Australian Credit Law Bulletin - Vol 6, No 1, January 2005
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:
- Can directors of failed companies defend voidable preference claims by liquidator against ATO even though ATO doesn't defend?
If the liquidator claws back tax payment from ATO, the directors may be personally liable to pay the tax - Defendants file for bankruptcy in an attempt to avoid a future judgment debt
But it doesn't work out as they'd intended. - Trying to recover unpaid salary when the company has a $42m deficit
A challenging task - Was the defence a mere delaying tactic which should be struck out?
Directors involved in a multi-million dollar insolvent trading case fail to get it right.
1. Can directors of failed companies defend voidable preference claims by liquidator against ATO even though ATO doesn't defend?
Hall v Commissioner of Taxation [2004] NSWSC 985 (25 October 2004)
Hall was the liquidator of Reynolds Wines Ltd and Reynolds Vineyards Pty Ltd. On 4 May 2004 he filed an order with the court trying to overturn payments of approximately $600,000 by the companies to the ATO. Hall was challenging the payments on the grounds they were a voidable preference under Part 5.7B of the Corporations Act 2001. In an insolvency, it's not fair if one creditor's overdue debt is paid shortly before the company fails, while other creditors miss out. The liquidator therefore has the right to claw back such payments.
If the ATO had to pay back the money, section 588FGA of the Corporations Act allows the it to recover the tax payments from the directors personally. The section states that the directors must reimburse the tax commissioner if certain tax payments are set aside as a voidable preference. In addition, the directors’ could also be held jointly liable for any order of legal costs made by the court against the tax commissioner.
In this case, on 17 September 2003 the tax commissioner simply admitted that the company was insolvent at the time that it made the tax payments. This virtually guaranteed recovery by Hall of the disputed tax payments.
The directors were not pleased. They issued interlocutory proceedings [proceedings in the middle of the case being heard between the liquidator and tax commissioner] in an attempt to defend the claim that the company was insolvent.
Hall argued that the directors’ proceedings should operate separate to those between the liquidator and the tax commissioner. Essentially, he said that if the ATO later tried to recover the money off the directors, they could argue about the issue of insolvency then. Even though the insolvency was accepted in one trial, he argued, that didn't decide the matter in a subsequent trial. The commissioner’s concession of insolvency did not cause any presumption to arise against the directors.
However, the court did not accept this. The judge said that making an order against the directors without the directors having become a party to the proceedings “cannot be contemplated". He referred to the concept of "natural justice" and said, "[t]here is thus, in my view, an implicit statutory direction that directors ... be accepted as being parties to the proceedings brought by the liquidator against the Commissioner."
So in the end, an order was made joining the directors to the action between Mr Hall and the tax commissioner. (This took place late in 2004 and we are not aware of the final outcome.)
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2. Defendants file for bankruptcy in an attempt to avoid a future judgment debt
BWK Elders v White [2004] FCA 1611 (10 December 2004)
On the 8th of June 2004 Peter Anderson, Matt Kaine and Graeme Moyle were defendants in a suit commenced by BWK Elders (Aust) Pty Ltd. BWK were suing the defendants for around $1.8 million for various breaches of the Trade Practices Act 1975. Once the defendants’ motions for adjournment (delay in the proceedings) had been exhausted, with all motions being declined, the parties decided not to defend the action. Instead they filed for bankruptcy.
However, their bankruptcies did not bring the action to an end, as presumably they had anticipated. S60(1)(b) of the Bankruptcy Act allows a court to halt legal proceedings against a bankrupt if the legal proceedings involve a claim for a “provable debt”. A provable debt is a debt that can be proved in a court. Here, however, there was no provable debt, but rather “unliquidated damages”. In essence, there wasn't a definite amount that they could be said to owe because the court had not actually decided how much they owed. Because the court had not ruled on the breaches of the Trade Practices Act, the debt did not yet exist so it couldn't be included in their bankruptcies.
The only debt which was then due and payable by any of them was approximately $200,000 which each had borrowed from their wives to cover the legal costs of the action. As a result, each bankrupt’s estate would go to his wife as the sole creditor.
As the proceedings weren’t able to be halted by the defendants, BWK proceeded with their claim and obtained judgment on 25 June 2004. The judgment awarded BWK damages of $1.83 million with interest. BWK then petitioned to bankrupt Anderson, Kaine and Moyle. Sequestration orders (an order to seize property) were made on 19 October 2004.
However, in order for BWK to recover at least part of their judgment from the three debtor, (given that they didn’t have enough to be able to pay the full judgment) BWK had to get the first bankruptcies annulled. The court has the power to annul a bankruptcy petition where it is founded on an abuse of process. This is the case where a debtor presents his own petition “for a purpose foreign to the bankruptcy laws”. On the facts, there were two bases found for holding that each person’s petition amounted to an abuse of process.
First, section 55 of the Bankruptcy Act, says that a person can only present a petition for bankruptcy if they are in fact insolvent (unable to pay their debts as they fall due). Here, it was found that because the judgment had not been entered against the defendants at the time that they filed for bankruptcy they were all able to pay their debts when they fell due.
Second, the intentional effect of the three men filing for bankruptcy was that their estate in bankruptcy would go to their respective wives leaving nothing to satisfy the judgment debt of BWK. The court found that “it is an abuse of process for a debtor to present a petition for the purpose of placing his estate beyond the reach of a person who will imminently become a creditor. The purpose of bankruptcy laws is to secure an equitable distribution of a bankrupt’s assets among all creditors.”
The court made an order annulling each of the three men’s own petitions for bankruptcy.
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3. Trying to recover unpaid salary when the company has a $42m deficit
Blundell v Macrocom Pty Ltd [2004] NSWSC 895
Mr Blundell was a former employee of Macrocom Pty Ltd. On 12 July 2004 he served on Macrocom a statutory demand for $84,000 for unpaid salary. Macrocom failed to comply with the statutory demand, so Mr Blundell applied to wind up the company.
The hearing was set for 6 September, but on 2 September a secured creditor of the Macrocom acted under section 436C of the Corporations Act to appoint an administrator. On 6 September, a judge delayed the winding up hearing until 20 September to allow a deed of administration to be created.
At the winding up application, on 20 September, the administrator sought the courts advice on how to approach the matter concerning Mr Blundell. The administrator had three main issues on which he asked for the courts guidance. First, whether Mr Blundell should be paid out as an expense of the administration of the company; secondly, whether Mr Blundell should be paid “as a priority creditor claim in the liquidation of the company,” (because as an unsecured, non-preferential creditor, he would get nothing); and thirdly, whether Mr Blundell should be required to provide some sort of security against the possibility of a later finding that he was involved in the trading of Macrocom while it was insolvent.
The directions the administrator sought were not made. The court assessed Macrocom’s financial position as having approximately $1.8 million worth of assets while owing $44.2m to creditors “representing a deficiency of $42,411,992”. The claims of the secured creditors - those secured by particular assets - exceeded $5.2 million.
Because Macrocom was clearly insolvent, the judge went said it was likely that “any payment now made by the administrator to [Mr Blundell] would be susceptible to recovery as an unfair preference”. He said, "no advantage to the general body of creditors will be achieved if the administrator agrees to pay ... the plaintiff’s claim and actually makes that payment."
The administrator's report showed a position of clear insolvency in which “continuation of administration will produce no advantage or benefit to creditors”. In his view, winding up was inevitable. The judge therefore declined to make any directions. He simply made an order for Macrocom to be wound up and appointed the administrator liquidator.
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4. Was the defence a mere delaying tactic which should be struck out?
Smith, in the matter of Barron Entertainment Ltd (In Liq) v Barron [2004] FCA 1596 (3 December 2004)
Barron Entertainment Limited was the parent company of the Barron Group of companies which made and distributed film and television products. On 16 December 2003, the liquidators of Barron Entertainment and one its subsidiaries, Barron Television Limited, began proceedings against two former directors of those companies, Paul Barron and David Humann for insolvent trading.
They claimed Barron and Humann had breached section 588G of the Corporations Act 2001 by failing to prevent the companies from incurring debts where there were reasonable grounds for suspecting that the companies were insolvent. Barron and Humann were given until February 2004 to file their defence or face a summary judgment against them for amounts ranging from $435,000 to $5.8 million.
On 6 February 2004, Barron and Humann asked the court for more time to prepare their defence to the liquidators claim. They said because of the complex nature of the case they needed to hire an accountant to perform extensive analysis of the company’s finances leading up to liquidation.
Barron and Humann contacted various accountants, including the parent company’s former accountant, in an attempt to retain their services. The company’s former accountant estimated that it would take between 100 and 200 hours of an accountant’s time to perform the analysis needed. The judge upon hearing this took into account the apparent complexity of the case and the sizeable amount of money involved and allowed a further 8 weeks for the filing of the defence. The defence was now to be submitted by 2 April 2004.
By the 2nd of April no defence had been filed. The liquidators then bought the matter back before the court for further directions as to when they could proceed with the trial. This hearing was heard on the 5th of May.
At this hearing, District Registrar Jan made a number of directions which extended the deadline for the defence again, this time requiring it to be filed by 5 August. The judge sought to enforce this new deadline by creating a “self-executing default order”. This was worded: “unless the respondents [Barron and Humann] comply with Order 1 [the now final deadline]… judgment [will] be entered for the applicants”.
A defence was filed on 3 August. On 25 August 2004 the liquidators went back to court arguing that the defence filed by Barron and Humann failed to comply with an order of the court, or that the defence should be struck out for breaching the Federal court rules because it was so deficient and lacking substance. The Federal Court Rules require that a statement of defence provide a “reasonable defence or other case appropriate to the nature of the pleading.” The liquidators claimed that Barron and Humann had failed to to this.
The court can strike out a statement of defence if it breaches the Court Rules relating to their form and substance. However, the judge stressed that such a striking out order is a very serious measure. This is because it effectively “deprives a party of its entitlement to have its case heard and determined on its merits”.
In this case, the judge found that the defence consisted of “some admissions but for the most part simply comprised denials of the greater part of the statement of claim”. It contained virtually no pleading of any material facts as required by the court rules. In particularly it didn’t raise any of the statutory defences to the insolvent trading provisions under the Corporations Act.
In summary the judge said that “the defence filed, on the face of it, did not amount to an attempt in good faith to plead to the statement of claim. It was plainly conceived as a ‘holding defence’ that is an attempt to defeat the operation of the self-executing default order and to obtain more time for the preparation of the real defence in these proceedings.” Because it “failed to comply with the requirements of the rules or to disclose any reasonable defence in accordance with those requirements, the defence should be struck out”.
However, the judge did find that there was no real intent on the part of Barron and Humann to breach the Courts rules. He put the breach down to “a misconception about what was sufficient to comply with them”. He therefore gave them another 14 days to file another defence. The defendants were ordered had to pay the liquidators' full costs of the action.
