In brief: A District Court of Queensland decision addressing defences to an unfair preference action, inclusive of: good faith; set-off; and running account. The Liquidator’s opinion that the company was insolvent in reliance upon records that failed to comply with s 286 of the Act is also considered.
Case summary by Scott D. Taylor.
For a copy of the full judgment, please click here.
Implications for Liquidators and Defendants to unfair preference actions:
South East Queensland Machinery Manufacturing and Distribution (Mining) Number 1 Pty Ltd (In Liquidation), previously named Aran Management Pty Ltd (‘Aran Management’), was one of eight within a group of companies that manufactured and supplied complex mining fill plants.
Rexel Electrical Supplies Pty Ltd trading as Inaco Automation Controls (‘Inaco’) supplied electrical components to Aran Management that were used in the manufacture of the mining fill plants.
Aran Management sought to recover $197,469.16 as unfair preferences under s 588FA of the Corporations Act 2001 (the ‘Act’).
Inaco relies on three defences to resist the claim:
(a) Good faith under s 588FG;
(b) Running account so as to trigger the operation of 588FA(3); and
(c) Set off pursuant to s 553C.
Further, Inaco did not admit that:
At trial, Inaco objected to the admission of various documents of Aran Management on the basis:
Inaco disputed the accuracy and authenticity of the documents, and the Liquidator’s conclusions drawn from the documents based on the Liquidator’s conclusion that Aran Management had failed to keep financial records in accordance with s 286 of the Act.
Solvency – Liquidators Opinion
His Honour accepted the Liquidators opinion that Aran Management was balance sheet insolvent from 14 February 2012 and cash flow insolvent from at least 1 March 2012 up until the appointment of the Liquidator on 14 August 2012.
The Liquidator’s conclusions based upon the books and records made available to him that the company was insolvent were accepted, notwithstanding that the books and records necessarily represent records sufficient to satisfy s 286 of the Act.
His Honour stated further that:
Running Account – 588FA(3)
In determining no running account defence existed, His Honour accepted that Aran Management had satisfied the onus of establishing that the payments were not an integral part of a continuing business relationship, but rather, a series of payments designed to reduce the pre-existing indebtedness.
His Honour held that Inaco’s focus was on reducing Aran Managements indebtedness to it:
Good Faith – s 588FG
His Honour held that Inaco failed to make out its defence of ‘good faith’ and referenced the following sequence of events:
Set-off – s 553C
His Honour accepted Inaco’s submissions in part, insofar as $64,658.15 of the $92,323.28 claimed was a set-off.
The plain language of s 553C was followed.
Section 553C can apply to unfair preference actions.
The decision of the NSW Court of Appeal in Buzzle Operations Pty Ltd (in liq) v Apple Computers Australia(involving the set-off of an uncommercial transaction rather than an unfair preference) was followed, as was the reasoning adopted by Mansfield J in Re Parker.
For the same reasons rejecting Inaco’s ‘good faith’ argument, His Honour found that in relation to all but the 31 January invoice, Inaco had actual notice of acts that would have indicated to a reasonable person in Inaco’s position the fact that Aran Management was unable to pay.
Taylor David successfully recovered legal costs of the entire action on an indemnity basis on behalf of the Mr Morton as liquidator. See: Morton & Anor v Rexel Electrical Supplies Pty Ltd (No 2)  QDC 6.
As of July 2012, the Australian Taxation Office (“ATO”) made important changes to the Director Penalty Notice (“DPN”) regime which has no doubt increased the liability of Companies and personal exposure of their directors. The changes were introduced to ensure that Companies are complying with the reporting and remittance of their PAYG and superannuation obligations.
In the past 12 months, we have noticed an increase in activity by the ATO, resulting in firmer action against Directors’. A director typically receives a notice for a Company’s debt under the ATO’s firmer action approach (called a firmer action notice) when the Company:
To avoid receiving a notice of firmer action, directors should make enquiries to the ATO as to whether there are any returns that haven’t been lodged, BAS’s, Superannuation Guarantee Charges, or PAYG liability.
As the new DPN regime applies retrospectively towards PAYG withholding, even if the director has placed the company into voluntary administration or Liquidation, the director may still receive a firmer action notice from the ATO. Director penalties are discretionally enforced by the ATO. A firmer action notice may escalate the threat to enforce the DPN provisions.
In this instance, the director should consult their legal advisor with respect to contacting the ATO with a view to proposing a repayment arrangement. The ATO has the power to proceed with actioning the DPN and commencing Bankruptcy proceedings.
What to do
Your clients should ensure that they lodge any outstanding BAS and PAYG returns as soon as possible. If a BAS return is lodged but PAYG is not paid, the ATO is within its’ rights to issue a DPN. The notice period is 21 days and at the end of the period if the debt is not paid, personal liability can attach to the director.
The director can avoid personal liability if the Company is placed into either Voluntary Administration or Liquidation prior to the expiration of the DPN (i.e. 21 days).
If unpaid PAYG is not reported within 3 months of the due date, the Director will automatically be personally liable for any unpaid amounts, even if the company is placed into external administration after this date.
It is evident that the ATO is able to override the “corporate veil” and apply personal liability to the company director should the above lodgements not be met.
The importance of communicating with the ATO and keeping them “in the loop” with the progress of ATO liabilities is paramount. Where it was the case Directors could hide behind the corporate veil to minimise their personal liability, the ATO is clearly looking at pursuing Directors’ in a personal capacity to assist in recovering tax liabilities owed by Companies.
It is imperative that your client be aware of their Companies financial position at all times including liabilities to the ATO and lodgments.
The ATO is under increasing pressure to recover outstanding tax liabilities and it is our view that this will be a focus for them in the coming quarters.
Should your client require any further advice with respect to the DPN regime or changes to same, please feel free to contact this office.
The term ‘Phoenix’ refers to the mythical creature which, upon its death, is reborn from the ashes of its predecessor. By analogy, this describes a new business becoming ‘reborn’ out of the ‘ashes’ of a defunct business. This can involve a number of different practices, but essentially sees a director cycle productive business assets through a series of companies in a deliberate effort to avoid liabilities including tax, or trade creditors
It is worth noting however, that whilst there is a common understanding of this general analogy, there are no express definitions found in any Australian laws.
The Australian Securities and Investment Commission (‘ASIC’) describes phoenix activity as conduct that meets the following criteria:
Where an entity:
The Corporations Amendment (Phoenixing and Other Measures) Act 2012 was recently enacted. The Amendment provides ASIC with increased power to wind up companies suspected to be engaged in phoenix activity.
ASIC issued a press release in September 2013 announcing it was stepping up surveillance of illegal phoenix activity. The release states (amongst other things):
‘Illegal phoenix activity has far reaching and unfair consequences’.
‘As part of the surveillance program, ASIC will focus on the building and construction, labour hire, transport, and security and cleaning industries.’
‘We are looking at failed companies, mostly within the small business sector, from July 2011 onwards where there have been allegations of illegal phoenixing ,’ said ASIC commissioner Greg Tanzer.’
To read the full ASIC press release, please click here.
The real risk associated with phoenixing for directors lies in the transfer of assets from a “dead” company to the company that is “reborn”. The issue here surrounds the consideration that follows the transfer more so than the transfer itself. The targeted phoenixing that may result in serious penalties being imposed on an individual has usually involved the undervaluation of the former company’s assets.
This risk is particularly high when a company is undergoing a restructure or pre-packing. Pre-packing is essentially when the core business assets are sold for fair market value to a new company, often a related entity.
It is imperative for any business considering a pre-packaged insolvency arrangement to take particular care and obtain advice from a lawyer.
Penalties and Liability
Should a director become involved in unlawful phoenixing activity, the individual is likely to breach a number of director’s duties under the Corporations Act 2001 (the ‘Act’) and general law.
The remedies that can be claimed against the director are varied and include:
Additionally, if the breach is reckless or dishonest, criminal liability can be imposed upon which further fines can be ordered, even imprisonment.
Furthermore, a director can be disqualified from managing a company for a period of up to ten (10) years.
Insolvent trading occurs when a company incurs a debt when it is unable to pay its debts as and when they fall due.
The law imposes on the directors, a duty to prevent the company from engaging in insolvent trading.
Breaching this duty can expose the directors of the company to personal liability.
The law places a duty on directors of an insolvent company to prevent the company incurring debts where a director has grounds for suspecting that it is insolvent. The duty contains five elements:
1. The person is a director at the time when the company incurs that debt.
2. The company was insolvent at the time or became insolvent by incurring that debt, or by incurring at that time or became insolvent by incurring that debt, or by incurring at that time debts including that debt.
3. At that time there were reasonable grounds for suspecting the company was insolvent or would become insolvent.
4. The debt was incurred after 23 June 1993.
5. By failing to prevent incurring the debt, the director was aware that there are such grounds for suspecting, or a reasonable person in a like position in the company, would have been aware that the company was insolvent.
It is important to note that past directors of the company (notwithstanding resignation) can also be held liable for insolvent trading.
Even if a company is insolvent, before a director becomes liable it must be established that there were reasonable grounds to suspect that the company was insolvent or would become insolvent. The test requires that whatever is “suspected” must be based on reasonable grounds and imports into this section an objective test for suspicion.
The Courts have relied upon some practical factors that may indicate insolvency in the context of director liability for insolvent trading, including:
Civil penalty orders for insolvent trading include the power of the court to disqualify a person from managing a corporation or imposing a pecuniary penalty order up to $200,000.00.
However, a court may not order civil penalties disqualification if it is satisfied that despite the contravention, the person is fit and proper to manage a corporation nor order a pecuniary penalty where is considers a contravention not to be a serious one.
Only Australian Securities and Investments Commission (‘ASIC’), a commission delegate or some other persons authorised in writing by the Minister can apply for a civil penalty order.
A director may be liable to criminal proceedings by ASIC through the Commonwealth Director of Public Prosecutions (the ‘Crown’) if they contravene a civil penalty provision.
A director will be convicted of such an offence where it is proven that the contravention was carried out in circumstances which established the following:
1. knowingly, intentionally or recklessly; and
2. dishonestly and intending to gain, whether directly or indirectly, an advantage for that or any other person; or
3. intending to deceive or defraud someone.
A director can avail themselves of one of four statutory defences contained in the Corporations Act 2001 which can absolve directors of liability in certain circumstances.
Compensation Payable by Directors
An application initiated by ASIC or the Crown to pay compensation to the court may be enforced as though it were a judgment of the Court. However, a liquidator does not have to wait for ASIC or the Crown to commence proceedings.
A liquidator may take recovery of compensation actions resulting from insolvent trading in circumstances where a creditor has suffered loss or damage and the company is being wound up