In the matter of Victory ASAP Pty Ltd
[2018] VSC 701
•29 November 2018
| IN THE SUPREME COURT OF VICTORIA | Not Restricted |
AT MELBOURNE
COMMERCIAL COURT
CORPORATIONS LIST
S ECI 2018 00104
IN THE MATTER OF VICTORY ASAP PTY LTD (ACN 618 922 517)
| ARVISH SHARDA | Plaintiff |
| v | |
| VINIT BANSAL & ORS | Defendants |
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JUDICIAL REGISTRAR: | Hetyey JR |
WHERE HELD: | Melbourne |
DATE OF HEARING: | 13 November 2018 |
DATE OF JUDGMENT: | 29 November 2018 |
CASE MAY BE CITED AS: | In the matter of Victory ASAP Pty Ltd |
MEDIUM NEUTRAL CITATION: | [2018] VSC 701 |
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CORPORATIONS ACT 2001 (Cth) – Part 2F.1 – oppressive conduct of affairs of company –– s 232 – interlocutory process by defendant to wind up company in insolvency.
CORPORATIONS ACT 2001 (Cth) – Part 5.4 - insolvency – winding up – s 459P(2) – application by director for leave to make application to wind up company in insolvency – s 459P(3) – whether prima facie case of insolvency – application for leave heard at same time as application to wind up.
CORPORATIONS ACT 2001 (Cth) – Part 5.4 - insolvency – winding up – s 459A – where company no longer trading but accruing debts - whether company is insolvent.
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APPEARANCES: | Counsel | Solicitors |
| For the Plaintiff | Vincent J Ryan | |
| For the First and Second Defendants | TJD Chalke | Morgan Couzens Legal |
JUDICIAL REGISTRAR:
Introduction
A dispute between shareholders can often have a disruptive and damaging effect on a company’s business. Sometimes it can reveal even deeper structural problems.
That is true of the company the subject of the present proceeding; Victory ASAP Pty Ltd (“the Company”). The matter commenced as an oppression proceeding brought by a shareholder and director under ss 232 and 233 of the Corporations Act 2001 (Cth) (“the Corporations Act”) in respect of the conduct of the affairs of the Company. However, an interlocutory application has since been filed by another shareholder and director seeking the winding up of the Company on the basis that it is insolvent.
Background
The Company was incorporated on 5 May 2017 in order to operate as a franchisee of Godfreys, a retailer of vacuum cleaners and associated appliances. The current shareholders are Mr Arvish Sharda (the plaintiff), Mr Vinit Bansal (the first defendant) and Mr Rajesh Jaswal (the second defendant). There is a dispute between the parties as to whether a purported allocation of shares to Mr Jaswal was effective. The current directors of the Company are Mr Sharda and Mr Bansal.
A few days prior to the incorporation of the Company, Mr Sharda and Mr Bansal arranged for the creation of the V1 Unit Trust (“the Trust”). The shareholders of the Company are also trustees of the Trust. Again, there is disagreement as to whether Mr Jaswal was effectively appointed as trustee. However, it seems that the Trust is of tangential relevance to the present winding up application. The Company itself was never the trustee of the Trust and there is no suggestion that the franchise business was ever operated by the Trust.
On 5 June 2017, the Company entered into a franchise agreement with Electrical Home-Aids Pty Ltd, trading as Godfreys (“the Franchisor”), in respect of the operation of a Godfreys store located at 1662–1666 Hume Highway Campbellfield, Victoria (“the Franchise Agreement”). The cost of purchasing the franchise was $650,000. A deposit of $50,000 was paid by the shareholders together. By loan agreement dated 5 June 2017, the Franchisor lent to the Company the balance of the purchase price (“the Loan Agreement”). The Loan Agreement requires monthly payments of $12,165.84, inclusive of principal and interest at the rate of eight percent per annum, compounding daily over a five year term.
There were other agreements entered into with the Franchisor at the same time. A supply agreement set out the terms on which the Franchisor agreed to supply stock for sale in the Company’s business (“the Supply Agreement”). There was also a licence agreement under which the Company was provided a licence to access the Campbellfield store in order to operate the franchise (“the Licence Agreement”). Pursuant to the terms of the Licence Agreement, the Company assumed the Franchisor’s obligations as tenant under a head lease and was required to make monthly payments. The Company’s obligations under each of the Loan Agreement, Supply Agreement and Licence Agreement were guaranteed by Mr Sharda and Mr Bansal.
It is common ground that from late November 2017, Mr Sharda no longer participated in the running of the Company’s business. However, the circumstances of his departure are a matter of dispute. The store continued to be operated by the defendants until late September 2018, at which point the Company’s ongoing operation was considered by Messrs Bansal and Jaswal to no longer be viable.
Procedural history
By originating process filed on 14 May 2018, Mr Sharda commenced his oppression proceeding under ss 232 and 233 of the Corporations Act. Various allegations have been made by Mr Sharda concerning his treatment as a shareholder and the manner in which the Company was operated. Orders were sought for the compulsory purchase of Mr Sharda’s shares in the Company or, alternatively, for the Company’s winding up. In addition, relief was sought under s 48 of the Trustee Act 1958 (Vic) for the removal of trustees of the Trust and/or the appointment of a receiver. It is unnecessary to determine at this time whether the allegations made by Mr Sharda constitute oppression within the meaning of the relevant provisions. Those matters have, to some extent, been overtaken by events.
Following the filing of Mr Sharda’s originating process on 14 May 2018, Sifris J made an order on 24 May 2018 referring the proceeding for management under the Court’s Oppression Proceeding Program.[1] At an initial conference held on 14 June 2018, Gardiner AsJ made orders for the efficient conduct of the oppression claim, including for the valuation of both the Company and the Trust by a joint expert (or joint experts), the granting of access to the plaintiff and his legal and accounting advisors to the books of the Company pursuant to s 247A of the Corporations Act, and the referral of the proceeding to judicial mediation. The judicial mediation was conducted on 5 September 2018, and subsequently adjourned until later that month, but was unfortunately unable to resolve the dispute between the parties.
[1]See Supreme Court of Victoria, Practice Note SC CC 8 - Oppressive Conduct in the Affairs of a Company, 18 May 2018.
The matter was listed before me on 13 September 2018 for the purpose of a further initial conference. At the hearing, the solicitor for Mr Sharda indicated that his client no longer sought the winding up of the Company or the appointment of a receiver. Instead, his client was principally concerned with the recovery of money said to be owing to him and for an order compelling Messrs Bansal and Jaswal to buy his shares in the Company at fair and reasonable value. At the same time, Messrs Bansal and Jaswal, through their counsel, indicated that they held serious concerns as to the solvency of the Company and foreshadowed making an application to the Court for its winding up.
Orders were made on that day extending time for compliance with Gardiner AsJ’s orders of 14 June 2018 to facilitate access to Company books by Mr Sharda in order that the valuation of the Company and the Trust could be completed in a timely manner. In addition, timetabling orders were made to facilitate the making of any application to wind up the Company by 11 October 2018.
On 11 October 2018, Mr Bansal filed an interlocutory process seeking leave under s 459P(2) of the Corporations Act to bring a winding up application in his capacity as director. The application is supported by an affidavit affirmed by him on 12 October 2018 and an affidavit sworn by Mr Jaswal on 12 November 2018. At the hearing of the interlocutory application on 13 November 2018, Mr Bansal sought and obtained leave to amend his interlocutory process to include an order that, in the event leave was granted pursuant to s 459P(2), the Company be promptly wound up in insolvency under s 459A of the Corporations Act.
In reliance on the matters referred to in his first affidavit of 3 May 2018 and his second affidavit of 4 November 2018, Mr Sharda submits that the Company is solvent and that the Court should refuse Mr Bansal’s application to wind it up.
Legal principles
The test for solvency found in s 95A(1) of the Corporations Act is whether a company can pay all its debts “as and when they become due and payable”.[2] Section 95A(2), in turn, provides that a company which “is not solvent is insolvent”.
[2]Corporations Act 2001 (Cth) s 95A(1).
In Ace Contractors & Staff Pty Ltd v Westgarth Development Pty Ltd,[3] Weinberg J (as he then was) relevantly summarised the principles governing the assessment of solvency of a debtor company as follows:
[3] [1999] FCA 728 (1 June 1999) [44] (“Ace Contractors”).
·[In the event of non-compliance with a statutory demand] [t]he respondent is presumed to be insolvent and as such bears the onus of proving its solvency: s 459C(2) and (3); Elite Motor Campers Australia v Leisureport Pty Ltd (1996) 22 ACSR 235 per Spender J; Commissioner of Taxation v Simionato Holdings Pty Ltd (1997) 15 ACLC 477 per Mansfield J.
·In order to discharge that onus the Court should ordinarily be presented with the “fullest and best” evidence of the financial position of the respondent: Commonwealth Bank of Australia v Begonia (1993) 11 ACLC 1075 at 1081 per Hayne J.
·Unaudited accounts and unverified claims of ownership or valuation are not ordinarily probative of solvency. Nor are 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: Simionato Holdings Pty Ltd (above); Re Citic Commodity Trading Pty Ltd v JBL Enterprises (WA) Pty Ltd [1998] FCA 232 per Heerey J; Leslie v Howship Holdings Pty Ltd (1997) 15 ACLC 459 at 463 per Sackville J.
·There is a distinction between solvency and a surplus of assets. A company may be at the same time insolvent and wealthy. The nature of a company’s assets, and its ability to convert those assets into cash within a relatively short time, at least to the extent of meeting all its debts as and when they fall due, must be considered in determining solvency: Rees v Bank of New South Wales (1964) 111 CLR 210 ; Re Tweeds Garages Ltd [1962] Ch 406 at 410 per Plowman J; Simionato Holdings Pty Ltd (above); Melbase Corporation Pty Ltd v Segenhoe Ltd (1995) 13 ACLC 823 at 832 per Lindgren J; Leslie v Howship Holdings Pty Ltd (above) at 465–6 .
·The adoption of a cash flow test for solvency does not mean that the extent of the company’s assets is irrelevant to the inquiry. The credit resources available to the company must also be taken into account: Sandell v Porter (1966) 115 CLR 666 at 671 per Barwick CJ (with whom McTiernan and Windeyer JJ agreed); Leslie v Howship Holdings Pty Ltd (above) at 466 ; Taylor v ANZ Banking Group Ltd (1988) 6 ACLC 808 at 812 per McGarvie J.
·The question of solvency must be assessed at the date of the hearing. However, this does not mean that future events are to be ignored: Leslie v Howship Holdings Pty Ltd (above) at 466–7 .
…
Although that case was concerned with the requisite standard of evidence necessary for a debtor company to rebut the statutory presumption of insolvency arising from non-compliance with a statutory demand[4] (which is not a feature of this case), the principles have application to the present matter.
[4] See ss 459C(2)(a), (3) Corporations Act.
In Crema Pty Ltd v Land Mark Property Developments Pty Ltd,[5] Dodds-Streeton J (as she then was) cited with approval the above passage from Ace Contractors and confirmed that s 95A of the Corporations Act “enshrines the cash flow test of insolvency which, in contrast to a balance sheet test, focuses on liquidity and the viability of the business”.[6] Her Honour elaborated further that:
While an excess of assets over liabilities will satisfy a balance sheet test, if the assets are not readily realisable so as to permit the payment of all debts as they fall due, the company will not be solvent. Conversely, it may be able to pay its debts as they fall due, despite a deficiency of assets.
Section 95A evolved from the test of insolvency classically enunciated by Barwick CJ in Sandell v Porter where his Honour stated:
[i]nsolvency is expressed in s 95 as an inability to pay debts as they fall due out of the debtor’s own money. But the debtor’s own moneys are not limited to his cash resources immediately available. They extend to moneys which he can procure by realization by sale or by mortgage or pledge of his assets within a relatively short time — relative to the nature and amount of the debts and to the circumstances, including the nature of the business, of the debtor. The conclusion of insolvency ought to be clear from a consideration of the debtor’s financial position in its entirely and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity. It is the debtor’s inability, utilizing such cash resources as he has or can command through the use of his assets, to meet his debts as they fall due which indicates insolvency.[7]
[5] (2006) 58 ACSR 631, 651-2 [140] (“Crema v Land Mark”).
[6]Ibid 652. See also Tru Floor Service Pty Ltd and Ors v Jenkins and Anor (No 2) (2006) 232 ALR 532, 543 (Sundberg J) and C&O Voukidis Pty Ltd (in Liq) v Break Fast Investments Pty Ltd [2014] FCA 1000 (16 September 2014) [3] (Davies J).
[7] Crema v Land Mark 652 [141]-[142].
There is also authority for the proposition that, in determining solvency, commercial realities will be relevant in assessing what resources are available to a company to source income from which to meet its liabilities.[8] Further, in C&O Voukidis Pty Ltd (in Liq) v Break Fast Investments Pty Ltd,[9] Davies J explained that:
… the assessment as to whether a company is solvent involves an element of “looking forward“ and it is material to consider not only the company’s capacity to pay debts currently due, but also its capacity to pay debts that will, or might, become due: Australian Beverage Distributors v Redrock Co (2008) 26 ACLC 74 at [157].[10]
[8]See Southern Cross Interiors Pty Ltd v Deputy Commissioner of Taxation (2001) 188 ALR 114; Australian Beverage Distributors v The Redrock Co (2008) 26 ACLC 74.
[9] [2014] FCA 1000 (16 September 2014) [3] (Davies J).
[10] Ibid.
In Australian Securities and Investments Commission v Plymin,[11] a case involving insolvent trading claims against directors, Mandie J set out a number of factors which may be indicative of insolvency:
[11] (2003) 175 FLR 124, 213-4 [386] (“ASIC v Plymin”).
1. Continuing losses.
2. Liquidity ratios below 1.
3. Overdue Commonwealth and State taxes.
4.Poor relationship with present bank, including inability to borrow further funds.
5. No access to alternative finance.
6. Inability to raise further equity capital.
7.Suppliers placing [company] on COD, or otherwise demanding special payments before resuming supply.
8. Creditors unpaid outside trading terms.
9. Issuing of post-dated cheques.
10. Dishonoured cheques.
11. Special arrangements with selected creditors.
12.Solicitors’ letters, summons[es], judgments or warrants issued against the company.
13.Payments to creditors of rounded sums which are not reconcilable to specific invoices.
14.Inability to produce timely and accurate financial information to display the company's trading performance and financial position, and make reliable forecasts.
Whilst these factors have been described as representing “commonsense indicators of insolvency”,[12] I accept the submission of counsel for the first defendant that they are not a proxy for the statutory test under s 95A. Further, as Mansfield J observed in Lewis, Re Damilock Pty Ltd (in Liq) v VI SA Australia Pty Ltd,[13] one or more of these indicia may have particular significance in a matter, but the absence of one or more of them does not, of itself, establish solvency.
[12] Morris v Danoz Directions Pty Ltd(in Liq) (No 2) [2010] FCA 836 (10 August 2010) [13] (Perram J).
[13] (2008) 68 ACSR 493.
Finally, the question of whether a company is able to pay its debts as and when they fall due is a question of fact.[14]
[14] Lewis v Doran (2004) 208 ALR 385, 408-9 [108] (Palmer J), approved by the New South Wales Court of Appeal in Lewis v Doran (2005) 219 ALR 555. See also Stone v Melrose Cranes & Rigging Pty Ltd (in Liq) (No 2) [2018] FCA 530 (19 April 2014) [146] (Marcovic J).
Evidence as to solvency
Evidence of Mr Bansal
The onus in establishing insolvency rests with Mr Bansal in this case.
In his affidavit of 12 October 2018, Mr Bansal deposes that:
[b]ecause of the significant cost of purchasing the business, the relatively high cost of sales and the high operating expenses (particularly the franchise fee on the purchase of stock and [the Company’s] obligations under the Licence Agreement), by November 2017 [the Company] had an excess of liabilities over assets, and was trading at a loss. Revenue from the business was insufficient to meet [the Company’s] liabilities when they fell due, in particular tax liabilities.[15]
[15] Affidavit of Mr Bansal sworn 12 October 2018 at para [19].
He explains that the Company did not engage external accountants to prepare accounts for its business but, from January 2018, instead used a software product called “Xero”. Xero was apparently linked with the Company’s bank account and all sales receipts and payments were directly entered from the bank account into Xero. Other payments and receipts, such as manual sales, expenses and journal entries, were entered manually into Xero.
The following financial information, found in exhibits to Mr Bansal’s affidavit of 12 October 2018 and an affidavit of Mr Edward Muscat of 15 October 2018, goes to the question of the Company’s solvency:
(a) a 30 June 2018 profit and loss statement, extracted from Xero,[16] suggests that the Company’s expenses exceeded its income by around $54,000. Significant items in the profit and loss statement include: total income of $1.287 million; cost of sales of almost $830,000; $57,688.05 in respect of franchise fees; $44,381.89 in respect of interest on the loan to the Franchisor and $221,521.65 in respect of rent (presumably payments made under the Licence Agreement);
[16]This balance sheet was provided to an independent liquidator, Mr Edward Muscat, and is located at exhibit EM-2 to his affidavit of 15 October 2018 at p 407.
(b) a profit and loss statement for 1 July 2018 to 18 September 2018 indicates the Company had a cash flow deficit of $10,240.93 for that limited period;[17]
[17]This profit and loss statement was relied upon by the joint valuer engaged by the parties and annexed to the valuer’s 4 September 2018 at p 327 of exhibit VB-1 to the affidavit of Mr Bansal affirmed 12 October 2018.
(c) a balance sheet as at 20 September 2018, also extracted from Xero,[18] is, on its face, suggestive of a net asset position of $121,786.55. However, Mr Bansal says the balance sheet significantly overstates an inventory figure of $235,419 which was carried over from a previous financial year. Instead, a stock-take undertaken by the defendants on 30 June 2018 arrived at a value of $21,829 in respect of inventory;
[18]This profit and loss statement was provided to an independent liquidator, Mr Edward Muscat, and is located at exhibit EM-2 to his affidavit of 15 October 2018 at p 401.
(d) the liabilities of the Company as disclosed in the 30 September 2018 balance sheet include taxation liabilities in excess of $55,000 (comprising PAYG tax withholdings, superannuation and GST). Other liabilities include shareholder loans ($46,205 in respect of Mr Sharda, $54,811 in respect of Mr Jaswal and $51,861 in respect of Mr Bansal). The amount owing under the Loan Agreement is identified as a non-current liability in the sum of $480,646.66;
(e) a balance sheet for 1 July 2018 to 18 September 2018 and dated 31 October 2018[19] contains the adjusted inventory figure of $21,829 with the result that the company has an excess of liabilities over assets in the order of $58,860.83 as at that date. The loan owing to the Franchisor is calculated to be $471,683.74;
(f) similarly a balance sheet for 30 June 2018, also extracted from Xero,[20] contains the adjusted inventory figure and reveals an excess of liabilities over assets in the order of $69,607.50; and
(g) an aged payables report for September 2018 shows an amount owing to “Godfreys-Head Office” for the sum of $30,165.84.[21]
[19] This balance sheet is at p 329 of exhibit VB-1 to the affidavit of Mr Bansal affirmed 12 October 2018.
[20]This balance sheet was provided to Mr Muscat and is located at exhibit EM-2 to his affidavit of 15 October 2018 at p 405.
[21] Ibid at p 403.
Mr Bansal says that as a consequence of its cash flow difficulties, the Company was required to reach an arrangement, in or around July 2018, with the Franchisor which entailed payment for stock on a cash on delivery basis. In addition, by the end of August 2018, Mr Jaswal had paid for almost $29,000 worth of stock on his personal credit cards (a loan amount which remains unpaid and which is reflected in the financial statements referred to above).
Around the same time, the Company had only a nominal sum in its bank account (around $55 as at 12 September 2018[22] and approximately $6,900 as at 30 September 2018).[23]
[22]See the Company’s bank account statement located at p 397 of exhibit VB-1 to the affidavit of Mr Bansal affirmed 12 October 2018.
[23]See the 30 September 2018 balance sheet provided to Mr Muscat, and is located at exhibit EM-2 to his affidavit of 15 October 2018 at p 401.
An independent liquidator, Mr Edward Muscat, was engaged by the first and second defendants on 13 September 2018. He concluded in a short report produced later that day that the Company required immediate funding of $70,000 – $100,000 to “become solvent”.[24] Mr Muscat confirms in his affidavit of 15 October 2018 that he had been provided with most of the financial statements referred to above in reviewing the Company’s solvency. He also clarifies that the immediate funding he identified as being necessary was principally to cover the Company’s taxation liabilities and to provide working capital. By way of qualification, Mr Muscat notes that he did not specifically consider the debt owed by the Company to the Franchisor in arriving at his conclusion (however, it is clear that the loan balance is referred to in the financial statements Mr Muscat was provided).
[24] See exhibit EM-1 to the affidavit of Mr Muscat sworn 15 October 2018.
By the middle of September 2018, Mr Bansal says he was concerned that the Company was unable to pay its bills from its revenue. He states that neither Mr Jaswal nor himself were prepared to inject any further capital into the Company or otherwise cover its current obligations. A letter dated 16 September 2018 was sent to Mr Sharda’s solicitors requesting a $70,000 capital contribution from their client but was not responded to within the requested timeframe.
In the event, on 19 September 2018 the defendants determined to close the business to prevent the Company from trading whilst insolvent. An email was sent to Mr Sharda’s solicitors on that same day advising of the closure and arrangements were made with the Franchisor for a final stocktake at the Campbellfield store. The Company has not traded since this time.
The Franchisor also appears to have taken matters into its own hands. On 21 September 2018, the Franchisor served notices on Mr Bansal as director of the Company terminating each of the Franchise Agreement, the Licence Agreement and the Supply Agreement.[25]
[25]The Franchisor’s Notices of Termination are located at p 265-269 of exhibit VB-1 to the affidavit of Mr Bansal affirmed 12 October 2018.
The Franchisor has now also taken possession of the store. Counsel for Mr Bansal also tendered, without objection, two further documents concerning the Franchisor. One is a document styled “Notice of Dispute” by which Mr Sharda as director of the Company, refutes that the Franchisor has validly terminated the Franchise Agreement and seeks the withdrawal of all three notices of termination issued by the Franchisor on 21 September 2018.[26] That document was met with a response from the Franchisor[27] which is dealt with further below.
[26] The Notice of Dispute was marked “MFI-1”.
[27] Response to Notice of Dispute was marked “MFI-2”.
On 4 September 2018, a few weeks prior to the closure of the Company’s business, the valuer jointly retained by the parties pursuant to the Court’s orders, produced his report. Having regard to the Company's financial statements, Mr Andrew Firth of Rushmore Group assessed, as at 14 May 2018, the fair market value of the Company (using a capitalisation of future maintainable earnings methodology) to be nil. In addition, Mr Firth made the following salient observations about the Company’s viability:
· financial liabilities of the company were noted as being $660,054 which well exceeded the value of the business and the surplus assets of the company;
· the rent paid during the period 1 July 2017 to 14 May 2018 of $203,050 represented nearly 50% of the Company’s gross profit over the same period; and
· for the same period, the cost of sales ($759,881) were more than 60% of the total sales revenue ($1.177 million).
Evidence of Mr Sharda
In response to Mr Bansal’s affidavit material in support of a winding up, Mr Sharda filed a further affidavit sworn on 4 November 2018.
He believes that “the Company is solvent, that …[Messrs] Bansal and Jaswal have deliberately failed to record or disclose all income of the Company and that they should be ordered to arrange an audit of the contents”.[28] Much of Mr Sharda’s affidavit of 4 November 2018 restates or expands upon matters already addressed in his earlier affidavit of 3 May 2018. One such matter was a suggestion in his first affidavit that instead of banking cash receipts into the Company’s bank account, Mr Bansal had taken the cash home with him.[29] To that allegation, Mr Bansal “reject[s] absolutely any implication or suggestion that [he] was stealing money from the business”.[30]
[28]Affidavit of Mr Sharda sworn 4 November 2018 at para [33].
[29] Affidavit of Mr Sharda sworn 3 May 2018 at paras [11] – [12].
[30] Affidavit of Vinit Bansal sworn 28 June 2018 at para [13].
In his affidavit of 4 November 2018, Mr Sharda observes that while cash takings were initially deposited into the Company account, after a number of months, this ceased to occur. He also exhibits a spreadsheet showing daily takings, for the period 9 July 2017 – 18 November 2017[31] to make good his point about the level of cash payments made to the Company by customers. In addition, he deposes to becoming aware of a more sophisticated scheme by which cash takings of the Company were deposited into the bank account of Global Investments Strategies Pty Ltd (“Global”), another company associated with Mr Jaswal, and then paid out as wages and used to repay private loans. Mr Sharda says that upon becoming aware of three such payments being made into his own bank account, he refused to be a part of such an arrangement.
[31] Exhibit G to the affidavit of Mr Sharda sworn 4 November 2018.
These further allegations of Company cash receipts being diverted are expressly denied by Mr Jaswal in his affidavit sworn on 12 November 2018. He exhibits a bank statement for Global[32] and explains that all cash deposits into that account are from clients of Global and that “[n]o cash earned by [the Company] in the Godfreys business has been deposited [into the] Global account”. He further explains that the payments made out of the Global account to Mr Sharda’s account were for consultancy work performed by Mr Sharda. Mr Jaswal also says that whilst he agrees cash receipts were initially deposited into the Company bank account, they were later used to pay for expenses. He exhibits a cash book for the period 1 July 2017 to 30 June 2018 by way of illustration.[33]
[32] See exhibit RJ-2 to the affidavit of Rajesh Jaswal sworn 12 November 2018.
[33] See exhibit RJ-1 to the affidavit of Rajesh Jaswal sworn 12 November 2018.
Mr Sharda also suggests in his second affidavit that the Company had unrecorded sales of up to $192,965 based on gross sales figures of $1.275 million as at 30 June 2018 and a franchise margin of between 35% to 45% on gross sales (effectively, the Company’s profit margin for the stock supplied by the Franchisor). He places reliance on the fact that the margins in the Franchisor’s price book are higher than the margins which appear in the Company’s own financial statements. There is a suggestion that margins have been manipulated to reduce the Company’s gross sales figures.
Mr Jaswal sought to respond to these concerns in his affidavit. He says that the average margins of 35% as recorded in the Company’s financial statements are accurate. He also says that the Franchisor’s price book only “sets out [the] minimum cost to the [Company] of purchasing the items and the maximum price for which the [Company] could sell those items”[34] but that sometimes goods were sold for less.
[34] Affidavit of Rajesh Jaswal sworn 12 November 2018 para [13].
Reasoning
Leave under s 459P(2)(c)
As a preliminary matter, the Court was asked to give Mr Bansal leave under s 459P(2)(c) to bring the winding up application in his capacity as director of the Company. It may be that Mr Bansal need not have sought leave because he has the right as creditor of the Company to bring a winding up application in any event.[35] However, it is appropriate for me to consider the question of leave as the issue is before me and lest there be any dispute about Mr Bansal’s status as a creditor.
[35] See s 459P(1)(b) Corporations Act.
Section 459P(3) makes clear that the Court may give leave if satisfied there is a prima facie case that the Company is insolvent. Even if the Court is satisfied that the required threshold is met, it retains a residual discretion whether to grant leave.[36]
[36]Bingham v Iona Corporation Pty Ltd (1995) 16 ACSR 436, 448 (Lindgren J) (“Bingham”); Melbase Corporation Pty Ltd v Segenhoe Ltd (1995) 17 ACSR 187, 190 (“Melbase”) (Lindgren J).
In my view, there is a clear prima facie case that the Company is insolvent in the sense that there is a probability a winding up order would be granted on the available evidence.[37]
[37] Bingham 438 (Lindgren J) applying Beecham Group Ltd v Bristol Laboratories Pty Ltd (1968) 118 CLR 618.
In addition, the following discretionary factors militate in favour of leave being granted:
(a) the evidence reveals a fundamental breakdown in the relationship between Mr Sharda and his fellow director, Mr Bansal. That being the case, it appears unlikely that the directors will agree on the appointment of a voluntary administrator if the Company is insolvent. Moreover, Mr Bansal is not in a position to appoint a voluntary administrator himself;[38]
[38]See s 436A of the Corporations Act which requires that the appointment of an administrator be in writing and may only occur following a resolution by the company that it is, or is likely to be, insolvent.
(b) Mr Bansal’s winding up application does not appear to be “mischievous or harmful”[39] and it was not suggested that it was intended to be so;
(c) there is a clear policy found in Part 5.4 of the Corporations Act that an insolvent company should be promptly wound-up as a matter of public interest.[40] The fact the Company is no longer trading is not an adequate answer to this concern. The Company has no present means to satisfy its liabilities, including future liabilities which continue to arise under the Loan Agreement; and
(d) Mr Sharda’s allegations regarding diversion of cash receipts and the under-recording of sales are matters which Mr Sharda in his capacity as director and creditor may properly raise with a liquidator for further investigation.
[39]Melbase 189 referring to Law Reform Commission, General Insolvency Enquiry, Discussion Paper No 32 (1987).
[40]See Kelly v J Stockland & Co Pty Ltd [2007] NSWSC 214 (12 March 2007) [11] (Barrett J); Equititrust Limited v Willaire Pty Ltd [2012] QSC 206 (9 August 2012) [90] (McMurdo J).
To the extent necessary, leave is given under s 459P(2)(c) to Mr Bansal to bring the winding up application in his capacity as director of the Company.
Application to wind up the Company
I turn then to the substantive application to wind up the Company. There are compelling reasons to conclude that the Company is unable to pay its debts as and when they fall due and that it is insolvent within the meaning of s 95A of the Corporations Act.
It is clear that the Company ceased trading on 18 September 2018 and the Franchisor terminated the Franchise Agreement a few days later. By its response to Mr Sharda’s Notice of Dispute, the Franchisor maintains that the Company was “subject to an insolvency event as defined in the Franchise Agreement on the basis that the [Company] had failed to pay its debts as and when they fell due including, but not limited to… the License Agreement and the Loan Agreement".[41] The Company's business as franchisee therefore appears to be at an end and is unlikely to be resurrected.
[41] See “MFI-2” – Response to Notice of Dispute.
The effect of the termination of the Franchise Agreement is also significant for other reasons. Firstly, the Company is required to pay all amounts owing under the Franchise Agreement.[42] I am prepared to infer that those amounts include a portion of the sum of $33,000 referred to in the Company's balance sheet of 30 September 2018 and described as “DC bills”[43] and the amount of approximately $30,000 owing to “Godfreys Head Office” in the Company’s aged payables of September 2018. Secondly, by clause 6(a) of the Loan Agreement, the loan will “at the option of the Lender, become immediately due and payable upon the termination of the Franchise Agreement...”.[44] There is presently an amount of at least $471,683.74[45] owing under the Loan Agreement. Even if the Franchisor does not demand immediate payment of the balance of the loan, the loan instalments will continue to accrue in the amount of $12,165.84 per month. None of the directors or shareholders of the Company have given evidence to suggest the loan is currently being serviced or will be serviced in the future. Further, given the Franchisor has also terminated the Supply Agreement, it seems highly unlikely that the Company will be able to procure any further stock from the Franchisor to generate future income.
[42]See clause 24.2 of the Franchise Agreement located at p 51 of exhibit VB-1 to the affidavit of Mr Bansal affirmed 12 October 2018.
[43]A number of debts owing to the Franchisor and described as “DC bills” are set out at p 333 of exhibit VB1 of Mr Bansal’s affidavit sworn 17 October 2018.
[44]See clause 6 of the Loan Agreement located at p 129 of exhibit VB-1 to the affidavit of Mr Bansal affirmed 12 October 2018.
[45]See 16 September 2018 letter from Mr Bansal’s lawyers to Mr Sharda’s lawyers located at p 245 of exhibit VB-1 to the affidavit of Mr Bansal affirmed 12 October 2018 and the balance sheet for 1 July 2018 – 18 September 2018 dated 31 October 2018 located at p 329 of exhibit VB-1.
It is plain that the Company had only two means by which it was able to meet its liabilities: (a) revenue earned from selling stock sold to it by the Franchisor; and (b) funds advanced from, or expenses directly paid by, its shareholders. However, as matters currently stand, the Company has no income from sales and therefore no cash flow. As previously mentioned, none of the shareholders are able to advance any further funds or otherwise cover any expenses of the Company.
In the financial year prior to the closure of its business, the Company was trading at a loss of $54,000. Immediately prior to the closure, the Company recorded a cash flow deficit of $10,240.93 in the space of approximately three months. It may be that the high cost of sales, rent and franchise fees contributed to make the enterprise unprofitable. The cost of servicing the Loan Agreement may have compounded these structural problems. On any view, it is clear that the Company’s liquidity problems were ongoing and not temporary.
The Company’s balance sheet position is equally sobering. The balance sheet for 1 July 2018 to 18 September 2018 and dated 31 October 2018[46] shows an excess of liabilities over assets in the order of $58,860.83 as at that date. The loan owing to the Franchisor is calculated at $471,683.74 and listed as a non-current liability. However, as previously mentioned, because of the termination of the Franchise Agreement, the loan may, at the option of the Franchisor, become due and payable in full. I accept the submission of Mr Bansal’s counsel that given the notices of termination served by the Franchisor and the closure of the store, there appears to be little prospect of the Company being able to sell the franchise business. Consequently, there do not appear to be any assets capable of being readily realised to pay out the loan.
[46] See exhibit VB-1 to the affidavit of Mr Bansal affirmed 12 October 2018.
Of further concern are the Company’s taxation liabilities in excess of $55,000. There is no suggestion by any party that there is any intention or capacity to pay these tax liabilities in the near future.
Mr Sharda’s solicitor submitted that the Court should not assume the Company’s financial documents referred to in Mr Bansal’s evidence are necessarily accurate. He noted that the first and second defendant had been in control of the Company since his client’s departure in November 2017. He also argued there was a real likelihood that the Company’s income had been understated by virtue of: (a) manipulated margins which resulted in an under-reporting of gross income from sales; and (b) the alleged diversion of cash receipts from the Company’s account. However, he properly conceded that the allegation concerning diversion of income involved an element of speculation and that it was not possible to estimate the extent to which this had occurred. The difficulty is illustrated by the fact that the cash deposits into the Global bank account[47] (which are said to emanate from the Company) do not correspond in dates or amounts to either Mr Sharda’s spreadsheet of daily takings[48] or the cash book referred to by Mr Jaswal.[49]
[47] See exhibit RJ-2 to the affidavit of Rajesh Jaswal sworn 12 November 2018.
[48] Exhibit G to the affidavit of Mr Sharda sworn 4 November 2018.
[49] See exhibit RJ-1 to the affidavit of Rajesh Jaswal sworn 12 November 2018.
Whilst I accept the financial records available to the Court in assessing the Company’s solvency are in the nature of management accounts (largely extracted from the Xero accounting system), have not been audited, and are far from perfect, they represent the best available evidence relevant to the Court’s task. Many of those records were relied upon by Mr Muscat, a registered liquidator, in arriving at his assessment that the Company requires immediate and significant funding to become solvent. Mr Firth, the joint valuer, also relied upon the Company’s financial documents[50] to conclude that it has nil value.
[50]Appendix 2 to Mr Firth’s report located at p 313 of RJ-1 to the affidavit of Rajesh Jaswal sworn 12 November 2018, shows that the valuer had regard to financial statements for the Company for the period up to 14 May 2018.
I have already noted that Mr Jaswal has sought to address Mr Sharda’s concern about the margins on the sale of stock. Clause 9.3 of the Franchise Agreement also relevantly provides:
(a) Subject to law, the Franchisee will not offer to sell or sell the Approved Products and Services at a price that is above the maximum price set by the Franchisor from time to time for the Approved Products and Services.
(b) Subject to law, the Franchisee will offer to sell or sell the Approved Products and Services sat a price that is not greater than the price advertised for the Approved Products and Services in any advertisement or promotion.
(c) Subject to clauses 9.3(a) and 9.3(b), the Franchisee will determine the prices at which it offers for sale and sells the Approved Products and Services.
The above provisions support Mr Jaswal’s evidence that goods could sometimes be sold for less than what the Company purchased them for.
Further, even if Mr Sharda is correct in his estimate that as a result of unrealistically low margins, there were unrecorded sales of up to $192,965, that is a matter he would be free to take up with a liquidator. So too his allegations about the diversion of cash.
Mr Sharda’s solicitor submitted that rather than raise these concerns with a liquidator for him/her to investigate, the better course would be for the Court to refrain from making a winding up order and to allow Mr Sharda time to progress his oppression claim, obtain an audit of the financial statements, and bring a further application for leave to commence an action in the name of the Company under ss 236 and 237 of the Corporations Act to pursue any diverted income or unrecorded profits of the Company.
There are several difficulties with this submission. Firstly, it is hard to quantify the value of any such derivative claim, its prospects of success and the likelihood of recovery. Secondly, it will take some time for Mr Sharda to progress his oppression claim and/or seek leave to bring any derivative action. In the meantime, the Company is continuing to accrue debts which are not being paid. There is also a real possibility that Mr Sharda’s litigation will be overtaken by the Franchisor, or another external creditor, such as the Australian Taxation Office, taking steps to wind up the Company.
The evidence clearly reveals that the Company is insolvent having regard to both its cash flow and balance sheet. Many of the indicia of insolvency identified by Mandie J in Australian Securities Investment Commission v Plymin are present in this case: continuing losses, overdue taxes, no access to alternative finance, an inability to raise further equity capital and a supplier placing the Company on cash on delivery terms. More critically, the Company has no ability to meet its current and future liabilities and expenses.
By reason of the foregoing, the Company should be immediately wound up and a liquidator appointed. I will hear the parties as to appropriate orders.
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