ACN 101 335 880 Pty Ltd and Pattison v Muscat

[2008] VMC 12

IN THE MAGISTRATES COURT OF VICTORIA

AT MELBOURNE

CIVIL

Case No. X00541083

ACN 101 335 880 Pty Ltd	First Plaintiff
Pattison	Second Plaintiff
v
Muscat	Defendant

---

MAGISTRATE:	P Lauritsen
WHERE HELD:	Melbourne
DATE OF HEARING:	20 August 2008, 30 September 2008
DATE OF DECISION:	12 November 2008
CASE MAY BE CITED AS:	ACN 101 335 880 Pty Ltd and Pattison v Muscat
REASONS FOR DECISION

---

Catchwords: s 588FB Corporations Act 2001 (Cth) – whether transaction voidable on

account of being uncommercial – insolvent transaction.

---

APPEARANCES:	Counsel	Solicitors
For the Plaintiff
For the Defendant  HIS HONOUR:

Introduction

1.   The second plaintiff is the liquidator of the first plaintiff (the company). The defendant acted as an advisor to the first company in the months before the making of the winding up order.[1] He charged for his services and was paid $22,500. It is this sum, principally, that the plaintiffs seek to recover.

[1] The defendant traded under the name “Director Support”.

Issues

2.   The plaintiffs bring their claims on the following bases:

(a) that the payment of $22,500 was an insolvent transaction and voidable;
(b) that $3,498 of the sum of $22,500 was an unfair preference and voidable;
(c) that a charge executed by the first plaintiff is void as against the liquidator.

Circumstances

3. Ltd. Its issued capital consisted of ten $1 shares. At relevant times, its sole director
and shareholder was Peter Hobbs (Hobbs). The company operated a joinery, cabinet

The company was incorporated in 2002 as Horsham Kitchens and Timber Sales Pty was another company called PL & IR Hobbs Pty Ltd (Hobbs Pty Ltd). Hobbs was its sole director.

4.   On 5 November 2006, the Australian Taxation Office (ATO) lodged an application to wind up the company in the Federal Court of Australia. The application concerned unpaid GST and PAYG withholding taxes. The amounts exceeded $300,000.[2]

[2] A balance sheet of the company generated on or before 10 February 2007 places the combined tax liability

5.   During November 2006, the defendant saw a notice in “The Age” advising of the winding up application. He made inquiries and was able to contact Hobbs. He explained his services to Hobbs. On 1 December 2006, Hobbs executed an agreement on behalf of himself, the company and Hobbs Pty Ltd. Hobbs and Hobbs Pty Ltd guaranteed the company’s obligations. On 4 December, Hobbs, on behalf of the company, executed a deed of charge in favour of the defendant.

6.   Turning to the agreement, it summarised what Hobbs sought to achieve by engaging the defendant:

(a)	the continued trading of the company’s business or its sale in an orderly manner; and
(b)	the development and pursuit of strategies that would minimise the impact of the winding up proceeding on Hobbs and “related entities”.

7.   The agreement also set out the defendant’s recommended strategies. These were to be pursued concurrently:

(a) negotiation with the ATO for further time to pay the outstanding taxation liabilities and to seek an adjournment of the winding up hearing;

(b) a restructure of the legal entity of the business; and
(c) obtaining short term finance to pay out the tax liabilities.

8.   Fees were payable on the hourly basis of $250 plus GST provided they were paid in advance. If not, the rate was $300 plus GST per hour. Reasonable out of pocket costs were additional to the time charges.

9.   The payment of the fees was to be secured by way of a mortgage or mortgages over the company’s assets and/or those of related parties on such terms and costs that the defendant required. In the interim, Hobbs promised to procure from Hobbs Pty Ltd a mortgage in favour of the defendant over a property known as “The Shed” and vacant land on Plumpton Road; and the company pledged all of its assets and undertaking.

10.The evidence shows that mortgages were not executed but a deed of charge was. This charge is the type of charge that a proprietary company would give its principal lender. It secured its entire undertaking and property, present and future, by creating a fixed charge over a broad range of proprietary interests of the company including freehold and leasehold property, plant and equipment[3] and a floating charge over the remainder of the charged property.[4] It restricted the company’s dealing with the charged property by requiring the chargee’s consent except, in the case of the floating charge, in the ordinary course of the company’s business and for value. It prevented, without the chargee’s consent, the creation or permitted existence of another security interest in the charged property.

[3] See clause 5.1 of exhibit J.

[4] See clause 5.2. “Charged property” is defined in clause 1 to mean all the present and future rights, assets

11.Notice of the charge was given to the Australian Securities and Investment Commission (ASIC) promptly. The fact of notification meant that the charge was not invalidated against the company’s liquidator owing to a failure to register it within 45 days of its creation. Second, it avoided the situation where a failure to notify causes a loss of priority over a later competing registrable charge notified to ASIC.

12.The defendant personally performed little of the work detailed in his invoice to the company. Most of it was performed by his associate and accountant, Andrew Poulter (Poulter).

13. company’s financial position and the existence of the charge, attempts to obtain

Negotiation with the ATO was short-lived and fruitless. Understandably, given the of the business” meant the sale of the business. Judging from the defendant’s invoice,[5] investigations of this option commenced as early as 1 December 2006. Also judging from the defendant’s invoice, the contract of sale of the business was prepared by Poulter over five days – 5, 8 December 2006, 13, 26 and 27 February 2007.

[5] Ex I.

14.Somehow Hobbs was able to adjourn the winding up proceedings on more than one occasion but on 5 March 2007 a winding up order was made.[6]

[6] This is the date of the commencement of the winding up: s 513A.

15.28 February 2007 was a significant day for the company. On that day, the company executed an agreement to sell its business (sale agreement) to another company, ACN 064 784 738 Pty Ltd (064 Pty Ltd); and received the defendant’s invoice for $27,095.84 (inclusive of GST).[7] On 1 March 2007, the company paid the defendant $22,500.[8]

[7] Exhibit I.

[8] The payment was made to an entity called “Insolvency Personnel”. It is undisputed that the defendant traded

16.The invoice is detailed. It sets out the date of each item of work performed, a short description of the work and a corresponding charge. The detail enables the identification of those pieces of work performed before the execution of the charge. The dollar value attributed to these items in the invoice is $3,498.00.

17.The parties’ obligations under the sale agreement were to be carried out on 28 February 2007. The purchase price was $95,796. The amount actually payable was “reduced by annual leave and superannuation entitlements which are to be assumed by the purchaser”. Those entitlements are set out in schedule 5 of the agreement and comprise $28,234.58 for annual leave entitlements and $60,502.86 for superannuation entitlements (a total of $88,737.44).

18.The purchase of $95,796 was broken up as follows:

(a) one dollar for each of goodwill, intellectual property, business records and “other sale assets”;

(b) $4,645 for stock;
(c) $5,388 for work in progress;
(d) $18,428 for trade debtors; and
(e) $67,331 for fixed assets.

19.064 Pty Ltd was incorporated on 18 August 1994. On 28 February 2007, its only director and shareholder was Hobbs and its issued capital consisted of 24 one dollar shares.

20.The second plaintiff was appointed liquidator of the company on 5 March 2007. When he reached the wreck it had sunk, almost without trace. His report to the company’s creditors on 26 November 2007 makes miserable reading. By then, the

company had no assets and its estimated liabilities were $566,634. He reconstructed total assets increased during each of those periods from $69,074 to $148,492 to $323,303. The working capital position was even worse over the same period. It went from a deficiency of $123,683 to $421,025. As one would expect, the company made net losses for each of those periods -- $130,301 to $174,811 – while its total income declined fro $1,744,562 to $918,361 (an 8 month period).
the financial position of the company from its accounting record at three dates – 30

21.In summary, the company’s financial position on 28 February 2007 was that on income of $918,361 over an eight month period, its current assets exceeded current liabilities by $421.025. Its non-current assets exceeded its non-current liabilities by $77,028. The non-current assets comprising the assets sold that day for $67,331. On a cash basis, its loss for the eight month period was $174,811. That is, the actual cost of producing an income of $918,361 was $1,093,172. How the company continued to operate in the face of its disastrous and deteriorating financial position is, in part, explained by the reason that the ATO sought its liquidation – non-payment of GST and PAYG instalments.

22.On 24 July 2006, Hobbs listed the company’s business for sale with a local estate agent, Horsham Real Estate. The asking price was $395,000 plus GST. The values then placed on the plant and equipment by Hobbs totalled $394,662. There was no interest in the business at that price and, at some stage, Hobbs reduced the price to $200,000 plus GST. As at 6 June 2007, the business had not been sold.

Relevant principles

23.For a transaction to be voidable on account of being uncommercial:

(a)	it must be entered into, or an act must be done giving effect to it, during the relation back period;[9]
(b)	at the time of the transaction or when something was done to give effect to it, the company must have been insolvent;[10]
(c)	it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction taking into account the benefits for the company, the detriment to the company, the benefits to other parties to the transaction and any other relevant matters.[11]

[9] S 588FE(3)(b).

[10] S 588FC(a).

[11] S 588FB(1).

24.There is no issue that the payment of $22,500 was a “transaction” for the purposes of s 588FB and that it occurred during the relation back period, which started on 5 November 2006.[12]

[12] See s 9.

25.The plaintiffs assert that the payment was an “insolvent transaction” under s 588FC and voidable under s 588FE because it is an “uncommercial transaction” under s 588FB and the company was insolvent at the time when the payment was made.

26.Relevantly, s 588FB provides that a transaction of a company is an uncommercial transaction if, and only if, it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction, having regard to:

(a) the benefits (if any) to the company of entering into the transaction;
(b) the detriment to the company of entering into the transaction;
(c) the respective benefits to other parties to the transaction of entering into it; and
(d) any other relevant factor.

27.In relation to s 588FB, the following propositions emerge from the authorities:

(a)	the section is specially aimed at preventing companies disposing of their assets or resources through transactions which result in the recipient receiving a “gift” or obtaining a bargain of such commercial magnitude that it could not be explained by normal commercial practice;[13]
(b)	the section is intended to emphasise the objective nature of the inquiry. It is not an inquiry into what the particular company might have done but rather into whether a reasonable person would not have entered into the transaction;[14]
(c)	the court must have regard to “the company’s circumstances” which includes the state of knowledge of the company, that is, of the knowledge of those who were relevantly its directing mind;[15]
(d)	the purpose of the Division was mainly to stop transactions to related entities or to relatives and the requirement to look at the benefits to other parties to the transaction must be seen in that light;[16]
(e)	for a transaction to be “uncommercial” it must result in “the recipient receiving a gift or obtaining a bargain of such magnitude that it cannot be explained by normal commercial practice or where the consideration lacks a commercial quality;[17]
(f)	where the purchaser is a related entity or a relation by blood or law, then the court should look at the transaction far more closely.[18]

[13] Explanatory Memorandum to the Corporate Law Reform Bill 1992 paras. 1034-5.

[14] Lewis v Cook [2000] NSWSC 191 at [45] per White J.

[15] Tosich Construction Pty Ltd v Tosich (1997) 78 FCR 363 at 367.

[16] McDonald v Hanselmann (1998) 28 ACSR 49 at 53 per Young J.

[17] Capital Finance Australia Ltd v Tolcher (2007) 245 ALR 526 at [129] per Gordon J.

[18] McDonald at 56.

28.In this proceeding, it is unnecessary to discuss the concept of “insolvency” beyond referring to s 95A. Plainly, the company was insolvent at the time of the payment of $22,500.

29.In relation to the issue of unfair preference, the following propositions apply:

(a) for the purpose of characterising an impugned transaction and its effect for the purposes of the preference provisions, a court should look at the ultimate effect of the entire transaction before determining whether it has worked an unfair

preference within the meaning of s 588FA;[19]

[19] Dye & Co v Peninsula Hotels (In Liq) [1993] 3 VR 201 at [38] per Ormiston JA.

(b)	the defendant must establish that he had no reasonable grounds to suspect that the company was insolvent at the time of the transaction;[20]
(c)	the court is required to look at the position through the eyes of a hypothetical person. In relation to the expression “the person’s circumstances” the defendant’s subjective appreciation of the facts will not be relevant unless that appreciation reflects that which would be expected by the “reasonable person;”[21]
(d)	in this statutory context, “suspicion” means a mistrust of the company’s ability to pay its debts as they become due and of its effect which acceptance of the payment would have as between the defendant and the other creditors of the company.[22]

[20] S 588FG(2)(b)(i) and Sands & McDougall v Comm. Of Taxation [1999] 1 VR 489 at [66].

[21] S 588FG(2)(b)(ii) And Sands & McDougall at [53] and [54] citing from Sims v Celcast (1998) 71 SASR 142

[22] Sutherland and Sutherland v Lofthouse and Cauchi [2007] VSCA 197 at [16].

Discussion
Uncommercial transaction

30.The charge was of the type a company would extend to its principal lender. It is surprising to see the company enter into it with an adviser pending the resolution of a winding up application. Its execution on 4 December meant that the company could not hope to raise moneys from any lender because there was nothing else to secure a loan. Moreover, its financial position on 4 December was so poor that it is unlikely anyone would have lent it money even for a very short period. The execution and notification of the charge meant that no one would lend money to the company on any terms. In the absence of the defendant’s consent, there was nothing which the company could offer by way of security to a potential lender. Of the three courses of action proposed by the defendant, the first was largely a matter for Hobbs and the ATO. As I have said, the third was eliminated by the execution and notification of the charge. Although the description of the second course was vague, it was meant to describe what actually occurred – the sale of the company’s business to a related party. In light of the above, the commencement of the drafting of the sale agreement on 1 December 2006 was amounted to recognizing that the sale to a related entity was the only real option.

31.A reasonable person in the company’s circumstances would not have made the payment. It largely, if not entirely, deprived the company of its remaining cash. Following the payment, the company had a massive debt and no assets. At the time of the payment, the company no longer possessed a business. This had been sold. The company had no source of income because its sale deprived the company of its income producing asset.

32.I am satisfied that at the time of the making of the payment, the company was insolvent and that the payment was an “uncommercial transaction”. It is voidable and is avoided. Accordingly, I would order the defendant to the plaintiffs the sum of $22,500.

33.The plaintiffs’ complaint relied upon two other bases. In view of the above conclusion, it is strictly unnecessary to consider them but because they were the subject of evidence and submission, I will do so.

Charge

34. relies upon ss 588F(2)(d) and (e) and, in turn, the plaintiff relies upon sub-s (5).
Paragraph (2)(d) excludes an amount payable for property or services supplied to

The plaintiffs assert that the charge is void by reason of s 588F(2). The defendant s (5) operates to modify the effect of paragraphs (d) and (e) to the extent that the amount payable exceeds the market value of the property or services when supplied to the company.

35.Plainly, the payment of $22,500 was made for services supplied to the company at a relevant time for the benefit of the company. “Benefit” in this context does not involve an evaluation of the quality of the service. It means nothing more than that the

service was provided to the company.

36.Assuming that the defendant bore the burden of establishing that the amount payable did not exceed the market value of the services when supplied, I am satisfied that he has through his own evidence. If, on the contrary, the second plaintiff bears the burden of establishing that the amount exceeds the market value of the services, then he has not.[24]

[24] The question of the burden of proof was not argued.

37. The charge is not void against the second plaintiff.

$3,498

38.The plaintiffs submit that the amount of $3,498 is not secured by the charge. They further submit that its payment is an “insolvent transaction” and is voidable. It is voidable because it is an unfair preference and the company was insolvent at the time of the making of the payment (which included the $3,498).

39.As the defendant performed work, the company became indebted to the defendant. The obligation to pay arose with the completion of each item of work even though payment was not requested until a later stage. The combination of clauses 1 and 4 of the Deed of Charge does not operate to include within the charge the moneys owed in relation to work performed before the making of the charge.

40. and it did so because the company agreed to create a charge in favour of the
defendant and pledge all of its assets and undertaking in support of any fees due

The defendant submits that the 1 December agreement created an equitable charge Ltd where two advances, intended to be secured by a debenture, were treated as creating an equitable charge over assets for the amount of the advances from the time they were made.[25]

[25] [1978] 1 NZLR 330 at 335-6.

41.An equitable charge which is not an equitable mortgage is created when property is expressly or constructively made liable, or specially appropriated, to the discharge of a debt or some other obligation, and confers on the chargee a right of realisation by judicial process – by appointment of a receiver or an order for sale.[26]

[26] Swiss Bank v Lloyds Bank [1982] AC 584 at 595 per Buckley LJ.

42.The language of the agreement between the company and the defendant falls short of creating an equitable charge. The following passage from the agreement does neither of the two things required to create an equitable charge through its use of the expression “you confirm if required”. This creates an uncertain state which is inconsistent with the creation of an equitable charge:

“Where fees cannot be paid in advance, the hourly time charge rate will be $300, and security must be provided by way of mortgage/s over assets of the Company and/or related parties on such terms and at such additional cost (including legal

costs and documentation fees) as Director Support reasonably requires. As an

interim step, you confirm if required:

• you will procure from PL & IR Hobbs Pty Ltd, a mortgage over both the ‘Shed’ and the vacant land on Plumpton Road in favour of Director Support; and

• the Company pledges all of its assets and undertaking;

in support of any fees due and payable to Director Support from time to time….”.

43.If the payment of $3,498 was unsecured, then looking at the ultimate effect of the entire transaction, contrary to the defendant’s submission, the payment was an unfair preference. For the reasons given above, the company gained virtually no advantages. The postponement of the winding up hearing did not benefit the company financially. It merely put off the time when the liquidator could start his duties. It enabled the transfer of the company’s only asset of substance. If the company had any hope of survival, it lay in retaining the only asset capable of generating income. Its sale merely made it financial position worse. It does not benefit the company by dissipating its assets in order to pay the entitlements of a class of creditors. From the perspective of ultimate effect, this was plainly an unfair preference.

44.The amount of the invoice was $27,095.84 but only $22,500 was paid. The defendant submits that the company did not pay the amount of $3,498. In that regard, he relies upon a passage from In Re Thomas Mortimer Ltd.[27]

[27] [1965] 1 Ch 186 at 190 per Romer J. Interestingly, it was a 1925 decision reported 40 years later.

“…as I understand the general law, it is open to a creditor, if the debtor himself in
making the payment has not directed appropriation, to make payment made by
his debtor to any part of the debt he likes…”.

45.This is a statement of an aspect of the rule in Clayton’s case.[28] It is true that a creditor’s right of election may be exercised “up to the very last moment.”[29] There is no reason to suppose that that right cannot be exercised even during the course of this proceeding. Certainly, there was no evidence as to how the defendant elected to treat the payment or any basis upon which an implication or presumption can be drawn prior to the initial of this proceeding.

[28] 1 Mer 572. See Cory Brothers & Co Ltd v Owners of Turkish Steamship “Mecca” [1897] AC 286 at 293-4

[29] Cory Brothers at 294.

46.There is merit in this last submission. If it had been necessary, I would have rejected the plaintiff’s claim in relation to $3,498.

ORDERS:

47.I am satisfied that the plaintiffs are entitled to an order against the defendant in the

at $327,883.33: see exhibit O.

and undertakings of the company.

under that name.

at 144, 145.

23 Paragraph (e) deals with interest on the amount in (d).

per Lord Macnaghten.