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1 SOLVENCY AND ONLY SOLVENCY THE NEW WINDING UP REGIME

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                       SOLVENCY AND ONLY SOLVENCY

                         THE NEW WINDING UP REGIME



Introduction

Notwithstanding that Part 5.4 of the Corporations Act was introduced in its present
form on 1 January 1993, it has taken until 2003 for there to be a definitive
determination of the practical application of the Part in so far as it applies to a
winding up in insolvency.

In three recent decisions the New South Wales Court Appeal has recast the practical
application of the Part and in doing so has for good reason restricted the scope of
resistance that can be mounted by the Company.1

Further, the principles laid down in the abovementioned authorities have been
followed in this jurisdiction.2

Disputed Debt and Abuse of Process

The relevant facts in Braams Group Pty Ltd v Miric3 was simple but unusual.

Mr Miric, the creditor, had obtained a judgement and subsequently served a statutory
demand.

The Company failed to satisfy the demand or applied to have the demand set aside.

The Creditor began winding up proceedings.

The Company then appealed the judgement debt and sought to stay or adjourn the
winding up proceedings.

At a later date the judgement was set aside by the consent of both parties.

Nevertheless, the winding up continued.

A presumption of insolvency had arisen pursuant to Section 459C and at the time of
the winding up application was filed the Applicant was a creditor holding a judgment.

1
    Switz Pty Ltd v Glowbind Pty Ltd (2000) NSWCA 37: (2000) 33 ASCR 723; Braams Group Pty
    Ltd v Miric (2002) NSWCA 417: (2002) 44 ACSR 124; Expile Limited v Jabb’s Excavation Ltd
    (2003) NSWCA 163: (2003) 45 ACSR 711
2
    Sindea Trading Co Pty Ltd v Asia Pacific Glass Pty Ltd (2003) QSC 406
3
    (2002) NSWCA 417: (2002) 44 ACSR 124
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On the return date of the winding up proceedings the Company filed material showing
that it was a trustee Company and that apart from its right of indemnity against the
beneficiaries or assets, it had no assets and it had debts for legal fees in respect to
earlier proceedings.

No current accounts were produced and it had not traded in the current financial year.

At first instance the Company was not given leave to dispute the debt because he
could not satisfy the requirements of Section 459S in that disregarding any disputed
debt it was nevertheless insolvent.

Accordingly, the Company was wound up.

Again while acknowledging the legislative scheme of Part 5.4 could have harsh
consequences if a Company did not take advantage of Section 459G to set aside a
statutory demand, the Court nevertheless found that there was no abuse of process in
the creditor pursuing the winding up application.

While the Court acknowledged that it was still possible for the pursuit of a winding up
application to be an abuse of process such pursuit would have to be an abuse of
process in the narrow and technical sense discussed in Williams v Spautz4.

In the present circumstances, once the Company had failed to comply with the
statutory demand the presumption of insolvency had arisen the only proper manner
for the Company to dispute the debt was seek leave under Section 459S and in the
circumstances the Company could not demonstrate it should be given leave to dispute
the debt as the Company always insolvent.

As the Company was always insolvent it should be wound up.

The Court did not address the issue as to whether at the time of the making of the
order whether Mr Miric was indeed still a creditor and therefore having standing
pursuant to Section 459P.

The answer may be that it is sufficient that Mr Miric was a creditor at the date of the
filing of the application and after that date it is sufficient a creditor does not pursue
such an application on its own behalf but on behalf of the world at large.




4
    (1992) 174 CLR 509
                                                3


In practical terms the lesson to be learnt is that once the presumption of the
insolvency arises then there is no abuse of process to pursue a Winding Up
Application relating to a disputed or even non-existent debt.5

Leave to Dispute the Debt

Section 459S provides:

(1)      Demand may not ground opposition

          In so far as an application for a Company to be wound up in insolvency relies
          on a failure by the Company to comply with a statutory demand, the Company
          may not, without the leave of the Court, oppose the application on a ground:

          (a)   that the Company relied on the for the purposes of an application by it
                for the demand to be set aside; or

          (b)   that the Company could have so relied on, but did not so rely on
                (whether it made such an application or not).

(2)      Ground material to solvency

          The Court is not to grant leave under subsection (1) unless it is satisfied that
          the ground is material to proving that the Company is solvent.

It is common for a Company to attempt to resist an application for winding up on the
basis that the debt founding the creditor’s statutory demand is disputed.

Further, a Company will often seek an injunction to prevent the Applicant/Creditor
from proceeding with a winding up based on a disputed debt.6

However, the introduction of Part 5.4 attempts to restrict the circumstances where
such relief could be granted7.




5
      For former position consider Fortuna Holdings Ltd v Deputy Commissioner of Taxation (1976)
ACLR 349




6
      Fortuna Holdings Limited v Deputy Commissioner of Taxation (1976) ACLR 349
7
      Explanatory Memorandum Corporate Law Reform Bill 1992, paragraphs 685 to 689
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Notwithstanding the sentiment expressed in the Explanatory Memorandum it was still
common place for injunctions to be granted against Creditors where the winding up
was proceeding in respect to a disputed debt.

In Switz8 however, the New South Wales Court of Appeal expressed the view section
459S should be applied strictly and further that the Court is not to grant leave to
dispute a debt unless the Court is satisfied that the resolution of such dispute will be
material to the Company proving it is solvent.

In summary the Court held:

(a)    if the Company can prove that it is solvent even accepting the existence of the
       debt then leave will not be granted to dispute the debt as it makes no difference
       to the Company’s solvency;

(b)    if the Company insolvent even if ignoring the disputed debt then leave will not
       be granted to dispute the debt as it makes not difference to the Company’s
       insolvency;

(c)    only in the circumstances where an examination of the disputed debt will be
       made is when the debt is material to the Company demonstrating its solvency.

Accordingly, the circumstances where leave will be granted will be very rare.

While the Court acknowledged that in some circumstances such an application of Part
5.4 may appear to operate harshly it was nevertheless the consistent with the
Explanatory Memorandum and the comments of the High Court in David Grant & Co
Pty Ltd (Receiver Appointed) v Westpac Banking Corporation9.

In practical terms the current position can be summarised as follows:

(a)    a Company seeking to dispute a debt without evidence of solvency will not be
       given leave under Section 549S or indeed be able to rebut the presumption in
       Section 459C and hence be wound up;

(b)    a Company which provides evidence of solvency but that evidence is not
       sufficient to demonstrate solvency even disregarding the disputed debt will not
       be given leave under Section 459S(2) and should be wound up;



8
      (2000) NSWCA 37: (2000) 33 ACSR 723
9
      (1994) 184 CLR 265
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(c)    a Company which provides evidence of solvency which demonstrates in the
       relevant sense solvency even allowing for the existence of the debt will not be
       given leave under Section 459S(2) but will not be wound up due to the rebuttal
       of the Section 459C presumption;

(d)    where a Company provides evidence of solvency but such evidence is not
       determinative due to the existence of the disputed debt then leave may be given
       and the matter will proceed as a contested winding up in a manner common
       prior to the introduction of Part 5.4.

Proving Solvency

Unfortunately, discussions of solvency and the context of insolvent companies usually
involves the reciting of nothing more than statements of principle as opposed to
examination at a most basic level of the evidentiary requirements.

In Expile Pty Ltd v Jabb’s Excavations Pty Ltd10, the sole issue to be determined was
whether the statutory presumption of insolvency was rebutted by the Company.

In finding that the Company had rebutted the presumption that Barrett J compiled a
useful summary of the evidence that is required.

In short, Barrett J made the following observations:

(a)    the Company is presumed to be insolvent and as such bears the onus of proving
       its solvency;

(b)    in order to discharge such onus the Court should be presented with the “fullest
       and best” evidence of the financial position of the Company;

(c)    unaudited accounts or unverified claims ownership of property or valuation are
       not ordinarily probative of solvency;

(d)    bald assertions of solvency arising from a general review of the accounts even if
       made by qualified accountants who have detailed knowledge of how those
       accounts were prepared is not sufficient;

(e)    the relevant test is not a surplus of assets but solvency;




10
      (2003) NSWCA 163: (2003) 45 ACSR 711
                                             6


(f)    while the nature of the Company’s assets and the ability to convert those assets
       into cash at a relatively short time are relevant there must be evidence as to the
       value of such assets;

(g)    the question of the solvency must be assessed at the date of hearing;

(h)    it is no abuse of process for an Creditor to seek to wind up a Company
       presumed to be insolvent by reason of its failure to comply with a statutory
       demand merely because the Company contends that it is solvent.

In Expile Pty Ltd v Jabbs Excavation Pty Ltd11, the Company relied on evidence from
the Director and Shareholders, an external accountant who provided accountancy
services to the Company and an accountant specifically retained to provide a report on
the Company’s financial position for the purposes of the proceedings.

Importantly, the financial accounts were supplemented by third party valuation
evidence of particular assets.

In short, the Company did far more than most.

At first instance the Winding Up Application was dismissed on the basis that the
presumption of insolvency had be rebutted.

However, on appeal the New South Wales Court of Appeal allowed the Appeal by the
Creditor and found that the while the observations of Barrett J in respect to relevant
evidence was correct the practical application of the relevant principles to the
evidence meant that the presumption had not been rebutted.

In particular:

(a)    the treatment of particular bank loans as a non-current liability was not justified;

(b)    evidence of sufficient borrowing capacity depending upon the reliability of
       verification of liabilities and assets should be regarded with suspicion unless
       there is independent third party valuation;

(c)    the value of equity in leased assets should be regarded with suspicion;

(d)    any gaps in financial records particularly concerning acquisition costs of assets
       must be explained;


11
      (2003) NSWCA 163: (2003) 45 ACSR 711
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(e)   any reliance on trade debtors as an asset is unreliable.

Accordingly, the Full Court found the evidence well short of that required to rebut the
presumption.

In practical terms as it concerns the Company, this decision has the effect that:

(a)   an external and independent should be engaged to prepare a special purpose
      report as to solvency;

(b)   the abovementioned report should be based on independent and third party
      valuation of assets;

(c)   liabilities must be brought to account as at the day of the hearing of the
      application and quantified with precision by corroborating documentation;

(d)   it is not sufficient that the Company use its own accounts or indeed own
      external or compliance accountants to prepare financial accounts for the
      purposes of a Winding Up Application;

(e)   evidence and reports should be prepared for hearing must be obtained in a
      sufficient time frame;

(f)   financial accounts produced internally using well known software packages are
      viewed as unreliable.

Conclusion

There is no doubt that the abovementioned decisions have swung the balance firmly
in favour of creditors making an application for winding up.

Once the presumption of insolvency arises it is clear that a Creditor can continue with
a winding up and that a Company faces a high hurdle in demonstrating to the
satisfaction of a Court that is solvent in the relevant sense.



                                                                           CD Coulsen
                                                                             Chambers
                                                                         27 March 2004

				
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