Australian Credit Law Bulletin - Vol 7, No 1, January 2006
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:
- Creditor services its debtor’s customers but can’t keep the money
A trap for unwary creditors! - Clawback of unfair payment leaves directors potentially personally liable for tax
Directors deny ATO should pay back the liquidator even though ATO itself doesn’t oppose - Break down in business relationship a disaster for the business
A lesson for small businesses - Lender takes mortgage over yacht based on fraudulent registration of title
Does the mortgage defeat an earlier unregistered mortgage by true owner?
1. Creditor services its debtor’s customers but can’t keep the money
Australian Kitchen Industries Pty Ltd v Albarran & Anor [2004] NSWSC 1047
W&J Kitchens Pty Ltd ran a kitchen renovation and construction business. It was a franchise of AKI and leased its premises from AKI also.
On 10 December 2001 W&J effectively walked away from the premises because of pressing debts and the unwillingness of AKI to buy W&J’s business. After W&J left, staff of AKI arrived at the premises and proceeded to make deliveries direct to customers who had previously placed orders with W&J. AKI then wrote off the monies received from these orders against the overdue debt owed to it by W&J.
As a result of this, AKI received $38,635 more than it would otherwise have received from the liquidation of W&J. One of the principles of insolvency law is that all unsecured creditors should suffer equally – it’s generally not fair that one should be paid more than its share, so a liquidator has the right to claw back unfair preferences.
Mr Albarran as liquidator of W&J made demand for repayment of the $38,635. AKI didn’t pay so Albarran went to court and judgment was awarded in his favour. AKI appealed.
The arguments of AKI on appeal were quickly dismissed. The key point for creditors in this case is to be aware of the risk of clawback of payments that they face in this sort of situation and to take legal advice to protect their position.
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2. Clawback of unfair payment leaves directors potentially personally liable for tax
J.A.G. Plastering & Carpentry Pty Ltd was placed in liquidation on 10 June 2003. Its liabilities were in excess of $1.2 million and its assets consisted of some trade debts and some machinery worth approximately $10,000.
In the six months before its winding up the company made several payments to the Commissioner of Taxation. The liquidator brought an action against the Commissioner of Taxation to set aside the payments and recover the $180,000 on the basis that the payments were made in unfair preference.
One of the principles of insolvency law is that all unsecured creditors should suffer equally – it’s not generally fair that one should be paid more than its share in the months immediately before a company fails, so a liquidator has the right to claw back money paid in these cases.
The Commissioner didn’t oppose the action but rather brought cross-proceedings against the former directors of the company. In other words, the Commissioner brought an action to hold the directors personally liable for tax incurred while the company was insolvent. JAG Plastering had paid this tax, but if the liquidator clawed it back, the directors would potentially be personally liable to pay the tax debt. The judge therefore granted the former directors the right to oppose the liquidator’s application, even though the Tax Office itself wasn’t opposing it.
The judge said that the liquidator must show that at the time of the payments the company was insolvent, that the payments were made when the company had other creditors, and that those creditors received less than the Commissioner: that is, that the Commissioner received a preference.
To establish his case the liquidator put forward a number of documents to show that the company was insolvent when the payments were made to the Commissioner. The directors however argued that the documents which the liquidator sought to rely on could not be proved to be the company’s records and it was “simply hearsay” to suggest that they were.
The judge said that insolvency is an inability to pay debts as they fall due out of the debtor’s own money. He said, however, that the debtor’s “own money” was not limited to his cash resources immediately available. He said that they extend to money which he can procure by realization, by sale or by mortgage or pledge of his assets within a relatively short time.
The judge also said that a liquidator assumes the functions of the directors. He or she is under a duty to correctly collect the company’s assets and apply them in discharge of its liabilities and distribute any surplus to those entitled to it. It was on this basis that the judge said that where the liquidator has sworn that he has the company’s records and indeed exhibited them, then until the contrary is shown “[h]e should be presumed to have done so as a matter of duty.”
The judge said that the books showed that the company was trading at a loss from its inception and two significant creditors were owed substantial amounts of money. In addition to this, the liquidator exhibited notices of demand from the Victorian Workcover Authority in respect of unpaid premiums and the judge said that this all proved that the company was insolvent for all of its working life.
One of the directors argued that as the company had two substantial contracts, one worth approximately $680,000 and another worth $1.39 million, this provided “a workable margin within which to meet its on-going obligations.”
The judge said, however, that this evidence was a far cry from establishing even an arguable case that these projects would have produced sufficient surplus income to discharge the company’s large debts within a reasonable time. He found for the liquidator and the payments were set aside.
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3. Break down in business relationship a disaster for the business
Labraga v Pomfret [2005] NSWSC 490 (19 May 2005 )
Exception Holdings was established in 2001 by three directors Mr Labraga, Mr Pomfret and Mr Highland. The three directors were equal one third shareholders.
In March 2003 Highland died and his share was left to the trustees of his family trust, his wife, Labraga, and Pomfret. After Highland’s death, Exception Holdings' indebtedness to Westpac Banking Corporation reached $1.45 million. On September 2004, Westpac sued Labraga and Pomfret, both personally and as executors of the estate of Highland, and Mrs Highland as trustee, under alleged guarantees of the indebtedness of Exception Holdings.
To pay the debt, Highland’s estate lent Exception Holdings $890,000 and Labraga borrowed $400,000 from an external source. An agreement was made whereby the company would pay Mr Labraga interest equivalent to that he had to pay to the external lender. There was confusion as to the security of this loan arrangement which was not cleared up at the time.
After this, there was a major falling out between the parties. Ultimately Labraga brought an application for the appointment of a provisional liquidator for Exception Holdings. His business partner, Pomfret, defended it.
The judge looked at the financial position of the company which showed a loss of $427, 606 for the year. In a report from the administrators of Exception Advertising it was said that “It is clear that the directors have focussed their attention on the ongoing dispute rather than the day to day management of the group. This has had a significant impact on the financial affairs of the company.”
Pomfret argued that the company was still operating even though there was some “argy bargy” between him and Labraga. However, Labraga argued that the assets were at risk due to the deadlock between them. It was also noted that the accounts were in “disarray and the administrators of Exception Advertising [a subsidiary company] were unable to give a view as to the separate assets and liabilities of the separate companies.”
Creditors had not been being paid in a “timely way” to the point where there was an outstanding statutory demand for over $330,000. Notices had been received by Mr Labraga as a director of Exception Holdings, threatening direct action by the Taxation Office. There was another demand for over $140,000 and Labraga was still waiting on being paid his interest from his $400,000 loan. The company was placed into liquidation and a liquidator appointed.
The judge said that having a company placed into liquidation was a “serious step” and a “drastic intrusion into the affairs of the company” but that there was good to cause to do so here.
There are at least 4 other cases reporting legal action in relation to this business:
Exception Holdings (in provisional liquidation) v Exception Finance [2005] NSWSC 690 (7 July 2005)
Labraga v Pomfret [2005] NSWSC 1039 (11 October 2005)
Labraga v Pomfret & Ors [2005] NSWSC 654 (7 July 2005)
Labraga v Pomfret; Highland v Labraga [2005] NSWSC 973 (29 September 2005)
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4. Lender takes mortgage over yacht based on fraudulent registration of title
Advertising Department Pty Ltd v The Ship “MV PORT PHILLIP” [2004] FCA 1762
The law of admiralty is a separate area of law with its own rules which have developed over many centuries.
On January 2002 Ray Evans purchased a 22 metre motor yacht built in Italy. He entered into a partnership to purchase the yacht with a silent partner, Advertising Department Pty Ltd. The agreement provided for the yacht to be held in Evans’ name but was to be “owned” by the partners in the proportions in which they contributed to the partnership.
The agreement said that on dissolution of the partnership the silent partner was entitled to the return of its capital and payment of any accrued profit in priority to any amount due to Evans. There was also an agreement not to sell each person’s interest in the partnership.
Advertising Department took a mortgage over the yacht to protect its position. This mortgage was not registered.
On April 2002 Evans fraudulently registered the yacht under his own name as the sole owner. This was affected on 13 August 2002. Later that year in September Evans approached BMW Finance Australia Ltd, and took out a mortgage firstly of $195,000 approximately and later on March 2003 of $300,000 approximately. BMW agreed to make the loan and took a ship’s mortgage in statutory form over the 64 shares as security. Evans defaulted under both loans and BMW sought to have the ship sold to recover its debt.
After a number of disputes Evans and Advertising Department (which still didn’t know about the BMW mortgages) agreed to dissolve their partnership. This involved Evans repaying the Advertising Department’s contribution and becoming sole owner of the ship.
On March 2004 Advertising Department discovered Evans’ fraudulent registration of the ship as sole owner and his mortgages to BMW. It immediately arranged a warrant of arrest for the Port Phillip as well as another ship owned by Evans. It also lodged a caveat forbidding the entry on the register of any dealings with the yacht.
There was then a contest between Advertising Department and BMW as to whether the unregistered goods mortgage had priority over BMW’s registered mortgage. Advertising Department wanted BMW to be removed from the register.
The judge said that whether this was possible is based on “a number of important provisions in the Shipping Registration Act.” He made a detailed examination of the history of registration of a ship and of a number of analogous cases. Ultimately the effect of these decisions was that the register of a ship is evidence of title. If a person in good faith acquires an interest in a ship from the registered owner he will obtain an “indefeasible” title that will defeat any prior unregistered right or interest, regardless of whether the prior right or interest is legal. It makes no difference that the owner obtained his registration by fraud, provided the person who acquired the interest was not party to, or did not know of, the fraud.
Advertising Department’s action was dismissed with costs.
