, s.588FC, s.588FE, s.588FF, s.588FGA, s.588FGB, s.588G, s.1274 - Taxation Administration Act 1953 (Cth)

CASES CITED : - Sims v Deputy Commissioner of Taxation (2006) 57 ASCSR 249 - Southern Cross Interiors Pty Ltd v Deputy - Commissioner of Taxation (2001) 53 NSWLR 213

Giles Geoffrey Woodgate (Liquidator of Fairlight ESP Pty Ltd (In liq)) - Plaintiff PARTIES : Commissioner of Taxation - Defendant/Cross Claimant David William Hannay - Cross Defendant

M.A. Ashhurst, S. Ipp - Plaintiff COUNSEL : P.A. Fury - Defendant/Cross Claimant In person - Cross Defendant

Peter Kemp Solicitors - Plaintiff SOLICITORS : ATO Legal Practice - Defendant/Cross Claimant In person - Cross Defendant

1 The Plaintiff, as Liquidator of Fairlight ESP Pty Ltd ("the Company"), seeks to recover from the Commissioner of Taxation ("the Commissioner") six payments made by the Company to the Commissioner totalling $195,000 as unfair preferences and insolvent transactions, pursuant to s.588FA(1), s.588FC and s.588FE(2) Corporations Act 2001 (Cth) ("CA"). 2 The sole ground upon which the Commissioner put in a defence was that the Company was not insolvent at the time that the payments were made so that they were not insolvent transactions within the meaning of CA s.588FC(a)(i). At the commencement of the trial, that defence was abandoned by Mr Fury of Counsel, who appears for the Commissioner. Mr Fury conceded that the Company was insolvent at the time of the payments, that the Commissioner is liable to repay the amount claimed by the Plaintiff together with interest and costs, and that the Court should make orders accordingly. 3 Of the payments made by the Company to the Commissioner, the sum of $175,986.58 was in respect of liabilities of the Company to the Commissioner under a provision of Subdivision 16-B in Schedule 1 to the Taxation Administration Act 1953 (Cth). By his Cross Claim, the Commissioner seeks an order under CA s.588FGA(1) and (2) against Mr David Hannay, who was a director of the Company at the time of the payments, for indemnity by Mr Hannay against the Commissioner's liability to pay to the Plaintiff the sum of $175,986.58 and a proportionate part of the interests and costs which the Commissioner must pay to the Plaintiff. 4 Mr Hannay, who has appeared and argued the case in person, raises two defences to the Commissioner's Cross Claim:

• that the Company was not insolvent at the time of the payments to the Commissioner so that the payments were not insolvent transactions within the meaning of s.588FC(a)(i);

• that even if the Company was insolvent at the relevant times, he has a good defence under s.588FGB(3) in that, at the times of the payments, he had reasonable grounds to expect, and did expect, that the Company was solvent and would remain solvent even if it made the payments. Undisputed facts

5 The Company was incorporated in 1988. Mr Hannay was appointed as a Director on 31 March 1989 and resigned on 16 July 2001. By July 2002, Mr Hannay was acting in an advisory capacity to the Company, and on 1 August 2002 he was reappointed as a Director. 6 In August 2002, the Commissioner agreed, at the Company's request, to accept reduction of its outstanding tax liability of $888,779.89 by instalment payments of $100,000 on the twenty-first day of each month until 21 March 2003, the final payment of $88,779.89 being due on 21 April 2003. While the Company later sought to change this arrangement by paying a lesser amount, no change was agreed to by the Commissioner. 7 The first of the instalment payments of $100,000 was made by the Company on 27 September 2002. A second payment of $100,000 was due on 21 October 2002 but it was not made. On 1 November 2002 the Company paid to the Commissioner only $10,000 in reduction of the payment due on 21 October. 8 On 21 November 2002, a further instalment of $100,000 was due but it was not paid. On 27 November the Company paid to the Commissioner only $10,000 in reduction of that instalment. 9 On 21 December 2002, a further instalment of $100,000 was due. On 20 December the Company paid to the Commissioner $25,000, apparently in reduction of that instalment. 10 The Company made no payment in respect of the instalment of $100,000 due on 21 January 2003. 11 On 20 February 2003, the Company made a payment of $25,000 to the Commissioner. It is not clear whether the payment was on account of the instalment of $100,000 due on 21 January 2003 or the instalment of $100,000 due on 21 February 2003, or was simply in reduction of the Company's debt generally. 12 On 10 March 2003, the Company made a payment of $25,000 to the Commissioner. Again, it is not clear whether the payment was made on account of any particular instalment or in reduction generally of the Company's debt to the Commissioner. 13 On 12 March 2003, the Plaintiff was appointed Voluntary Administrator of the Company and on 17 April 2003 he was appointed Liquidator of the Company pursuant to a resolution of the Company's creditors. 14 The payments made by the Company to the Commissioner from 27 September 2002 to 10 March 2003 were made during the six month relation-back period referred to in s.588FE(2)(b). Whether the Company was solvent at the time of the payments

15 The test of solvency prescribed by CA s.95A(1) is whether the Company was able to pay all its debts as and when they became due and payable; it is essentially a cash flow test. The legal principles upon which that question is to be decided have not been put in issue by the parties. Relevantly for the purposes of this case, those principles are summarised in the following passage from Southern Cross Interiors Pty Ltd v Deputy Commissioner of Taxation (2001) 53 NSWLR 213, at para 54 (omitting citations): "(i) whether or not a company is insolvent for the purposes of the Corporations Act (Cth) , ss 95A, 459B, 588FC or 588G(1)(b), is a question of fact to be ascertained from a consideration of the company's financial position taken as a whole;

(ii) in considering the company's financial position as a whole, the Court must have regard to commercial realities. Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security, and when such realisations are achievable;

(iii) in assessing whether a company's position as a whole reveals surmountable temporary illiquidity or insurmountable endemic illiquidity resulting in insolvency, it is proper to have regard to the commercial reality that, in normal circumstances, creditors will not always insist on payment strictly in accordance with their terms of trade but that does not result in the company thereby having a cash or credit resource which can be taken into account in determining solvency;

(iv) the commercial reality that creditors will normally allow some latitude in time for payment of their debts does not, in itself, warrant a conclusion that the debts are not payable at the times contractually stipulated and have become debts payable only upon demand;

(v) in assessing solvency, the court acts upon the basis that a contract debt is payable at the time stipulated for payment in the contract unless there is evidence, proving to the court's satisfaction, that: • there has been an express or implied agreement between the company and the creditor for an extension of the time stipulated for payment; or • there is a course of conduct between the company and the creditor sufficient to give rise to an estoppel preventing the creditor from relying upon the stipulated time for payment; or • there has been a well established and recognised course of conduct in the industry in which the company operates, or as between the company and its creditors as a body, whereby debts are payable at a time other than that stipulated in the creditors' terms of trade or are payable only on demand;

(vi) it is for the party asserting that a company's contract debts are not payable at the times contractually stipulated to make good that assertion by satisfactory evidence." 16 The Liquidator prepared a report dated 21 April 2004 as to the Company's solvency at the times of the payments. The report was admitted without objection and Mr Hannay did not challenge the report in cross examination. The report is extremely detailed and is supported by four volumes of materials, including records of the Company and summaries and analyses prepared by the Liquidator. 17 Also in evidence are three affidavits of Mr Rowling, an accountant in the employ of the Liquidator. Those affidavits are likewise supported by voluminous records of the Company and analyses and summaries prepared by Mr Rowley. Mr Rowley was cross examined by Mr Hannay but nothing emerged from the cross examination which had the least effect in casting doubt on Mr Rowley's evidence, as I shall explain more fully in a moment. 18 Mr Hannay produced no expert evidence to support his contention that the Company was solvent at the time that the payments were made. He gave evidence himself and made submissions as to solvency to which I will come shortly. 19 The reports of the Liquidator and of Mr Rowley demonstrate overwhelmingly that the Company was insolvent from at least 31 August 2002 until its demise. The Commissioner was entirely correct to concede insolvency. Because the evidence of insolvency is so strong and so voluminous I will merely summarise the main features so as to place Mr Hannay's evidence and submissions as to solvency in context. 20 As I have said, solvency is essentially a question of cash flow. The following circumstances show that the Company was not, in fact, meeting its liabilities as they fell due and had insufficient resources to do so. 21 The Company was clearly in financial difficulties, at least from the beginning of 2000 onwards. It had made a trading loss of $4,010,819 for the year ended 31 December 1999. In November 2000, it applied to the ATO to pay its PAYG debt of $404,818 by instalments. It made a trading loss of $7,777,136 for the year ended 31 December 2000. 22 In April 2001, the Company made an agreement with the Office of State Revenue ("OSR") to pay its outstanding payroll tax debt by monthly instalments. On 30 August 2001, a report on the Company's financial position was provided to ANZ Bank Limited. The report stated that the Company's financial performance had been significantly worse than budgeted: an operating loss of $1,394,000 had been incurred for the six months to 30 June 2001 instead of a forecast nett profit of $2,108,000. A balance sheet as at 30 June 2001 showed current assets of $6,259,000 and current liabilities of $15,868,000. 23 In a report to the Company's "stakeholders" on 22 November 2001, a director of the Company, Mr Kim Ryrie, said: "Fairlight's Directors have advised that if an investment of at least $4.5M cannot be available for Fairlight within a week, and if satisfactory arrangements cannot be made with the company's secured lenders, then it will be necessary to appoint an administrator." 24 The Company made a trading loss of $6,890,279 for the year ended 31 December 2001. 25 On 22 March 2002, the Company requested its financier, ANZ Bank, to grant a further period of six months for the Company to replace its existing facility of $700,000, which was due to expire that day. The Company explained that the request was "due to the need to put [the company] on a sound financial footing, including the payment of many large outstanding creditors …". On 9 April 2002 the Bank declined the Company's request for an extension of credit facilities. 26 By 21 May 2002, the Company had failed to pay seven of the twelve instalments due for payroll tax and the OSR demanded payment of the outstanding sum of $154,905. The Company failed to pay any part of that amount and the OSR made a further demand for payment on 11 June 2002. 27 On 31 July 2002, Mr Hannay wrote to the OSR requesting agreement that the Company pay its outstanding payroll tax liability by monthly instalments. Mr Hannay explained the Company's financial position as follows: "~ Fairlight ESP successfully attracted investment by venture capitalists during the late 1990s. When funds were raised, the company embarked on the development of a new product range so that it could continue its world leadership in the manufacture of digital audio editing and mixing equipment. The Company must develop a new range of products approximately every 4 years to maintain its sales advantage.

~ It was originally estimated that development costs would be A$5 million, however, the development costs have greatly exceeded that amount. As a result the company was drained of funds and most shareholders were unable to continue to fund the Company's operations.

~ The Company has a successful product range and employs 50 people in Sydney in its research, development and manufacturing plant. The Company also operates 5 overseas offices and should again achieve sales in excess of A$25 million per annum.

~ In mid 2001 a minority Japanese shareholder agreed to continue to fund the Company's operations provided all other shareholders sold their shares to him for a nominal amount. These negotiations took until 20 December to complete, during which time the Japanese shareholder was reluctant to fund the operations. As a consequence it appears many creditors were unable to be paid.

~ The Company's financial difficulties were further exacerbated as a result of its major supplier, ICM Ltd., a listed public company, being placed into receivership in July 2001. This resulted in no production for a 3-month period. This seriously affected our cash flow.

To make matters worse, the Japanese investor has had its own Japanese financial facilities withdrawn since taking over the Company. This was because the Japanese Government announced its intention to withdraw a government guarantee of some classes of bank savings accounts. As a consequence many Japanese people have withdrawn their funds from banks and as a consequence the Japanese banks have withdrawn ordinary loan facilities from many Japanese small businesses. It is intended that replacement funding is now being put in place for us in Japan.

The amount outstanding is a significant amount and the Company is unable to pay all outstanding taxes in one lump sum. It, therefore, requests that the Office of State Revenue agree to an arrangement whereby the outstanding tax is paid in 12 instalments commencing with an instalment of $11,709.00 in August 2002.

We further request that favourable considerable [sic] be given to the remittance of penalties as the Company was in serious financial circumstances up until December 2001 and is heavily reliant upon the continued support of its new shareholders to reduce its outstanding creditors and to keep current liabilities up to date." 28 On 5 August 2002, the OSR agreed to the Company paying its payroll tax liability by thirteen monthly instalments. 29 I come now to the relation-back period during which the relevant payments to the Commissioner were made. The first of those payments of $100,000 was made on 27 September 2002. The Liquidator has done an analysis of the position of the Company as at 30 September 2002. Relevantly, as at that date the amounts outstanding to trade creditors outside the creditors' trading terms was $880,278. If one includes a claim by a supplier, ICM, which was at first disputed by the Company but later conceded, the amount outstanding beyond creditors' trading terms was $2,680,278. 30 As at 31 October 2002, the amount outstanding to trade creditors outside their trading terms (including the ICM debt) was $2,400,122. As at November 2002 the amount was $2,393,632. As at 31 December 2002, the amount was $2,438,394. As at 31 January 2003 the amount was $2,571,431. As at 28 February 2003 the amount was $2,671,099. 31 The Liquidator's analysis shows that, as at 30 September 2002, debts outstanding to creditors for ninety days or more amounted to $338,456. As at 31 October 2002, the amount was $247,825. As at 30 November 2002, the amount was $197,079. As at 31 December 2002, the amount was $196,013. As at 31 January 2003, there were no debts outstanding for ninety days or more but debts outstanding for sixty days amounted to $123,714. As at 28 February 2003, debts outstanding for ninety days or more amounted to $367,195 and as at 12 March 2003 the amount was $493,652. [for checking: RJR8 pp 17ff] 32 From 21 August 2002 onwards, the Company failed to comply with the agreement it had made with the OSR on 5 August 2002 for the payment of outstanding payroll tax by instalments of $11,700 per month. The first instalment was due on 21 August 2002 but was not paid until 20 September 2002. Thereafter, the Company was unable to pay the instalments in the amount agreed and unilaterally decided to pay instalments of only $4,000 per month. 33 As I have noted above, from 25 October 2002 onwards the Company was in breach of its obligations to pay instalments of $100,000 per month to the Commissioner in respect of outstanding tax. 34 The Company was also constantly overdue in the payment of the rent of its premises, often for periods of ninety days or more. The total of rent outstanding as at the end of February 2003 was $145,803. In an intra office e-mail dated 17 February 2003 the Company's General Manager advised that he had agreed with the lessor's agent to pay $34,159.18 on account of outstanding rent, with the balance due in March. The e-mail continued: "[the agent] did say that the balance would need to be paid by March 12 … I gave him no assurances that we could make that date." 35 In short, the evidence is overwhelming that during the relation-back period the Company was not paying, and was not able to pay, its debts as they fell due and that the payments made to the Commissioner further depleted cash resources which were already insufficient to pay all creditors' debts. Mr Hannay's submissions on solvency

36 Mr Hannay submits that the Company was solvent at all times during the relation-back period. 37 Mr Hannay submits that the Australian Securities and Investments Commission ("ASIC") investigated the solvency of the Company during the first half of 2002 and was satisfied that the Company was able to pay its debts. He relies on that investigation as a proof of solvency. There is no substance in this submission. 38 First, for the purposes of this case any opinion as to the Company's solvency formed by ASIC is irrelevant: what is relevant are the facts as to the Company's financial position disclosed by the evidence now adduced and the inferences which are to be drawn from those facts. The facts adduced by the Liquidator demonstrate very clearly that the Company was insolvent at all times during the relation-back period. 39 Second, ASIC did not conduct its own independent investigation into the Company's solvency at any time. In early 2002, ASIC notified that Company that it had failed to lodge its financial reports and had failed to file tax returns for the financial years ended 31 December 1999, 2000 and 2001. By letter dated 14 June 2002, ASIC threatened action under CA s.1274. On the same date, ASIC issued a notice under s.30 of the Australian Securities and Investments Commission Act 2001 (Cth) requiring the Company to produce by 24 June 2002 its books and records for the purposes of ensuring compliance with CA s.588G. 40 On 21 June 2002 Mr Fukuda, a director of the Company, responded to ASIC's letter, giving an explanation of the Company's failure to lodge its financial reports and requesting an extension of time for their lodgement. By letter dated 25 July 2002, ASIC reiterated a number of concerns, including the fact that it appeared that the Company relied on the continuing support of its Japanese parent to enable it to trade as a going concern. ASIC required:

• the appointment of an Australian resident director of the Company (which resulted in Mr Hannay's appointment on 1 August 2002);

• a confirmation that there was written assurance from the Japanese parent that $4M in funding would be provided to the Company by the end of August 2002;

• confirmation from Mr Fukuda that he was satisfied that there were reasonable grounds to believe that the Company was able to pay its debts as they became due. 41 On 1 August 2002, Mr Fukuda confirmed to ASIC that the Japanese parent had given the assurance requested and that he was satisfied that there were reasonable grounds to believe that the Company was solvent. By letter dated 13 August 2002, ASIC required Mr Hannay, as resident Australian director of the Company, to confirm that there was a reasonable belief in the Company's solvency. Mr Hannay responded by letter sent on 4 September 2002 in which he referred to the difficulties experienced by the Company and said: "Despite having only been involved with the operational side of the Company for a few weeks, and in an environment where the Company has obviously been experiencing difficulties I believe that there are reasonable grounds to believe that Fairlight will be able to pay its debts as and when they become due and payable." 42 It is clear that ASIC did not have available to it the information as to the Company's position which the Liquidator has and that it relied largely on the written assurances of solvency given by Mr Fukuda and Mr Hannay. Accordingly, if ASIC made any conclusions at all as to the Company's solvency, those conclusions are of no weight for the purposes of this case. 43 Mr Hannay next submits that the Company's trading and its cash position were improving in the period from January 2002 to March 2003. However, the evidence which I have summarised above shows clearly that, even if the Company's position was improving, it was still unable to pay its debts as they fell due. The evidence shows that the Company's cash flow inadequacy was not temporary but chronic. 44 Next, Mr Hannay submits that the Company was not insolvent because there was no deficiency in its assets available to pay creditors. In this respect, he disputes the valued attributed by the Liquidator to certain stock. 45 I do not accept Mr Hannay's criticism of the values placed by the Liquidator on the Company's stock. However, it is not necessary to decide the true value of the Company's stock. The test of insolvency is a cash flow test, not an assets test. The Liquidator referred to deficiency in the Company's assets only as ancillary to, and supportive of, the principal contention that the Company's cash resources were insufficient to meet its liabilities as they fell due. 46 Mr Hannay submits that the ICM debt should not be taken into account in determining the Company's solvency because the debt was genuinely disputed. There is no substance in this submission. First, the validity of the debt was conceded by the Company during the relation-back period. Second, the ICM debt was not paid, yet the Company was still unable to pay its other creditors as their debts fell due. 47 Mr Hannay submits that the debt to the Commissioner should not be taken into account in assessing solvency because the Commissioner had agreed to accept payments of the debt by instalment. However, the fact remains that the Company was unable to pay even those instalments according to the agreed terms. 48 Mr Hannay submits that the Company's debts outstanding to creditors had, in many cases, been left outstanding for long periods because there were informal arrangements with the creditors for extended credit. 49 However, there was no admissible evidence adduced of any particular agreements with any creditors for extended credit terms. On the contrary, there was evidence that a number of creditors had cut off supplies or had refused to continue to supply except upon a c.o.d. basis or had complained of late payment on frequent occasions. The mere fact that a creditor does not issue a statutory demand or does not sue for a debt after the stipulated time for credit elapses does not in itself indicate that the creditor has agreed to waive its contractual trading terms: see Southern Cross Interiors (supra at para 54). I am not persuaded that the Company's creditors whose debts remained unpaid outside their normal trading terms had extended their credit terms so that their debts were not payable by the Company during the relation-back period. 50 Mr Hannay refers to trial balances prepared by the Company during the relation-back period which show that there was cash at bank on the trial balance dates. This submission, however, disregards the fact that as at the balance date the Company's outstanding liabilities to creditors very substantially exceeded the cash at bank available to pay them. Reasonable expectation of solvency

51 Mr Hannay says that he expected at all times during the relation-back period that the Company was solvent and that he had reasonable grounds for that expectation so that a defence to the Commissioner's claim is made out under s.588FGB(3). I do not need to decide whether Mr Hannay actually had the expectation which he asserts because the success of his defence ultimately turns on whether, assuming he had such an expectation, he had reasonable grounds for it. That test is entirely an objective one. 52 The Company commenced operations in April 1989 when it acquired the intellectual property of Fairlight Instruments Pty Ltd from that company's receiver and manager. The Company's business was the development and manufacture of equipment for digital recording, mixing and editing and the manufacture of software for that equipment. 53 At all material times the Company was a wholly owned subsidiary of Fairlight Inc., a Delaware corporation based in California. In turn, Fairlight Inc was a wholly owned subsidiary of Fairlight Japan Inc ("Japan Inc"), a company incorporated in Japan which was associated with Mr Kenji Fukuda, who was also a director of the Company. 54 By April 2002, the Company was already heavily dependent upon funds provided by Mr Fukuda or Japan Inc to enable it to continue trading. In a letter dated 5 April 2002 to the OSR, the Company recited a history of financial dependence on Japanese sourced funds and concluded: "It can be seen from the above that the liquidation of the Fairlight group has been avoided by the willingness of the Japanese investor to support the business." 55 During April and May 2002 Japan Inc transferred substantial sums to the Company to keep it trading. Even with the benefit of those funds, the Company was unable to bring its agreed instalment payments to the OSR up to date, resulting in the OSR making a demand for all outstanding amounts due on 21 May 2002. 56 By a Deed of Loan dated 21 June 2002 between Japan Inc and the Company, it was recited that Japan Inc had advanced, and intended to continue to advance, monies to the Company. By Clause 3.1 it was provided that Japan Inc would: "… advance such further monies as the Company may require, to ensure that the Company is able to pay all debts owed to its creditors and incurred in its ordinary course of business, as and when they are due and payable [up to a cap of Loans of $Australian Dollar 2,000,000.00."

Clause 3.2 provided: "The Lender shall remit such further Loans within 2 weeks of receiving [not legible] statement from the Company, accompanied by a signed request from a board member of the Company, which explains the amount of Loans required by the Company and the purposes for which the amounts are required." 57 The loans by Japan Inc to the Company were repayable, with interest, on 31 December 2003, or upon such other date as might be agreed by the parties in writing: Clause 2.1. 58 On 27 June 2002, despite the existence of the loan agreement with Japan Inc, the Company wrote to the Commissioner requesting agreement to pay its outstanding tax by instalments. In support of that request, the Company gave the following explanation of its relationship with Japan Inc: "Fairlight Japan (a company not associated with Fairlight Inc. or Fairlight ESP Pty. Ltd., except for a small strategic shareholding in Fairlight Inc.) relies upon Fairlight product to conduct its own business and has been a distributor of Fairlight product for more than 12 years. When it become [sic] aware that Fairlight ESP was likely to be placed in to liquidation Fairlight Japan agreed to provide loan funds to Fairlight ESP Pty Ltd. However, after lending a large sum of money to Fairlight ESP, Fairlight Japan became impatient to be repaid the money loaned. The old shareholders had no alternative other than sell their shares in Fairlight Inc. to Fairlight Japan for a nominal A$1.00 per share. Fairlight Japan took control of the company on 20 December 2001 and has been addressing the financial problems of the company one by one. Fairlight Japan has access to funds from a Japanese venture capitalist; however, these are being released gradually over a period of 12 months. Funds received since 1 January 2002 are listed on attached Schedule "Funds Received From Fairlight Japan".

At present negotiations have been entered into with many creditors for the gradual reduction of amounts owing to them and Fairlight ESP Pty. Ltd. has been put on COD with many of its creditors.

However, all creditors recognize that the purchase of the company by Fairlight Japan provided the only possible opportunity for them to receive payment; the alternative would have been the liquidation of Fairlight ESP Pty. Ltd.

It is for this reason that we make a submission to the Australian Taxation Office for the payment of the outstanding Taxation Office liability over approximately a 12-month period commencing April 2002. The amount owing at 28 June 2002 is calculated to be $770,728 and the company is offering to pay $100,000 per month off old debt and keep all current liabilities paid on time.

As the attached balance sheet shows the company would have great difficulty obtaining funds from any ordinary financier or bank. Indeed as soon as the Japanese were committed to the acquisition of Fairlight, the ANZ Bank withdrew all overdraft facilities contrary to all indications given earlier." 59 During June and July 2002, Japan Inc continued to make substantial payments to the Company. On 30 July 2002, Japan Inc gave the Company a letter confirming that it would provide a further $2M in additional funding so that the total to be provided under the loan agreement dated 21 June 2002 was increased to AUD4M. 60 Despite receipt of this letter, on the following day Mr Hannay wrote to the OSR requesting agreement to an instalment payment plan. The relevant terms of his letter are set out at paragraph 27 above. In that letter, Mr Hannay refers to the financial difficulties which were then being experienced by the "Japanese investor", a reference to an entrepreneurial bank called Softbank. It is a clear inference from the Company's request to the OSR that the Company realised that, even with the support of Japan Inc as provided in the Deed of Loan, the Company could not hope to pay all of its creditors as their debts fell due. 61 Japan Inc made further substantial transfers of funds to the Company in August and September 2002. The Company paid the first agreed instalment of $100,000 to the Commissioner on 27 September 2002 but, as I have recounted above, there was still a large amount outstanding and overdue to the other creditors of the Company at that time. 62 Further substantial transfers were received from Japan Inc in October 2002. Even so, the Company was not able to pay its agreed instalments to the OSR and on 18 October 2002 Mr Hannay wrote to the OSR seeking to reduce the instalment payments from $11,700 per month to $4,000 per month. Mr Hannay said: "Our initial business assumptions and projections have proved somewhat flawed due in part to an underestimation of the down turn caused by the current unpredictable financial and political worldwide environment. This has resulted in longer than anticipated time to get the overseas operations, USA in particular, fully operational. In addition a greater than expected market mix of third party product has resulted in our achieving a lower than anticipated gross margin base.

As a consequence of the above it has now become evidence that the company does not have the capacity, in the immediate future, while it tries to recover to continue making large cash repayments of our overdue Payroll Tax commitment and still meet our other payment obligations as and when they fall due.

Our parent company is currently undertaking fund raising activities to support us and should be able to supply us with substantially more funding in 2003." 63 Substantial sums were transferred to the Company by Japan Inc on 2 and 3 December 2002. Even so, on 16 December 2002 the Company wrote to the Commissioner seeking agreement to reduce the agreed instalments for outstanding tax liability to $25,000 per month until March 2003. The letter stated: "… the above schedule can be met with careful cash flow monitoring, however any increase in payment would be very difficult if not impossible to accommodate." 64 ­As I have noted, the Commissioner did not agree to this proposal for the reduction of instalments so that the Company remained in default of its obligations to pay outstanding tax under the previously agreed instalment plan. 65 Japan Inc transferred substantial sums to the Company in late December 2002 and in January 2003. However, on 17 January 2003 Mr Hannay wrote to the Commissioner, again seeking a reduction in the agreed instalments. He said: "At the moment our shareholders are working hard to raise additional funding for our growth. At the current time our cash flow is extremely tight and we are only just managing to remain solvent. This is being achieved with the support of our shareholders and our secured creditors.

It is our specific wish to clear our overdue payments to the Taxation office as quickly as possible but having made a proposal upon my return to the company last August which we unfortunately failed to meet I am reluctant to make nay further proposal that I am not one hundred percent confident that we can honour.

We have no surplus cash and it is therefore not possible for us to make a lump sum payment at this stage; although if our shareholders are successful in raising substantial funds through a new investor, clearance of all of our over dues would be a priority." 66 I should note that Mr Hannay's statement that the Company remained solvent with the support of its secured creditors was not correct, for the reasons which I have given earlier. 67 The Commissioner did not agree to a reduction in the Company's instalments for outstanding tax. 68 On 12 February 2003, Japan Inc gave the Company a letter confirming its agreement to provide an additional $2M pursuant to the loan agreement and stating that the total to be advanced under that agreement was increased to $8M. 69 Notwithstanding this letter, and a further transfer of funds on 18 February 2003, the Company was unable to pay in full the instalments of $100,000 due to the Commissioner in January and in February 2003. 70 As will have emerged from the earlier consideration of the Company's solvency in general, throughout the whole of the relation-back period the Company was unable to pay creditors within their trading terms or within periods of extended credit, notwithstanding the substantial financial support being provided by Japan Inc. It is clear that the support provided by Japan Inc was simply not enough to enable the Company to pay its debts as they fell due. 71 One would have thought that if Japan Inc was substantial enough, and willing enough, to pay the Company's debts to such an amount as was necessary to keep it solvent, the Company would have made requests for additional funds during 2002 and Japan Inc would have been prompt in complying with those requests. But Japan Inc was willing to commit in writing only to limited additional funding, which was obviously inadequate for the Company's needs. 72 It emerged in cross examination that Mr Hannay was by no means certain as to how Japan Inc was going to be able to pay even such money as it had committed to pay for the support of the Company. He believed that the majority of the funds which Japan Inc would need were to come from its financier, Softbank, and that some money could be coming from its majority shareholder, Mr Fukuda. He conceded that the ability of Japan Inc to fund the Company largely depended upon the willingness of Softbank to provide support to Japan Inc and that Softbank had made no commitment directly to the Company. He thought that "there was some level of letter of comfort from Softbank at one point" to provide funding to Japan Inc but he had not been able to find such a letter: T96.18-T97.5. 73 In general, it is fair to say that Mr Hannay had no reliable knowledge of what arrangements Japan Inc had at any time with its financiers for the provision of funding which would enable Japan Inc in turn to provide funds to the Company in sufficient amounts to enable the Company to pay its debts as they fell due: see e.g. T98.9-T100.15, T101.5-T101.10. 74 It is clear that Mr Hannay was aware that Mr Fukuda, the majority shareholder of Japan Inc, was anxious not to procure Japan Inc to pay money for the support of the Company by obtaining funds from Softbank because there was some agreement with Softbank to the effect that the more money it advanced to Japan Inc the more its equity in that company increased, to the detriment of Mr Fukuda's equity. For that reason, amongst others, there were "big question marks" from Japan Inc if there was a request by the Company for an increase in funding: T102.6-T103.2. 75 Mr Hannay was asked why the Company did not pay the whole instalment of $100,000 due to the Commissioner on 21 November 2002. He said: "Because without asking for additional funds from Japan, it did not have the money to do so."

He was then asked: "Why didn't you ask for additional funds from Japan." Mr Hannay's answer was rambling and evasive; he was asked a number of times to give a responsive answer. He did not do so. He continued to avoid the question and, to my observation, he appeared distinctly uncomfortable in doing so: T109.2-T110.5. The impression I received from Mr Hannay's answers to a simple and obvious question was that he had realised at the time that there was no point in making requests for further funds to Japan Inc and that the Company would have to struggle on as best it could, delaying payments to creditors for as long as possible, in the hope that the Company's fortunes improved. 76 There is no question but that Mr Hannay was acutely aware of the Company's financial difficulties throughout the whole of the relation-back period and that he was also acutely aware that the financial assistance committed by Japan Inc to the Company was, in fact, insufficient to enable the Company to pay its debts as they fell due. In the light of the evidence to which I have referred above, I am far from persuaded that, if Mr Hannay did actually believe that Japan Inc was willing to support the Company to the extent necessary to make it solvent, that belief was founded on reasonable grounds. Japan Inc had made it clear that it was not willing to write "a blank cheque" for the payment of the Company's debts. Further, Mr Hannay had no reliable knowledge as to how Japan Inc would be able to fund even those payments to the Company to which it had committed. 77 For these reasons, Mr Hannay's Defence to the Commissioner's Amended Cross Claim fails. Orders

78 The Liquidator is entitled to orders in terms of paragraphs (a) and (b) of the Relief claimed in the Statement of Claim. 79 The Commissioner is entitled to orders in terms of paragraphs (a) and (b) of the Relief claimed in the Amended Cross Claim. 80 As the amounts to be included in the Orders require some calculation, I will stand the proceedings over for a short time to enable the parties to bring in Short Minutes of Order reflecting these reasons. Costs

81 There is no dispute that the Commissioner will be ordered to pay the Liquidator's costs of the Statement of Claim. In turn, the Commissioner seeks in his Amended Cross Claim an order that Mr Hannay indemnify him in respect of a specified proportion of the amount of costs that the Commissioner is ordered to pay to the Liquidator. 82 I note that the terms of the costs order sought by the Commissioner limit recovery from Mr Hannay to a proportion of the costs which the Commissioner is ordered to pay to the Plaintiff; the Commissioner does not seek an order that Mr Hannay indemnify it under s.588FGA(2) and (4) in respect of the costs which the Commissioner has incurred in the conduct of his defence to the Plaintiff's claim. This is an important distinction, as has been observed by Campbell J in Sims v Deputy Commissioner of Taxation (2006) 57 ASCSR 249. 83 I respectfully agree with the suggestion of Campbell J in Sims that the Court's jurisdiction under s.588FGA(2) and (4) does not extend to making orders indemnifying the Commissioner in respect of costs and expenses incurred by him in the conduct of his own case. The Court can order indemnity only in respect of "loss and damage resulting from" an order against the Commissioner under s.588FF. A costs order made against the Commissioner in proceedings instituted by a liquidator can properly be said to be a loss "resulting from the order". But the Commissioner's own costs of conducting his defence to that claim are incurred by him regardless of the outcome of the proceedings and cannot be said in any way to have been incurred "as a result of" an order under s.588FF made against him in favour of a liquidator. 84 For this reason, the indemnity order actually sought by the Commissioner in his Amended Cross Claim is properly limited to such part of the Liquidator's costs as the Commissioner is ordered to pay. 85 I will hear submissions, if any, as to the incidence of costs orders when the Short Minutes are brought in.

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