Australian Credit Law Bulletin - Vol 5, No 8, August 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:
- The perils of sexually transmitted debt - the appeal of the Southern Cross Interiors case
Wife’s reliance on her husband let her escape liability as a director of his liquidated company when this case was first heard. But the ATO appealed... - Liquidators try to claw back tax payments from the ATO
Could the ex-directors oppose the application to try to avoid personal liability to pay the taxes? - Statutory demand issued in a foreign currency
Is that allowed? - Who gets paid first – the administrators or the liquidator?
A dispute over the priority of liens and remuneration in winding up a group of companies - Claim of breaches by directors of their fiduciary duty to act honestly
De-registered company reinstated to allow the case against the directors to proceed
1. The perils of sexually transmitted debt - the appeal of the Southern Cross Interiors case
Deputy Commissioner of Taxation v Clark [2003] NSWCA 91
Incautious husbands or wives who sign contracts and other documents when told to "sign here" by their spouse sometimes end up with debts they weren't expecting. This is sometimes known "sexually transmitted debt". This is an appeal from a case we summarised in Vol 2, No 7, October 2001.
In 1994 Robert Clark, a carpenter by trade, and three of his friends incorporated a company called Southern Cross Interiors Ltd to carry on a business doing small fit-out jobs. Robert was not a director of the company but in August 1995 he asked his wife, Carole to become a director of the company when one of the others resigned. He did so because he mistakenly believed that a company was required to have at least two directors. Carole agreed to become a director as she thought she had a duty to accept her husband’s wishes. In May 1996 Robert was appointed director when the remaining original director resigned.
Carole had never been a director of a company and had no business experience. Throughout the time that the company was in business Carole occasionally signed company documents. These were never explained to her however, and Carole later said that she was signing papers in situations where "I would usually have a frying pan in one hand and be signing with the other."
At the end of September 1997 an administrator was appointed to Southern Cross Interiors and the company was wound-up in October. The liquidator applied to the court to clawback a total of $208,737.44 in group taxes paid to the ATO. The liquidator argued that the tax had been paid while the company was insolvent and therefore were unfair preference payments. The court agreed and ordered the ATO to pay back the taxes to the liquidator. At the same time the ATO asked for declarations under s.588FGA of the Corporations Act 2001 that Robert and Carole (as the directors) had to indemnify the ATO against the repayment. This meant that the Clarks would have to refund the tax payments to the ATO.
Carole opposed the ATO’s action on the grounds that she had no idea what she had been signing and she not been active in the management of the company. Under
s.588FGB(5), if Carole could show that because of “illness or for some other good reason”, she was not taking part in the management of the company at the time the taxes were paid, then she could escape liability. Carole explained that she had trusted husband to tell her if any decision was to be made that could have put her at risk in the future. The court determined that Robert was required to indemnify the ATO but said that Carole had established good reason for not participating in management of Southern Cross Interiors. The judge explained that Carole had not participated in the management of the company because she did not believe that she was required to do so and that nothing had been brought to her attention during her directorship which should have made her aware of Southern Cross Interior's financial position or as to her responsibilities as a director.
The ATO Taxation appealed. The ATO argued that in light of the recent tightening up on directors’ responsibilities and duties under the Corporations Act, Carole should also be held liable for the debt. The Court of Appeal agreed that Parliament had made clear the importance of directors ensuring that they understood and performed their duties as director. The court examined the history of case law on the subject and determined that there was “a core, irreducible requirement of involvement [by a director] in the management of the company”. The excuse of “good reason” for not taking part in the management of a company was only available with respect to non-participation at a specific point of time. As a result reasons which cause a director never to participate in management were not capable of constituting a "good reason" for not participating at a particular point.
The court was therefore very firm that total failure to participate in company affairs was no longer permissible. This meant that Carole’s reliance on her husband was not considered a “good reason” under s588FGB(5), and so did not excuse her from liability as a director.
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2. Liquidators try to claw back tax payments from the ATO
Craig Crosbie and Ian Carson were the joint liquidators of the manufacturing company, Trollope Silverwood & Beck Pty Ltd. The liquidators were trying to clawback $2,054,333.77 from the ATO. They alleged the payments Trollope Silverwood had made to the ATO for "pay as you go" withholding amounts, goods and services tax and fringe benefits tax were "unfair preferences" under s.588FA of the Corporations Act 2001 or "insolvent transactions" under
s.588FC. In order to succeed the liquidators had to prove that when the withholding and other taxes were paid, the Trollope Silverwood had been insolvent. The ATO indicated that it would not contest the liquidators' claim. The ATO did, however, seek an indemnity from the former directors of the company, Barry and Suzanne Trollope, if the liquidators succeeded.
Section 588FF gives the court the power to order the repayment of amounts determined to be unfair preferences or insolvent transactions. If the court does order the repayment of tax liabilities for those reasons then
s.588FGA requires "[e]ach person who was a director of the company when the payment was made ... to indemnify the [ATO] in respect of any loss or damage resulting from the order". A director will have to do so unless he can show that he had reasonable grounds to expect that his company was solvent at the time it paid the taxes and would remain solvent even if it paid them (as outlined in s.588FGB).
Although the ATO was not going to defend the liquidators’ claim, the liquidators did not have the ATO's consent to judgment. Crosbie and Carson still had to prove that Trollope Silverwood was insolvent at the time it paid the taxes). If they succeeded, the Trollopes would be liable for the taxes, so the Trollopes asked the court for leave to defend the liquidators' action.
The court said the procedure for a third party to be introduced in to an action was established by the Judicature Act 1873 (UK). The main objects of the procedure were: (1) when relevant, to ensure that the third party is bound by the decision between the plaintiff and the defendant; (2) to have any issue between the defendant and the third party decided as soon as possible after the decision in the case against the defendant; and (3) to avoid the delay and expense of two trials. The court went on to say that for the procedure to operate fairly, it was recognised that it might be necessary for the third party to play some role in the action against the defendant. So third parties were given the right to appear at the trial (which is now expressly allowed for in the Federal Court Rules Order 5 rule 12(2)(c)), to cross-examine witnesses and sometimes to obtain discovery of relevant evidence.
The court explained that even where action was not being taken against the third party, the interests of justice might demand that third parties be given permission to intervene. This was particularly so when, as in this case, the defendant (ATO) was not taking any steps to protect its possible liability to the plaintiff liquidators.
The judge said that "[i]t is clear that the order sought by the former directors should be made. They would suffer grave injustice if that leave were refused". The court granted leave to the Trollopes to defend the liquidators' claims. However, they were to be bound by whatever decision was made in the claim.
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3. Statutory demand issued in a foreign currency
JTEC v Industrial Development Agency (Ireland) [2003] NSWSC 10
In mid-1997 JTEC Pty Ltd and the Industrial Development Agency (IDA), an enterprise development agency of the Irish government, entered into a grant agreement. The IDA was to give JTEC finance to allow them to expand to give employment to 15 Irish citizens. The IDA agreed to grant JTEC a maximum of 96,000 Irish pounds (known as punts) or 8,000 punts for every job created over the first three (up to 15 jobs) whichever was the lesser. The period of employment concerned was five years after the payment of the grant and the agreement allowed the IDA to revoke the grant and demand any amounts already paid if JTEC stopped operating.
JTEC said that between July 1997 and August 2001 it employed four people which activated payment of the grant. At the end of 1997 the IDA paid JTEC 36,000 punts but it was never made clear how this was calculated as JTEC was not paid for four employees at 8,000 punts each (equal to 32,000 punts), and the figure of 36,000 punts did not accord with the provisions of the agreement.
In August 2001 JTEC sold its business to Ericsson Australia Pty Ltd. In response the IDA wrote to JTEC advising them that it had revoked the agreement and demanded the repayment of the 36,000 punts. JTEC did not dispute either the revocation or the demand for repayment but did explore the continuation of the agreement with Ericsson. Nothing came of this and in July 2002 the IDA served a statutory demand on JTEC to try and force repayment.
JTEC applied to have the demand set aside. It argued that there was a genuine dispute that centred on the proper interpretation of the wording of the agreement and whether or not JTEC had substantially fulfilled its side of the bargain (which would mean that the IDA could not demand full repayment). JTEC also argued that there were defects in the demand that related to the foreign currency calculations.
JTEC said that in employing four people it had fulfilled its side of the agreement as the agreement only called for jobs for up to 12 persons over the base 3. The IDA however, claimed that the grant only applied to jobs for a total of 12 over the base 3 and JTEC was obliged to employ that number. The fact that JTEC had not done so meant that the IDA could claim the full amount back under the entire contract. JTEC responded by explaining it was not an entire contract as the grant allowed for part payment in respect of each employee. The court agreed and said that there appeared to be a genuine dispute over both the proper interpretation of the agreement and whether or not there had been substantial performance of the agreement.<>JTEC also claimed that the demand referred to two different sums involving two different currencies. It listed the sum required as 36,000 punts which was calculated as equivalent to 45,710.57 euro.
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<>JTEC said it was not clear in which of the two currencies payment was to be made. The problem was also that, if the debt, as expressed in Irish punts, was to be paid in euro, no reference had been made to applicable exchange rates or the relevant date of conversion. Although it is allowable for a statutory demand to be issued in a foreign currency, JTEC was forced to look beyond the documents to determine the relevance of the reference to the euro. The judge felt that, considering the timeframe within which JTEC had to comply with the statutory demand, an “impermissible burden” had been placed on JTEC.
<>This was further complicated by the fact that the punt was no longer legal tender and so the IDA had issued a statutory demand which could not be paid in legal tender. This meant that JTEC had been put in a position where it would suffer a substantial injustice if the demand was allowed to stand. Coupled with the existence of the genuine dispute, that was enough for the court to order the statutory demand set aside.
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4. Who gets paid first – the administrators or the liquidator?
John McKenney owned 54 companies concerned with managed investment schemes under the "Lifestyle Group" brand. In June 2000 eleven of those companies were placed into voluntary administration. Around the same time a number of McKenney’s other companies were placed in liquidation on the application of the Deputy Commissioner of Taxation and the Australian Securities and Investment Commission (ASIC). After an application by ASIC, which was opposed by the administrators of the eleven companies in voluntary administration, those companies were also wound-up. Clyde White was appointed liquidator of all of the Lifestyle Group companies.
The winding-up orders required that all of the assets of the companies within the Lifestyle Group were to be pooled and sold off. The "proper remuneration" and costs of the administrators and ASIC were to be paid as a matter of priority. White however, did not realise that the pooling order meant he had to treat all of the companies as one entity. Instead, he dealt with each company separately.
White recovered a total of $729,720.29 from the assets of the Lifestyle Group companies. He paid himself $375,528.81 which left $201,969.23 in the bank. White, however, claimed $497,704.90 was still owing to him.
White had only recovered $4,286.64 from the 11 companies that had been under administration. The original administrators of the 11 companies were owed a total of $199,797.27.
Two years after the original pooling order had been made, the courts were finally able to endorse that White should have treated all the companies together during the liquidation process. White applied to the court seeking orders to validate his actions. Section 1322 of the Corporations Act gives the court the power to rectify any procedural irregularities which have been committed and which relate to the Act.
White claimed that the payment of any costs to the administrators should wait until the completion of the winding up, even though there were insufficient funds to cover them. The administrators however, asserted priority and said they ought to have the benefit of the pooling order and be paid now, with White making up any shortfall. ASIC for its part, was simply anxious to ensure that its costs were paid.
White argued that the administrators could only be paid for their services out of the assets that were realised from the eleven companies while those companies were under their administration. He argued that the administrators' equitable lien, which gave them the status of secured creditors in relation to their remuneration and costs, extended only to those assets realised under their administration - only $4,286.64. The administrators and ASIC, on the other hand, argued that the pooling order had created a statutory lien in their favour over the accumulated assets of the group companies which took priority over White’s equitable lien over those same assets.
The court observed that the law relating to liens outweighed considerations of the practical function of the pooling order. The administrators were entitled to be paid remuneration in relation to those assets of the companies realised under their administration, in accord with their equitable lien. The administrators' statutory lien attaching to assets of the group companies realised in the winding up was subject to the provisions of s. 556 of the Corporations Act 2001. This meant that the administrators' remuneration was a deferred expense and could only be paid after other expenses, outlined in s.556 (1), were met. The court said that the equitable lien of the liquidator attaching to the realisation of assets in the winding up, took priority over the administrators' statutory lien. The court considered that it would be unconscionable for the administrators to benefit from the fruits of the White's labours in recovering those assets. The court also concluded that ASIC could not be in a better position than the administrators. White's lien had priority over those costs also.
The court was satisfied that White had not intended any impropriety in not acting in accordance with the pooling order. The court said that as long as there was no substantial injustice or prejudice inflicted on any creditor it would validate White’s remuneration. In order to ensure this White had to provide detailed information showing that his costs and rates were reasonable and were no higher due to his conducting separate liquidations. So White’s actions in the liquidation were validated and the administrators only got $4,286.64 for their troubles.
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5. Claim of breaches by directors of their fiduciary duty to act honestly
Re Fensford Pty Ltd; Nour Pty Ltd v ASIC & Anor [2004] VSC 179
Benson McGann is a Californian dentist. He was the sole shareholder and a director of Progressive America Inc which operated a business running training seminars and suppling equipment in the practice of orthodontics.
Nour Pty Ltd was established to conduct the operations of Progressive America in Australia. McGann was a director of Nour and held half of its shares. He employed Julie Vella to co-ordinate seminars for Nour and to purchase and distribute dental supplies. She was appointed a director of Nour late in 1990. Vella had been employed however, on an hourly rate although there was no written contract of employment. From 1995 it was arranged that Vella’s salary would be paid to Fensford Pty Ltd, a company of which Vella was also a director and which she controlled.
Vella operated the business of Nour from the family home. Payments were made by Nour to Fensford for a set amount each month for "administration services". The payments were used exclusively to cover Vella’s salary although she kept no time sheets of hours worked. Julie Vella died in September 1999. Her husband, Ricky Vella, began acting as a director of Nour. He apparently appointed himself as a director in January 2000, although McGann did not know of this. Under s.60 of the Corporations Law then in force (now contained in s.9 of the Corporations Act 2001) that still made Ricky at least a "de facto" director, which meant that he had to perform all the duties of a director appropriately (as Julie had had to do before him). Ricky was removed as a director of Nour when McGann reorganised the company in mid-2000.
In January 2001 Nour Pty Ltd told Fensford Pty Ltd , Ricky and the administrators of Julie’s estate that it intended to issue proceedings against them. Nour was claiming overpayments for the services provided by Julie, payments made to Fensford following Julie’s death, wages paid to Ricky and overpayments of rent that Nour had paid Fensford for space in the Vella family home. Nour said that the Vellas had failed to exercise their directorships of Nour with the proper care and attention. It also said the Vellas had profited at Nour’s expense and had breached their fiduciary obligations to act honestly and faithfully in the best interests of Nour. The claims added up to almost $350,000.
Soon afterwards Ricky applied for the voluntary deregistration of Fensford under s.601AA of the Corporations Act. The application failed because Fensford had not paid all the fees and penalties required under the Act. Late in 2003 however, the Australian Securities and Investment Commission (ASIC) successfully applied to have Fensford deregistered under s.601AB of the Corporations Act for failing to lodge annual returns. In order to continue its case against Fensford, Nour then applied under s.601AH of the Corporations Act to get the company registration of Fensford reinstated.
Nour argued that it would have no prospect of taking further action against Fensford unless the registration of Fensford was reinstated. That was because, with Fensford no longer in existence and such property as it may have had vested in ASIC, Nour had no means of pursuing any debt unless Fensford was brought back into existence. The court agreed - reinstatement for the purpose of enabling a company to be subjected to legal processes that it would otherwise escape was an appropriate use of s. 601AH.
That meant that Nour could continue its claim against Fensford and the Vellas. The case was heard on the same day (see NourPtyLtdvFensfordPtyLtd& Ors [2004] VSC 182). In that case the court determined that the common directorship of Fensford and Nour had the effect that Fensford must have been aware that the excessive payments from Nour to it for "administration services" and rent were made in breach of the duties of the directors (the Vellas). It was made clear that the directors of a company had to be regarded as holding on trust any moneys of a company under their control. The circumstances showed that the Vellas had assisted in the transfer of funds from Nour to Fensford "with knowledge in a dishonest and fraudulent design" and so were liable to Nour for the overpayments as constructive trustees.
