Neville Smith Timber Industries v DP Lennan

[1995] QSC 164

IN THE SUPREME COURT
OF QUEENSLAND

Brisbane  Writ No. 1801 of 1992

Before the Hon. Justice Mackenzie

[Neville Smith Timber Industries v. D.P. Lennan & Ors]

BETWEEN:

NEVILLE SMITH TIMBER INDUSTRIES PTY LTD (ACN 000 041 814)

Plaintiff

AND:

DAVID PATRICK LENNAN, JENNIFER DALLAS LENNAN & ROY VICTOR WELFARE

Defendants

JUDGMENT - MACKENZIE J.

Judgment delivered  11/08/1995

CATCHWORDS: CORPORATIONS LAW - s.592 - Company 2 supplied Company 1 with timber products - Company 1 in arrears of payment - accounting evidence indicated Company 1 in negative asset situation during relevant period and no realistic prospects of future improvement - whether reasonable grounds for directors of Company 1 to expect that company would not be able to pay all its debts as and when they became due at time of incurring of particular debt - whether defences under s.592(2) available - husband and wife directors - wife played no part in "running of the business" - whether debt incurred without express or implied authority or consent - whether no reasonable cause to expect that company would not be able to pay its debts as and when they became due.

Counsel:M. Daubney for the Plaintiff

M. Byrne for the Defendants

Solicitors:Middletons Moore & Bevins for the Plaintiff

Samuel Leonard & Associates for the Defendants

Hearing dates:         5-7 June 1995

IN THE SUPREME COURT
OF QUEENSLAND

Brisbane  Writ No. 1801 of 1992

Before the Hon. Justice Mackenzie

[Neville Smith Timber Industries v. D.P. Lennan & Ors]

BETWEEN:

NEVILLE SMITH TIMBER INDUSTRIES PTY LTD (ACN 000 041 814)

Plaintiff

AND:

DAVID PATRICK LENNAN, JENNIFER DALLAS LENNAN & ROY VICTOR WELFARE

Defendants

JUDGMENT - MACKENZIE J.

Judgment delivered 11 August 1995

This is an application under s.592 of the Corporations Law to recover from the three defendants the sum of $218,161. The three defendants were directors of Brisbane Wholesale Timbers Pty Ltd ("BWT") which went into liquidation on 17 July 1992 and is therefore a company to which s.592 applies. During the course of the trial, proceedings against Mr Welfare were adjourned to the settlement list by consent. The trial proceeded against Mr and Mrs Lennan.
The plaintiff, which is based in Victoria, had supplied timber products to BWT since 1989. The proceedings are concerned only with the months of September to November 1991 during which the plaintiff supplied timber products to the value of $240,606.36 to BWT. Of that sum only $22,445.36 has been paid to the plaintiff. The allegation, reflecting s.592, is that immediately before each debt was incurred during this period there were reasonable grounds to expect that the company would not be able to pay all its debts as and when they became due or that if the company incurred that debt it would not be able to pay all its debts as and when they became due.
          Further and Better Particulars of the Statement of Claim particularised that the terms of payment of the account between the companies were that it was a 30 day account.  Particular individual orders and deliveries of goods were particularised, as was the manner of appropriation of the $22,445.36 (part of a larger sum paid on 22 April 1992) towards payment for goods ordered and delivered in September 1991.  Particulars were also given of what were alleged as current debts of BWT which it was unable to meet at the end of the months of September to December 1991 and of overdue debts in the same period.  The particulars also set out what were alleged to be the liquid assets and current assets of BWT during the same period.
The defence did not admit the paragraphs in the statement of claim relating to the supply of goods, their value and the level of indebtedness. There was a denial of the elements of liability under s.592. A number of specific matters relating to that aspect of the case were pleaded in the defence and supplemented by Further and Better Particulars. The defendants' position was as follows:-

(a)at all material times prior to incurring the debts the company had current assets in the form of real property at Yamanto registered in BWT's name, in which it held a substantial equity and which had been listed for sale "after 30.6.1991";

(b)at all material times BWT had support and financial accommodation by way of overdraft of $40,000 from the National Australia Bank and an unlimited factoring facility with Custom Credit Corporation in respect of trade debtors;

(c)debts owing to BWT by ordinary trade debtors were such that the company was able to pay its debts as and when they came due and that the sum total of trade debtors exceeded the sum total of trade creditors during relevant months;

(d)debts incurred to the plaintiff in the relevant months were incurred pursuant to various firm and substantial orders by established customers of BWT and that in incurring the debts the defendants had regard to such orders;

(e)the plaintiff was fully aware of BWT's system of onselling the plaintiff's goods and that it was an accepted practice and arrangement that debts incurred by BWT were subject to extended times and terms of payment.  It was alleged that the agreement, to the extent that it was oral, was made between Craig Anderson on behalf of the plaintiff and David Lennan on behalf of the Defendants on many occasions between November 1990 and December 1991 by telephone and personal discussion.  It also arose by conduct in that period and could be identified by reference to monthly invoices received by BWT from the plaintiff and Mr Anderson's personal visits to BWT's premises to inspect its books.  The time of payment was neither fixed nor specified.

In respect of Jennifer Dallas Lennan the defence under s.592(2)(a) was pleaded. I am satisfied that goods to the stated value were ordered and delivered during the periods alleged. The issues are whether the matters in s.592(1) have been made out and whether the defences in s.592(2) have been proved by the respective defendants.
          Mr Anderson, Sales and Export Manager for the plaintiff, gave evidence that initially the account had been a net 30 days account which BWT paid in about 40 or 45 days in the early stages.  He considered a debtor who paid within 60 days a good account.  Prior to April 1991 he had no concern over payments of the account.  However by May 1991 it became hard to get payment in full.  An arrangement was made whereby the plaintiff was given cheques for various sums less than the full indebtedness but generally amounting in aggregate to the oldest component of the debt.  The plaintiff was told not to bank the cheque until advised by BWT that it could be banked.  Initially individual cheques were able to be banked weekly which was acceptable to the plaintiff and which meant the portion of the debt to which the cheques related was discharged within the period of a month.  This was acceptable to the plaintiff.  However, from late June onwards the arrangement became less certain.  Mr Anderson said that he had to badger BWT to get permission to bank cheques.  This on occasions involved daily phone calls.  He was given access to monthly sales figures but not at that stage information about the age of debts.  The situation with respect to banking the cheques deteriorated even more during July and August which resulted in the debt growing.  On raising the matter personally and by phone, he was told that there were no underlying problems, that sales were growing and were extremely good and the problem was simply that of a typical growing company in getting its debts in.
          In August 1991 the plaintiff was concerned about the level of indebtedness to such an extent that the question of Mr Lennan and Mr Welfare giving personal guarantees was discussed with them.  The plaintiff also became concerned that stock from other suppliers was coming into BWT's premises with the risk that available funds might be diverted to payment of those suppliers instead of the plaintiff.  Assurances continued that sales were strong. 
          By September 1991 the plaintiff was concerned that money from what were continually represented as strong sales was not flowing through to it.  The question of personal guarantees was revived and such discussions continued through October and November 1991, with Mr Lennan and Mr Welfare expressing willingness to execute such guarantees.  There was a meeting in this regard on 26 November 1991.  On that occasion a problem about collecting a particular debt which Mr Anderson believed was of the order of $100,000 from Coastal Wholesale Timbers was revealed for the first time.  On 28 November 1991, Mr Anderson told Mr Lennan that the plaintiff would not allow BWT to increase its indebtedness.  A problem about a debt due to BWT from Queensland Timber and Truss was mentioned on this occasion.
          On 13 December 1991 Mr Anderson came to Brisbane for the purpose of having the personal guarantees executed but after Mr Lennan and Mr Welfare had conferred with their solicitor the guarantees were not and have not ever been executed.  Mr Anderson said that at some time after May 1991 he learned that BWT was factoring its debts with Custom Credit Corporation.  There is no evidence that he discussed this with the defendants.
          In cross-examination he said that in practice payment of a debt within 30 - 60 days was acceptable but anything which became older than 60 days was kept under scrutiny.  He denied that he had told Mr Lennan or Mr Welfare to "keep pumping through the timber and don't worry too much about the costs" for the purpose of breaking into the Queensland market and disposing of excess stock.  He said that the lead time to produce saleable timber and the fact that it was a finite resource made it impractical to open up markets which could then not be supplied.
          Mr Lennan gave evidence that he arranged with Mr Anderson that BWT would market the plaintiff's timber in Queensland and pay the plaintiff when it could, by which he meant when BWT was paid.  He agreed that an arrangement was made to give post-dated cheques to cover the oldest component of the debt on the understanding that it was not to be presented  until the plaintiff was told it could be presented.  He expressed the view that the plaintiff was financing BWT's slow debtors by allowing 90 to 120 days to pay.  He said that during the relevant time there was a practice of drawing cheques to other creditors at the end of the month, removing the amount of the cheque from BWT's books as a company debt but not sending the cheque to the creditor.  Because the cheque was not presented during that month there was no increase in the overdraft.
          Mr Lennan said that he did have regard to the aging of the debts but did not consider a debt of more than 100 days, as a number of the debts were, as a bad debt because often in his experience payment came in much later.  It was only if a debt was "in actual fact bad", by which he meant that the company had gone into liquidation or ceased trading that it was treated as a bad debt.  He agreed that there had been provision for bad debts of $35,925 made in the tax return for the year ending 30 June 1991.  Only $5,000 was allowed in any balance sheets for doubtful debts.  He agreed that the question of personal guarantees had been raised some time prior to December. 
          He agreed that the overdraft had expanded to twice its limit.  He agreed that notwithstanding the claim of support from the National Australia Bank in the defence he was looking for other avenues to pay the creditors rather than go to the bank, having regard to BWT's record.  He also agreed that notwithstanding his claim that late payment of debts to BWT contributed to its lateness in paying the plaintiff, the factoring arrangement meant that moneys in relation to debts were received promptly.  He agreed that the sum actually received was less than the whole amount otherwise due because Custom Credit was at relevant times deducting sums from current debts representing the value of debts 90 days or more old.  He agreed that the land at Yamanto had a contract signed in respect of it in December 1991 but the sale had not been completed until April 1992.  He claimed that he checked the books and believed that the total volume of stock and debtors exceeded the volume of creditors.  He said that a retired bank manager audited the books periodically and that he had never indicated any problems.  He also said that he believed on the basis of his accountant's advice that the company had shown a small profit for the year ending 30 June 1991.
          On the accounting aspects of the case the only expert called was Mr Richards who had been concerned with the administration of the winding‑up of the company.  He examined the books of the company and reconstructed balance sheets for the months of June to December 1991 making what were in his opinion prudent allowances for bad or doubtful debts.  Such provision was based on the proposition that debts of more than 90 days old should be the subject of provision, taking a conservative approach to the question of collectability of money in the short term.  Annexure 1 to his report showed that on that basis at the end of each of those months, while there were fluctuations, the company was in a negative asset situation, the smallest deficit being $43,702 and the largest being $154,868.
          On the same basis a comparison of current liabilities and current assets showed that at no point for the months of June to December 1991 did liquid assets equal or exceed trade creditors even having regard to the $40,000 overdraft.  The balance sheet for each of the months showed a negative asset position.  He expressed the view that current assets could not support the level of immediately repayable debt.  He also expressed the view that the only sources of future funding appeared to be sale of plant and equipment, which would hamper the capacity of the business to continue, and further accommodation from the bank.  However, the amount of funds likely to be realised was small because of securities associated with the equipment and the overdraft.  He also expressed the view that further advances were unlikely having regard to the limit of the overdraft and the effect of withholding cheques upon that.  He concluded that the company had been insolvent from September to December and had, indeed, been insolvent well prior to that period.  He expressed the view that a provision of only $5,000 for doubtful debts was unrealistic.  He also said that the sale of the land at Yamanto would not turn the net asset position from negative to positive. 
          During the course of the witness' evidence a complication arose by reason of a variance between the Further and Better Particulars and the evidence in his report as to the provision for non-recoverable debts.  In the Further and Better Particulars of the Statement of Claim dated 5 April 1993 the figure reflected debts which were at relevant times indisputably bad debts.  The figure reflected debts owing by companies in liquidation, under some other form of compulsory management or where other factors indicated that the debt would never be paid.  Mr Richards' report was made available to the plaintiffs' solicitors in early March 1995.  The figures in the report included not only the indisputably bad debts but also all the debts which were 90 days or more old on the basis that they were doubtful.
          The case was not one which had been managed and no direction had been given with respect to provision of experts' reports.  In any event, Mr Richards' report was not disclosed to the defendant's solicitors until the Friday before the Monday when the trial began, some two months after it had been in their possession.  I ruled against an application for amendment to have the Further and Better Particulars conform to the report, having already raised the question whether the blanket inclusion of all debts that were 90 days or more old in a provision for doubtful debts was necessarily an appropriate approach in this kind of case and expressing the view that it might well be that some provision against the possibility that some of the debts would not be recoverable should be made but that it might be a pessimistic submission in the business sense to include the whole amount.
          In light of this ruling Mr Richards redid his calculations, which are reflected in ex.12.  In the months of September, October and November there was a slight positive balance but in December there was a loss.  On the original basis the calculation each month showed a substantial loss.  An examination of Annexure 4 to Mr Richards' report, "debtors 90 days and over", shows that a number of accounts had been owing for much longer than 90 days by the beginning of September 1991.  Many of them showed no indication of any attempt to discharge the debt even by instalments.  In those circumstances there is much force in Mr Richards' observation that $5,000 was seriously inadequate as a reflection of the doubtful debt position of the company.  I am satisfied that a reasonable director would have easily been able to ascertain this from the company's records without the need for complex financial analysis and in any event Mr Lennan said in his evidence that he knew who the very slow debtors were.  I should record that overall I did not find Mr Lennan's evidence as to his lack of knowledge of the overall position particularly convincing.  Mr Richards also recalculated the net asset position of the company on the basis of the figures in the Further and Better Particulars.  Even on this basis there was a substantial shortfall in the value of the current assets compared to current liabilities.
          The existence of reasonable grounds to expect that the company will not be able to pay debts is to be determined according an objective test (3M Australia Pty Ltd v. Kemish (1986) 4 ACLC 185; Commonwealth Bank of Australia v. Friedrich (1991) 9 ACLC 946). The words referring to a company's inability to pay all its debts as and when they become due requires the plaintiff to show that at the relevant time there were reasonable grounds to expect that the company would not be able to meet its current financial obligations (Commonwealth Bank of Australia v. Friedrich).  Such grounds must be established having regard to the standard of a director of reasonable ability (Rema Industries and Services Pty Ltd v. Coad (1992) 10 ACLC 530; Statewide Tobacco Services Ltd v. Morley (1990) 8 ACLC 827; 3M Australia Pty Ltd v. Kemish).  The question, after taking these factors into account, is whether there are reasonable grounds to expect that the company would not be able to pay all its debts as and when they became due at the time of incurring of the particular debt in question.  The test is whether there are reasonable grounds to expect the company is commercially insolvent at the time of incurring relevant debts.
The word "expect" should be given its ordinary meaning so that it involves a prediction, on the basis of the circumstances of the case, of what the company's ability to pay its debts at a future time will be. In the context of s.592(1) what must be capable of being said is that a reasonable and prudent director had reasonable grounds for regarding it as likely to be the case that the company would not be able to pay its debts as and when they fell due. When a debt falls due depends on the circumstances of the case. The course of dealing between the parties, where there is an extended business relationship between them, is relevant. (3M Australia Pty Ltd v. Kemish; Calzaturfico Zenith Pty Ltd (in Liquidation) v. NSW Leather Trading Co Pty Ltd (1970) VR 603). The onus to establish the requirements of s.592(1) lies on the plaintiff.
          I am satisfied that the arrangement between the plaintiff and BWT was not that BWT could wait for an unlimited time until it was paid for selling stock originating from the plaintiff before it was required to pay the plaintiff's account.  I am satisfied that the debt created by the sale of a particular order to BWT fell due in each case in accordance with the practice of their business relationship.  There was no basis to be derived from the course of dealing upon which BWT might have believed that it would have unlimited time in which to pay.  The acceptance by the plaintiff of forward cheques to be banked when the company said it was appropriate to do so must be viewed in the context of the way in which Mr Anderson continually pursued BWT in that connection.  His persistence and BWT's preparedness to deliver cheques in the knowledge that there would be enquiries with a view to banking them at the earliest opportunity demonstrate that both parties regarded the debt as having fallen due.

Applying the objective test required by s.592(1) the question is whether a reasonable and prudent director would have grounds to expect that the company would not be able to pay its debts as and when they fell due. The test is one of commercial insolvency and requires more than proof of temporary lack of liquidity. In determining what a person would expect, expectation must not be confused with mere hope. I am satisfied that a reasonable and prudent director applying an ordinary measure of skills attributable to such a person and without the need for sophisticated accounting knowledge, would have been aware by the beginning of September 1991 of the deteriorating position of the company and that a number of the debts were becoming so old and showing no signs of being paid as to discount them as being collectable in the short term if at all. It would have been apparent that the provision of only $5,000 in the accounts to allow for this contingency was little better than nominal. Analysis on this basis would have shown that the company was not generating sufficient funds to pay its debts as they fell due. I am satisfied from no later than the beginning of the month of September 1991, there were reasonable grounds to expect that the company would not be able to pay all its debts as and when they became due at the time when each of the subsequent debts to the plaintiff was incurred.
Section 592(2)(a) allows a person to defend an action if it is proved that the debt was incurred without the person's express or implied authority or consent. That defence has no possible application in the case of Mr Lennan. However, it was raised in respect of Mrs Lennan. There is no reason to suppose that it is necessary for the person seeking the benefit of the defence to give evidence personally provided other evidence and the circumstances generally are compelling enough to allow an inference to be drawn that the debt was incurred without the person's express or implied authority or consent. In the present case, Mrs Lennan did not give evidence and the only evidence on the subject was given in the following passages of Mr Lennan's evidence-in-chief and cross examination:-

"Mr Byrne:Your wife is a director of the company? -- That's right.

Can you tell the Court what part she played in the running of the company? -- None.

None at all? -- None at all.

She didn't - you didn't show her books or did show her books?

Mr Daubney: I object.  He is leading the witness now, relevant issue -----

His Honour:   No.

Mr Byrne:Was your secretary on the financial return? -- I can't remember, actually.

But as far as you can remember she played no part at all? -- No.

...............

Mr Daubney: Your wife was a director of the company, wasn't she? -- Yes.

She drove a company car, didn't she? -- Yes.

She wasn't just sitting at home doing housework, was she? -- No.

In fact, she had her own travel agency, didn't she? -- Yes.

And she ran that business for some years? -- About three, I think.

Yes? -- Approximately."

If the transcript correctly records my intervention as "No" in the examination-in-chief it was clearly understood at the time that the objection was being upheld.  My recollection is that in the next question, "she", not "your", was said.
          Mr Byrne relied on Metal Manufacturers Ltd v. Lewis (1988) 13 ACLR 357 in support of the proposition that Mrs Lennan had discharged the onus. Metal Manufacturers Ltd v. Lewis has been distinguished in several instances and the trend of authority is towards a more stringent view of what is required to establish the defence than was applied in that decision.  (see Morley v. Statewide Tobacco Services Ltd (1992) 10 ACLC 1233 affirming the decision of Ormiston J. (1990) 8 ACLC 827; Group Four Industries Pty Ltd v. Brosnan (1992) 10 ACLC 1437; Commonwealth Bank of Australia v. Friedrich (supra); Rema Industries and Services v. Coad (supra)).
          In Morley Ormiston J. expressed the view that a director remains liable for the debt incurred by another on behalf of the company unless want of the necessary consent or authority is proved. The director is required to show that he or she bears no relevant responsibility for the authority given to incur the debt. The "authority" to which s.592(2)(a) refers is an authority given as a matter of fact by a director, either as an executive director or as a participating member of the Board of Directors on behalf of the company. The authority should be sufficient to authorise the incurring of the liability and may be either in express terms or implied from the terms of an authority given as part of a general or usual authority to an executive director, manager or other employee or agent of the company. If a director participates in the giving of such express or implied authority then he or she should not be entitled to rely on the defence where the person authorised continues to incur debts while the company is unable to pay its debts as and when they fall due.
          I should mention that although it is asserted in the written submissions on behalf of the defendants that Mr Lennan was managing director, I am not aware of any evidence before me to that effect.  To the extent that the status of managing director may have some particular significance in this area, that question is unresolved before me.  Further, because Mrs Lennan did not give evidence there is no evidence that she did not participate in the decision that her husband and Mr Welfare would run the day to day affairs of the company.
The onus of positively establishing that the debts in question were incurred without Mrs Lennan's express or implied authority or consent lies on her. On the evidence as it stands I am not satisfied that the bare fact that she played no part at all in "the running of the company" discharges the onus. With respect to s.592(2)(b) it is a defence for a defendant to prove that he or she did not have reasonable cause, at the time when the debt was incurred, to expect that the company would not be able to pay all its debts as and when they became due or that if the company incurred that debt it would not be able to pay all its debts as and when they became due. So far as Mrs Lennan is concerned there is no evidence as to what she did to acquaint herself with the affairs of the company. It is a reasonable inference from the limited evidence quoted that she did nothing.
          Ormiston J. said in Morley that the issue was directed to what the director might reasonably know and understand of the company's general financial position at the relevant time. He expressed the view that a defendant was not entitled to say that he or she was entitled to hide behind ignorance of the company's affairs of his or her own making or which has been contributed to by his or her own failure to make necessary inquiries.  He said that directors were not required to have omniscience but a director was entitled to take a diligent and intelligent interest in the information either available to him or which he might with fairness demand from the executives or other employees and agents of the company.  He said at the least a director could not assert from a state of total ignorance that he or she had no reasonable cause to expect that a company could not pay its debts as they fell due.  An opinion on the company's solvency based on ignorance arising from the failure to make enquiries could not be characterised as reasonable. 
          He said that even in a small company a director should ask for and receive figures, albeit of a basic kind, on a more or less regular basis.  He said that if that was sought and revealed no difficulties and the director had no other reason to suspect the company may not be able to pay its debts as they fell due then the director may be shown to have acted reasonably.  Directors should not be required to make their own further investigations or to "audit" the accounts provided.  They could only be required to seek more information if the company's accounts together with any other information from the company's executives put them on enquiry.  At the end of the day it was a question of fact to be considered on each occasion whether the onus had been discharged.  I adopt this approach in this case.
          Ormiston J.'s description of the defendant's situation in Morley is also apt in this case.  He said that the defendant -

"made no ... enquiries, required no accounting figures to be provided to her and sought no regular reports ... as to the company's business.  She cannot thus say that she had no reasonable cause to expect that the company would not be able to pay all its debts as and when they became due for in truth she had no expectations at all based on objective information."

As Lockhart J. points out in Rema Industries it would be absurd for a defendant to be able to establish the defence simply on the basis of what he in fact knew because that would reward the incompetent director who ought to have known a great deal more than he in fact knew.
The defence under s.592(2)(b) is not made out in Mrs Lennan's case.
          So far as Mr Lennan is concerned, the fact that he had access to and knowledge of the financial information pertaining to the company and played an active role in all relevant phases of its business has been referred to above.  Notwithstanding the information prepared by the accountants and by the former bank manager, I am satisfied that there was sufficient by way of warning signs in the financial affairs of the company to put him on enquiry as to the state of the business.  Applying the test proposed by Lockhart J. in Rema Industries to the effect that the test of "reasonable cause" in s.592(2)(b)(i) imports an objective standard which must be applied to the facts and circumstances known to the defendant and facts and circumstances which by reason of the defendant's duties as a director ought to be known to him, I am satisfied that the defendant fails to establish the onus.
          Having regard to the findings the plaintiff is entitled to judgement.  I give judgement for the plaintiff against the defendants David Patrick Lennan and Jennifer Dallas Lennan in the sum of $218,161 with costs including reserved costs if any to be taxed.