Australian Credit Law Bulletin - Vol 5, No 5, May 2004
A free, plain English review of recent law and items of interest for creditors, produced by Hattaway & Associates Ltd, Credit Consultants. To subscribe send a blank email to: aus-bulletin-join@mailman.hattaways.com
Plain language disclaimer:
This bulletin is not legal advice. Do not make decisions on legal matters based on a brief commentary. Instead, get professional legal advice.
In this issue:
- A win for the ATO
Debtor company was acting as a reasonable, solvent debtor with short term cash flow problems would act -- Liquidator unable to clawback sales tax. - A loss for the ATO
Creditors indemnify liquidator and receive priority payout. ATO doesn’t indemnify and therefore gets nothing. - Bank tries to get the amount owed on its creditor’s petition adjusted upwards
Turns out to be pushing its luck too far - Court decisions are final until overturned
Was a pending appeal on a judgment enough to hold up a statutory demand? - Receivers can’t hold on to creditors’ funds “just in case” problems arise
Receiver has to pay up - Don’t forget to respond to a statutory demand within the time limit allowed
Where the debtor is clearly solvent, trying to wind it up might be an abuse of process
1. A win for the ATO
Cussen and Anor v Commissioner of Taxation [2003] NSWSC 841
Akai Pty Ltd had been a substantial distributor of electrical goods since incorporation in 1977. Akai had always complied with its obligations to pay sales tax on time until August 1998.
At that time Akai asked the ATO for an extension of time to pay the sales tax due from July sales as well the tax that would fall due for sales in August. This was due to what was explained as “cash flow timing” difficulties. The ATO agreed to the extensions but still insisted on levying penalty tax for late payment. Akai made similar requests to delay the payment of sales tax due for the months of November and December 1998. Again, the ATO agreed and Akai paid on the delayed dates.
Early the next year Akai began restructuring its Australian business which included selling its premises at Australia Ave, Homebush for $6.5 million. Further short-term cash flow difficulties caused Akai to request more extensions between the months of March and June 1999. The ATO said that it could not grant a blanket extension of time and that late payments would still attract penalties. A payment plan was worked out and although it was extended due to further difficulties over the sale of the Homebush premises, the arrears were cleared by 3 September 1999.
Akai then had to approach the ATO again to try and get the payments due in September deferred as a dramatic drop in sales in July 1999 impacted on its cash flow. The sales decrease was a result of the 29 July reduction in the wholesale sales tax rate from 32% to 22% which caused customers to put off purchases until the next month. Again, the ATO and Akai agreed a payment plan which was kept to by Akai and up until March 2000, all subsequent sales tax payments were paid when due.
On 22 March, an application for the winding-up of Akai was filed. Akai was wound up by the court in April 2000 and Neil Cussen was appointed liquidator. Cussen applied to the court seeking repayment of the eight payments of sales tax made by Akai to the ATO between 5 October 1999 and 21 March 2000, which totalled $8,185,525.12. He claimed that the payments were unfair preferences (as described in s.588FA of the Corporations Act 2001), insolvent transactions (s.588FC) and voidable transactions (s.588FE).
The ATO did not dispute that Akai was insolvent at the time that the payments were made or that the payments were unfair preferences. It argued however, that it had a defence under the terms of s.588FG(2)(b) – it said that at the time of the payments, the ATO did not have any reasonable grounds for believing that Akai was insolvent or would become insolvent by making the payments and that a reasonable person in the ATO’s position would have felt the same.
The court sided with the ATO. It said that, for 20 years, Akai had conducted a very successful business and had previously had no trouble in making its sales tax payments. Even from 1998 onwards, the court said, Akai had been acting as a reasonable, solvent debtor with short term cash flow problems would act. Finally, Akai had in fact, met all its repayment obligations.
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2. A loss for the ATO
DCT v Currockbilly [2002] NSWSC 1061
Currockbilly Pty Ltd went in to liquidation at the end of May 2001 and William Hamilton was appointed liquidator. Earlier, Currockbilly had sold the whole of its business to Funtastic Ltd.
Hamilton made many unsuccessful attempts to obtain the books and records of Currockbilly from the former directors. He also asked the directors to prepare and file a report as to the affairs of the company but his requests were ignored.
Hamilton prepared a report in early August which indicated it was likely that Currockbilly had been insolvent at the time of sale of the company's business to Funtastic. Hamilton also suggested that there be examination of the directors of Currockbilly and some selected directors of Funtastic. He pointed out however, that as the liquidation had no funds it would be necessary for creditors to indemnify the liquidator in respect of any examination (under part 5.9 of the Corporations Law).
Hamilton’s report was presented to a creditors’ meeting at which all the creditors present, except the ATO, agreed to indemnify the liquidator for the purpose of examining the directors (under s. 597 of the Corporations Act 2001) .Later, Hamilton was forced to issue a summons before he finally received the books and records.
After the examinations were held the evidence presented showed that Currockbilly had been insolvent as far back as June 2000. Hamilton recommended to the creditors that they proceed with litigation against the former directors for uncommercial transactions and insolvent trading. Although the creditors were reluctant to provide an indemnity to allow the litigation to proceed, they did approve Hamilton entering into a funding agreement to fund the court action.
The former directors settled before the case got to court. This recovered over $425,000. Although the total claim that might have been recovered after litigation was about $850,000, settling for the lower figure was justified as the costs of funding would have increased substantially (from $30,000 to over $300,000) if the litigation had begun. A meeting of creditors resolved that Hamilton should apply to the court under s 564 of the Corporations Act so that the indemnifying creditors could be given a priority over unsecured creditors in order to receive full payment of their debts before the other creditors received a dividend. Such a distribution was of course, a departure from the usual principle of ranking all debts and claims in a winding up equally.
The court explained that in the ordinary case of applications made under s. 564, the creditors have indemnified a liquidator in respect of the cost of litigation brought for the recovery of property. That had not happened and in fact, the indemnity was only in respect of the liquidator's costs incurred in the public examinations.
The court went on to conduct a complicated analysis of the wording and semantics of s.564. The examination process had protected the creditors’ cause of action by throwing up even more evidence that supported court action. The court went on to point out that although s.564 only mentions indemnity for costs of litigation, it could be taken as understood that this would also cover other legal proceedings, like examinations.
Add in the fact that the risk assumed by the creditors in pursuing the examinations, in the face of earlier difficulties in getting any information at all, was large and the court was able to grant Hamilton’s request. The judge said that “the risk was quite substantial and unless the indemnifying creditors assumed the risk nothing would have been received in the liquidation. In these circumstances it seems appropriate to encourage creditors to give indemnities and I am satisfied that the indemnifying creditors should receive a 100 per cent recovery”.
Unfortunately, after all costs had been met only $160,030.57 remained to be distributed. That meant that even admitting only the indemnifying creditors (amounting to $1,073,688.65) for a dividend, they received only 14.90 cents in the dollar. Ranking all creditors (amounting to $1,246,078.23) equally however, would have reduced the dividend to 12.84 cents in the dollar.
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3. Bank tries to get the amount owed on its creditor’s petition adjusted upwards
Australia & New Zealand Banking Group v Coutts [2003] FCA 968
Robert Coutts was a director and the secretary of Diamond Air Ltd. In July 1998 he signed a guarantee and provided an indemnity in relation to the overdraft facility that Diamond Air had with ANZ Bank. The potential liability of a debtor to ANZ under the guarantee and indemnity was unlimited. In early May 2001 Coutts resigned his directorship and Diamond Air’s shareholding was sold.
On 14 March, ANZ was awarded a default judgment for $36,553 based upon Diamond Air’s outstanding liabilities. In early May Coutts was served with a bankruptcy notice for that amount as Diamond Air’s guarantor. The next day Coutts applied to pay the judgment debt by instalments of $700 per month but the court turned him down. At the end of May 2003 Diamond Air was put into liquidation.
On 26 June 2003 ANZ filed a creditor's petition against Coutts, the next stage in bankrupting him. When the creditor’s petition was due to be heard a month later, the hearing was adjourned for 3 weeks to allow Coutts to sell the family home in Greenacre. A sale contract for the house was signed in early August but settlement was not due until mid-October and ANZ was not prepared to wait for its money.
On 12 August 2003 Coutts tried to pay ANZ $37,914, which was the amount outstanding plus accrued interest since 14 March. ANZ however, refused to accept the payment, although ANZ’s lawyers kept hold of the cheque unbanked. ANZ countered by claiming that under the “full indemnity” basis signed by Coutts, he now owed them $55,000 without providing any breakdown of how this increase had occurred. One week later ANZ applied to the court to have its creditor’s petition amended to reflect the increase.
The court said that retention of Coutt’s cheque unbanked was of legal significance. It was likely that after the cheque had been tendered by Coutts, interest ceased to accrue on the debt.
More importantly, the court went on to explain that it was settled in law that the debt on which a petition and a sequestration order are based must be a debt which existed at the time of the relevant act of bankruptcy. The court could not see how the increased debt, which ANZ now also wanted to rely on as a ground for the sequestration order, was a liquidated (that is, a fixed and certain) sum due and payable at the time of the act of bankruptcy (i.e. 31 May).
Section 44 of the Bankruptcy Act also requires a liquidated amount in order to issue a creditor’s petition. The terms of the guarantee that Coutts had signed however, required ANZ to make written demand for repayment before the debt became payable. As the increased sum had not been demanded until mid-August the increased debt could not have been in existence at the time of the act of bankruptcy. This meant that ANZ’s application to amend the amount on its creditor’s petition was refused and it had to accept Coutts’ cheque as full payment under the guarantee.
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4. Court decisions are final until overturned
Australian Foods Company Pty Ltd v Harvest Grain Pty Ltd [2003] WASC 227
In 2001 Australian Foods Company Pty Ltd entered into a contract with Harvest Grain Pty Ltd to supply $18,400 worth of Faba beans. The beans were delivered to the port of Aqaba in Jordan but Harvest Grain claimed that they were substandard. Harvest Grain went to court to try to recover the difference between the purchase price and what it claimed the beans were worth. Australian Foods denied that the beans were substandard.
Mr Sivnani was the sole director of Australian Foods and although he knew the case was going to be heard in November 2002, he did not realise that he had to attend to give evidence. He told his lawyers to ask for an adjournment but the court refused. Australian Foods’ lawyers then withdrew. Harvest Grain however, proceeded to call evidence and had the dispute decided in its favour for the sum of $17,492.07.
Australian Foods applied for a rehearing but were turned down as the court was not satisfied that Shivnani had had a good reason for not turning up to the trial. Australian Foods then made an application for review to the Supreme Court seeking an order that the decision to deny it a rehearing be overturned. Later, a further application for a stay of execution of the November decision was dismissed.
In the meantime, Harvest Grain served a statutory demand on Australian Foods requiring payment of the $17,492.07. Australian Foods applied to the court to have this set aside. Sivnani argued that the amount was subject to a genuine dispute. He also claimed that waiting for the decision on the application for review before the Supreme Court fell under the meaning of “some other reason”, which s459J(1)(b) of the Corporations Act 2001 lists as a justification for setting aside.
The court explained however, that once a judgment or order was made following a trial, even where no evidence had been presented by the defence, it was a fixed and final decision. Until that judgment was overturned it concluded the issue of whether there was a genuine dispute. For the purposes of setting aside a statutory demand, it was irrelevant that the judgment was under appeal (even though that that might be a relevant consideration if there was a later winding-up application).
Australian Foods was in effect, seeking a de facto stay of execution on the judgment. A pending appeal did not amount to "other reasons" for setting the demand aside. Indeed, the court was absolutely clear: “There is a presently existing and enforceable debt under the judgment. The fact that there is a subsisting application which may at some time in the future lead to a rehearing of the defendant's original claim does not … give rise to a genuine dispute about the existence of the debt within the meaning of s.459H or "some other reason" within the meaning of s. 459J(1)(b) of the Act”. Harvest Grains’ statutory demand remained in force.
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5. Receivers can’t hold on to creditors’ funds “just in case” problems arise
Flexible Manufacturing Systems Pty Ltd v Fernandez [2003] FCA 1491
In May 1992 Avitus Fernandez was appointed receiver and manager of Flexible Manufacturing Systems Pty Ltd (FMS) by the company’s mortgagees under a registered debenture charge. The mortgagees signed a deed of indemnity that covered Fernandez against all claims arising out of the management of FMS as well as promising to pay all the receiver’s costs and remuneration. This is normal practice.
During the course of his receivership Fernandez conducted litigation in the United States which resulted in a net recovery of $2,741,087. He repaid $2,391,336 to the mortgagees.
Fernandez and the mortgagees disagreed over taking further court action and so it was decided that the receivership should be finalised. Fernandez transferred $150,000 to the FMS bank account but the mortgagees said he owed nearly double that. He paid a further $30,000 in early 1999. Mr Lamb (FMS’ new administrator) demanded the rest. Fernandez’s payment proposal was turned down so Lamb applied to the court to get Fernandez to pay.
Fernandez argued that he was entitled to hold a lien over the FMS funds in respect of costs and expenses connected with other litigation that he was facing. This other court case concerned claims that payments which Fernandez had made as receiver to the debenture holders, or as directed by the debenture holders, could be challenged as having been not properly payable or not properly authorised. Fernandez was also worried that the indemnity provided by the mortgagees might not be enough to defend the case if it came to court.
The court decided that Fernandez was not entitled to the lien over FMS funds. Receivers can claim a lien on the assets in their hands against all proper liabilities for which they are personally liable. These liabilities must be actual, rather than contingent liabilities.
The court explained that the validity of the lien has to be assessed at the time the receivership is terminated. If there was no lien at that time, Fernandez was obliged to hand over the funds to the mortgagees or pay it at their direction to FMS. Since there was at best a contingent claim (i.e. the other litigation was only a possible, future complication), Fernandez was not entitled to retain the funds. If there were any outstanding issues Fernandez had to rely on his indemnity.
He was ordered to pay $58,091.18 plus interest and FMS’s court costs.
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6. Don’t forget to respond to a statutory demand within the time limit allowed
Mammoth Investments Pty Ltd v London Partners Australia Pty Ltd [2002] WASC 157
Mammoth Investments was having problems with its creditors. Mammoth had made some share sales but London Partners Australia Pty Ltd said it had not passed on London Partners’ part of the profit, which was $493,668.78. In March 2002 London Partners served Mammoth with a statutory demand to try and collect what they were owed.
Section 459G of the Corporations Actwould have allowed Mammoth to apply to have the demand set aside on the grounds that the debt was the subject of a genuine dispute. To do so however, Mammoth was required to make application within the prescribed time limit (i.e. 21 days). Mammoth, by mistake it seems, failed to do so and there is no scope for extending the time in which to apply.
Failure to comply with a statutory demand usually leads on to winding up proceedings. Within such proceedings Mammoth could have used the terms of
s.459Sto apply to the court to dispute the existence of the debt. Mammoth was keen however, to avoid the winding up proceedings even beginning.
So Mammoth tried an alternative way to stop London Partners – it applied for what amounted to an injunction to stop London Partners applying to have Mammoth wound up on the grounds that it was an abuse of the process of the court. Mammoth argued that London Partner’s claim was out of all proportion to the situation. There was still a big dispute about the existence of the debt and London Partners were only pursuing winding up proceedings in order to create pressure for the immediate payment of the disputed debt. London Partners countered that, as a creditor, it was entitled to be paid immediately and it should not be obliged to wait.
The court explained that this type of application was not an appropriate forum to decide whether or not Mammoth was insolvent. The court could, however, infer that a creditor was motivated by improper purposes and was abusing the process of a court if it was trying to advance winding-up proceedings in circumstances where a debtor company was unquestionably solvent and could clearly pay the disputed debt, if due.
Unfortunately, for Mammoth, the books and records it provided were not orthodox accounts. They had not been audited, there was no admissible evidence of underlying valuations for substantial real property, nor any ageing of the liabilities. On that basis the court could not establish that Mammoth was unmistakably solvent. This meant that London Partners’ actions, in following the statutory procedure, could not be seen as an abuse of process. Mammoth’s application was declined and it was left to contest the question of its solvency as part of the normal winding up procedure.
