Re Balmz Pty Ltd (in liq)

IN THE SUPREME COURT OF VICTORIA

Not Restricted

AT MELBOURNE
COMMERCIAL COURT
CORPORATIONS LIST

S ECI 2018 02135

IN THE MATTER of BALMZ PTY LTD (IN LIQUIDATION) (ACN 119 906 642)

STEPHEN JOHN MICHELL in his capacity as liquidator of Balmz Pty Ltd (in liquidation) (ACN 119 906 642)	First Plaintiff
BALMZ PTY LTD (IN LIQUIDATION) (ACN 119 906 642)	Second Plaintiff
v
ANNE ISABELLA PATCH	First Defendant
MELVIN IVOR PATCH	Second Defendant

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JUDGE:	Randall AsJ
WHERE HELD:	Melbourne
DATE OF HEARING:	29 July 2019
DATE OF JUDGMENT:	7 October 2020
CASE MAY BE CITED AS:	Re Balmz Pty Ltd (in liq)
MEDIUM NEUTRAL CITATION:	[2020] VSC 652

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CORPORATIONS – External administration – Company trading whilst insolvent – Section 588G of the Corporations Act 2001 (Cth) – Company is presumed to be insolvent pursuant to s 588E(4) of the Corporations Act 2001 (Cth) if it has failed to keep financial records – Directors’ failure to prevent the company trading whilst insolvent – Defences to insolvent trading pursuant to s 588H of the Corporations Act 2001 (Cth) – Section 588GA Safe harbour provisions – Relief from liability under s 1317S of the Corporations Act 2001 (Cth) – Liquidator seeks recovery of compensation from the company directors pursuant to s 588M(2) of the Corporations Act 2001 (Cth).

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APPEARANCES:	Counsel	Solicitors
For the Plaintiffs	Mr J Kohn	Doherty & Colleagues Solicitors Pty Ltd
The Defendants appeared on their own behalf

TABLE OF CONTENTS

Background......................................................................................................................................... 1

Relevant statutory provisions........................................................................................................ 10

Director’s duty to prevent insolvent trading by company................................................... 10
Section 588G of the Corporations Act 2001 (Cth)............................................................ 10
Section 588H of the Corporations Act 2001 (Cth)............................................................ 11
Section 588GA of the Corporations Act 2001 (Cth)......................................................... 12
Section 588M of the Corporations Act 2001 (Cth)........................................................... 15

Relief from liability under s 1317S of the Corporations Act 2001 (Cth)................................. 15
Books and records....................................................................................................................... 17

The liquidator’s position................................................................................................................ 17

The defendants’ position................................................................................................................ 19

The issues.......................................................................................................................................... 21

Consideration.................................................................................................................................... 22

Solvency........................................................................................................................................ 22
Deemed insolvency........................................................................................................... 22

Actual insolvency........................................................................................................................ 24
When were these debts incurred?................................................................................... 25
Availability of funds......................................................................................................... 27

Defence pursuant to s 588H(2).................................................................................................. 33
Reasonable grounds to suspect the company was insolvent...................................... 33
Did Mrs Patch have a reasonable expectation as to the company’s solvency?........ 35

Other defences under s 588H of the Act.................................................................................. 35
Mr Patch....................................................................................................................................... 36
Section 588GA of the Act........................................................................................................... 37
Section 1317S of the Act............................................................................................................. 38

Conclusion......................................................................................................................................... 40

HIS HONOUR:

This is an application by the first plaintiff (‘the liquidator’) in his capacity as liquidator of the second plaintiff (‘the company’). The liquidator seeks compensation from the first and second defendants, Mrs and Mr Patch respectively, for not preventing the company from trading whilst insolvent.

Pursuant to s 588M(2) of the Corporations Act 2001 (Cth) (‘the Act’), in the event that a director has contravened ss 588G(2) or (3) in relation to the incurring of a debt, the company’s liquidator may recover from the director, as a debt due to the company, an amount equal to the amount of the loss or damage so suffered. The liquidator contends that the total sum of the debts incurred during the relevant period were in the sum of $101,151.91.

Background

On 12 November 2012, the Deputy Commissioner of Taxation (‘Deputy Commissioner’) filed an originating process in the Federal Court of Australia seeking, amongst other things, an order winding up the company in insolvency. The winding up order was made on 17 December 2012.

Prior to its winding up, the company operated two cafes:

(a) Café Caldera situated at 214 Spencer Street Shopping Centre; and

(b) Willi’s Takeaway situated at 282 Ballarat Road, Braybrook.

The liquidator contends that between 30 September 2009 and 17 December 2012, the company incurred debts totalling the sum of $101,151.91. It is common ground that both Mrs and Mr Patch were directors of the company during that period.

The company failed to lodge activity statements for the period 1 October 2008 to the date of liquidation.

On 27 February 2008, the company received a notice from the Deputy Commissioner requiring the PAYG withholding payment summary annual report for the year ended 30 June 2007 to be filed.

On 10 May 2008, the Deputy Commissioner served a notice requiring the company to lodge its activity statement for the period 1 October 2007 to 31 December 2007.

On 8 August 2008, the Deputy Commissioner required the company to lodge overdue activity statements for the periods 1 October 2007 to 31 December 2007 and 1 January 2008 to 31 March 2008.

On 10 October 2008, the Deputy Commissioner served a final notice requiring the lodgement of activity statements immediately for the periods:

(a) 1 October 2007 to 31 December 2007;

(b) 1 January 2008 to 31 March 2008; and

(c) 1 April 2008 to 30 June 2008.

On 25 October 2008, the Deputy Commissioner required the company to provide its PAYG withholding payment summary annual report for the year ended 30 June 2008.

On 28 March 2009, the Deputy Commissioner served a notice upon the company as a second reminder with respect to the PAYG withholding payment summary annual report for the year ended 30 June 2008.

On 1 April 2009, the Deputy Commissioner served the company with a notice requiring the lodgement of its activity statement for the period 1 October 2008 to 31 December 2008.

On 2 May 2009, the Deputy Commissioner provided a reminder notice with respect to the activity statement for the period 1 October 2008 to 31 December 2008.

On 18 August 2009, the Deputy Commissioner provided the company with a final notice with respect to the activity statements for the periods 1 October 2008 to 31 December 2008, and 1 January 2009 to 31 March 2009.

On 2 October 2009, the Deputy Commissioner provided the company with a notice with respect to the activity statement for the period 1 April 2009 to 30 June 2009.

On 11 May 2010, Dun & Bradstreet (Australia) Pty Ltd provided the company with a ‘notice of intention to seek instructions to issue a court summons’. The notice was provided on behalf of National Foods Australia Pty Ltd (‘National Foods’) and the amount sought was $3,493.32.

On 19 June 2010, the Deputy Commissioner provided the company with a final notice with respect to activity statements for the periods:

(a) 1 April 2009 to 30 June 2009;

(b) 1 July 2009 to 30 September 2009; and

(c) 1 October 2009 to 31 December 2009.

On 12 July 2010, EC Credit Control notified a debt owing to D Borthwick and Sons Pty Ltd (‘Borthwick and Sons’) in the amount of then $55,852.63.

On 19 July 2010, EC Credit Control advised ‘legal action is pending’ with respect to the Borthwick and Sons debt.

The notice referred to in the preceding paragraph was followed up with a ‘notice of intention to issue legal proceedings’ dated 26 July 2010.

On 2 August 2010, EC Credit Control provided a final notice with respect to the same debt.

On 31 August 2010, a Magistrates’ Court of Victoria complaint was filed by National Foods Australia Pty Ltd seeking to recover against the company and Mrs Patch the sum of $3,493.92.

On 18 November 2010, the landlord, Austexx Spencer Street Pty Ltd and Austexx Spencer Pty Ltd, gave notice to the company that it was in default under the provisions of the lease for the premises at F214 Spencer Street. It was contended that the total amount due and payable was then $57,135.76.

On 17 March 2011, a further notice of default was provided by Austexx Spencer Street Pty Ltd and Austexx Spencer Pty Ltd. That notice set out that the total amount then due was $107,011.58.

On 11 July 2011, Baker Jones advised the company that its client, National Foods Australia Pty Ltd, had obtained judgment against the company in the amount of $2,741.42. A copy of the order was enclosed.

On 13 October 2011, the Deputy Commissioner gave notice to the company that it had been selected for an audit of its compliance with employer obligations as set out in the notice. The appointment date was specified as 8 November 2011.

Mrs Patch attended a meeting with staff from the Australian Taxation Office (‘ATO’) on 15 November 2011. On 25 January 2012, the Deputy Commissioner confirmed that Mrs Patch, as a director of the company, had agreed to lodge the outstanding statements and returns which were set out in a table. In summary, the agreement related to lodging activity statements for the period since 1 October 2008 to 30 June 2011 by 29 November 2011. Superannuation guarantee charge statements from the period 1 July 2006 through to 30 June 2011 were to be lodged by 21 November 2011. Fringe benefit tax records for the year ended 31 March 2011 were to be lodged by 29 November 2011. Notwithstanding the agreement, such returns were not lodged by the due dates or at all.

Given that the returns sought by the Deputy Commissioner had not been lodged by the specified dates or at all, on 16 March 2012, the Deputy Commissioner gave notice that the PAYG amounts withheld had been estimated as set out in a table. The amounts estimated were as follows:

(a) 1 July to 30 December 2009 — $3,855;

(b) 1 October to 31 December 2009 — $3,855;

(c) 1 January to 31 March 2010 — $3,855;

(d) 1 April 2009 to 30 June 2010 — $3,855;

(e) 1 July to 30 September 2010 — $1,488;

(f) 1 October to 31 December 2010 — $1,488;

(g) 1 January to 31 March 2011 — $1,488;

(h) 1 April 2009 to 30 June 2011 — $1,489;

(i) 1 July to 30 September 2011 — $1,488; and

(j) 1 October to 31 December 2011 — $1,488.

The notice advised that the company would receive a ‘notice of estimate’ advice within 28 days containing details of the estimated amounts and other information.

The notice further dealt with the consequences of not filing PAYG returns, income tax returns or superannuation guarantee returns.

On 27 April 2012, the Deputy Commissioner gave the company a notice that the penalty originally assessed at 200 per cent of the superannuation guarantee charge would be changed to 80 per cent and that assessments would be received.

On 6 October 2012, the Deputy Commissioner gave the company a notice that it had not received its activity statement for the period 1 January 2012 to 31 March 2012.

On 18 October 2012, the Deputy Commissioner gave Mr Patch notice that a garnishee notice had been given [to a redacted addressee] as an amount of $24,352 remained unpaid despite the ATO’s previous requests for payment. The notice required the addressee to deduct an amount from Mr Patch’s salary or wages to pay the debts.

The Deputy Commissioner subsequently served a statutory demand dated 30 July 2012 upon the company. The statutory demand set out how the sum of $108,218.23 was calculated. In summary, that amount comprised of the running balance account deficit as at 31 July 2012 in the sum of $49,134.66 and then the detailed quarterly superannuation guarantee charges for the quarter commencing 1 October 2006 through to the quarter commencing 1 April 2011. It was set out that each amount was due and payable on 19 April 2012 (the date of the original assessments). The total superannuation guarantee charge assessment debt at 30 July 2012 was $59,083.57, which comprised the base superannuation guarantee charge, penalties and general interest charges.

On 23 November 2012, the company’s directors resolved to appoint Trajan Kukulovski as voluntary administrator of the company.

The s 439A(4) report provided to the creditors of the company and dated 6 December 2012 sets out that the company held the following secured loans with the Commonwealth Bank of Australia (‘CBA’):

(a) Better Business Loan (of $290,000) No 3179 1044 6998 — $136,587.03;

(b) Overdraft Cheque Account No 3179 1044 7026 — $21,058.55; and

(c) Contingent Liability No 330499 — $49,500.00.

The total amount secured by the CBA loan facilities was $207,145.58. Those loan facilities had been personally guaranteed by the directors. The contingent liability represented a bank guarantee in favour of the landlord of Café Caldera which had not then been called upon.

As at the date of the report, the unsecured creditors apart from the ATO were relatively minor. The total claimed amount was just over $10,000.

The voluntary administrator recommended that the company be wound up.

Given the recommendation by the voluntary administrator it is unsurprising that on 17 December 2012, the Federal Court of Australia wound up the company in insolvency. Stephen Michell was appointed liquidator for the purposes of the liquidation.

On 18 January 2013, Mrs Patch completed a questionnaire provided by the liquidator. Mrs Patch certified that ‘the answers furnished to the foregoing questions are true and complete to the best of [her] knowledge and belief’.

I will come back to some of the answers set out in the questionnaire but in the meantime I note:

(a) that question 10 dealt with the details of rentals. In relation to the Braybrook premises, it had been paid up to December 2012. In relation to Caldera, Mrs Patch set out: ‘haven’t paid long time, Korda Menta [centre manager] advised to continue without paying rent’;

(b) in answer to question 11, dealing with remuneration received by her during the three years prior to liquidation, Mrs Patch set out:

(i) salary — ‘nil’; and

(ii) other — ‘creditors $750,000 as only put into company. No wages’;

(c) in answer to question 12 as to how much capital Mrs Patch introduced into the company by way of loans, she answered — ‘$750,000 roughly’;

(d) the combination of the answers to questions 21 and 22 is that Mrs Patch maintained creditor correspondence, excel, receipts, invoices, leases and bank statements;

(e) the answer to question 44 — ‘[w]ho prepared income tax returns to the company?’ — was ‘[n]one prepared’;

(f) the answer to question 46 — ‘[a]re there any unremitted tax instalment deductions owing to the Commissioner of Taxation?’ — was ‘have not been paid for a few years’. The delay was said to have occurred ‘when purchased Caldera’;

(g) the answer to question 47 with respect to unremitted goods and services tax was ‘same as tax instalment’;

(h) the answer to question 49 — ‘[a]re there any unremitted superannuation contributions?’ — was ‘all super — 2006 onwards’;

(i) the answer to question 53 — ‘[w]hen did creditors begin pressing the company for payment?’ — was ‘only really landlord & ATO’;

(j) the answer to question 56 — ‘[w]hat steps did you take to satisfy these creditors? Give details of the significant payments made’ — was ‘Nil – had meeting with ATO’;

(k) the answer to question 78 — ‘[w]hen did you first realise that the company might have to go into liquidation?’ — ‘October, November 2012’;

(l) the answer to question 79 — ‘[w]hat caused you to realise this? What did you do as a result?’ — ‘ATO correspondence’;

(m) the answer to question 84 — ‘[w]hat do you consider were the causes of the failure of the company?’ — ‘[p]oor trading conditions/economic conditions [and] [p]oor maintenance of records’; and

(n) the answer to question 85 — ‘[a]re you of the opinion that any offences may have been committed by officers in relation to the affairs of the company? (eg accounting records, contracting debts whilst insolvent, improper use of company property etc) — ‘[r]ent and ATO — unable to pay from trading as debts incurred. Could have been paid from other sources’.

The Deputy Commissioner of Taxation lodged a proof of debt with the liquidator dated 16 February 2013 seeking payment of $107,531.28.

The Department of Employment lodged a formal proof of debt in the sum of $11,811.48 dated 17 October 2013. That sum had been advanced under the Fair Entitlements Guarantee (‘FEG’) for the payment of outstanding employment entitlements to former employees of the company. That sum was advanced pursuant to s 28 of the Fair Entitlements Guarantee Act 2012 (the ‘FEG Act’). Under s 29 of the FEG Act, the department has the same right of priority payment as former employers if there is a distribution of company assets.

Mr and Mrs Patch had made numerous personal contributions to the company's overdraft account from 8 October 2010 to 8 November 2012 totalling $116,175.00, as provided in the liquidator’s report dated 9 July 2019. These contributions were in addition to the amounts paid to the CBA from the sale of their Croydon property (discussed below). Further, from 28 October 2010 to 27 July 2011, Mr and Mrs Patch had contributed amounts from their superannuation accounts to the company’s overdraft account totalling $350,991.58. In the liquidator’s report, ‘top up’ amounts were not included in the report as the liquidator was unable to identify who contributed those funds; however, Mrs Patch contended that the ‘top up’ amounts were payments made into the CBA account from the directors.

In relation to the Croydon property, the liquidator observed that it appeared that funds from its sale were paid into the company’s bank accounts on 19 August 2011: $100,786.23 was deposited into the overdraft account, $154,000 was paid into the Better Business Loan of $290,000 account and $60,666.20 was paid into the Better Business Loan of $90,000 account. The payment into the $90,000 loan account was the final payout and that account was subsequently closed on 22 August 2011. While no date of sale was provided, it is likely that the Croydon property was settled on or around 19 August 2011.

Shortly after the liquidator’s appointment on 4 February 2013, the CBA advised the liquidator that the company owed it $206,958.43.

On 4 February 2013, the sum of $136,865.37 was paid into the company’s Better Business Loan of $290,000 account and a payment of $21,300.92 was paid into the company’s overdraft account.

By February 2013, three of the accounts with the CBA had been paid out — the two loan accounts for $90,000 and $290,000, and the overdraft account.

In relation to the contingent liability, the receivers and managers of Austexx Spencer Pty Ltd and Austexx Spencer Street Pty Ltd demanded payment of $49,500 pursuant to the bank guarantee in a letter addressed to the CBA dated 7 February 2013. No other information has been provided as to when this amount was subsequently paid to the bank.

Relevant statutory provisions
Director’s duty to prevent insolvent trading by company

The relevant statutory provisions are as follows.

Section 588G of the Corporations Act 2001 (Cth)

Director’s duty to prevent insolvent trading by company

(1) This section applies if:
(a)a person is a director of a company at the time when the company incurs a debt; and
(b)the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and
(c)at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be; and

(d) that time is at or after the commencement of this Act.

…
(2)By failing to prevent the company from incurring the debt, the person contravenes this section if:
(a)the person is aware at that time that there are such grounds for so suspecting; or
(b)a reasonable person in a like position in a company in the company’s circumstances would be so aware.
Note:This subsection is a civil penalty provision (see section 1317E).

(3) A person commits an offence if:
(a)a company incurs a debt at a particular time; and

(aa) at that time, a person is a director of the company; and
(b)the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and
(c)the person suspected at the time when the company incurred the debt that the company was insolvent or would become insolvent as a result of incurring that debt or other debts (as in paragraph (1)(b)); and
(d)the person’s failure to prevent the company incurring the debt was dishonest.

(3A)For the purposes of an offence based on subsection (3), absolute liability applies to paragraph (3)(a).
Note: For absolute liability, see section 6.2 of the Criminal Code.

(3B)For the purposes of an offence based on subsection (3), strict liability applies to paragraphs (3)(aa) and (b).
Note:For strict liability, see section 6.1 of the Criminal Code.

(4)The provisions of Division 4 of this Part are additional to, and do not derogate from, Part 9.4B as it applies in relation to a contravention of this section.

Section 588H of the Corporations Act 2001 (Cth)
Defences about reasonable grounds, illness or reasonable steps
(1)This section has effect for the purposes of proceedings for a contravention of subsection 588G(2) in relation to the incurring of a debt (including proceedings under section 588M in relation to the incurring of the debt).
(2)It is a defence if it is proved that, at the time when the debt was incurred, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.
(3)Without limiting the generality of subsection (2), it is a defence if it is proved that, at the time when the debt was incurred, the person:
(a) had reasonable grounds to believe, and did believe:
(i)that a competent and reliable person (the other person) was responsible for providing to the first-mentioned person adequate information about whether the company was solvent; and

(ii) that the other person was fulfilling that responsibility; and
(b)expected, on the basis of information provided to the first-mentioned person by the other person, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.

(4)If the person was a director of the company at the time when the debt was incurred, it is a defence if it is proved that, because of illness or for some other good reason, he or she did not take part at that time in the management of the company.
(5)It is a defence if it is proved that the person took all reasonable steps to prevent the company from incurring the debt.
(6)In determining whether a defence under subsection (5) has been proved, the matters to which regard is to be had include, but are not limited to:
(a)any action the person took with a view to appointing an administrator of the company; and

(b) when that action was taken; and
(c) the results of that action.

Section 588GA of the Corporations Act 2001 (Cth)
Safe harbour—taking course of action reasonably likely to lead to a better outcome for the company
Safe harbour

(1) Subsection 588G(2) does not apply in relation to a person and a debt if:
(a)at a particular time after the person starts to suspect the company may become or be insolvent, the person starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company; and
(b)the debt is incurred directly or indirectly in connection with any such course of action during the period starting at that time, and ending at the earliest of any of the following times:
(i)if the person fails to take any such course of action within a reasonable period after that time—the end of that reasonable period;

(ii) when the person ceases to take any such course of action;
(iii)when any such course of action ceases to be reasonably likely to lead to a better outcome for the company;
(iv)the appointment of an administrator, or liquidator, of the company.

Note 1:The person bears an evidential burden in relation to the matter in this subsection (see subsection (3)).
Note 2:For subsection (1) to be available, certain matters must be being done or be done (see subsections (4) and (5)).

Working out whether a course of action is reasonably likely to lead to a better outcome
(2)For the purposes of (but without limiting) subsection (1), in working out whether a course of action is reasonably likely to lead to a better outcome for the company, regard may be had to whether the person:
(a)is properly informing himself or herself of the company’s financial position; or
(b)is taking appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company’s ability to pay all its debts; or
(c)is taking appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company; or
(d)is obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice; or
(e)is developing or implementing a plan for restructuring the company to improve its financial position.

(3)A person who wishes to rely on subsection (1) in a proceeding for, or relating to, a contravention of subsection 588G(2) bears an evidential burden in relation to that matter.
Matters that must be being done or be done

(4) Subsection (1) does not apply in relation to a person and a debt if:
(a)when the debt is incurred, the company is failing to do one or more of the following matters:
(i)pay the entitlements of its employees by the time they fall due;
(ii)give returns, notices, statements, applications or other documents as required by taxation laws (within the meaning of the Income Tax Assessment Act 1997); and

(b) that failure:
(i)amounts to less than substantial compliance with the matter concerned; or
(ii)is one of 2 or more failures by the company to do any or all of those matters during the 12 month period ending when the debt is incurred;

unless an order applying to the person and that failure is in force under subsection (6).
Note: Employee entitlements are defined in subsection 596AA(2) and include superannuation contributions payable by the company.
(5)Subsection (1) is taken never to have applied in relation to a person and a debt if:
(a)after the debt is incurred, the person fails to comply with paragraph 429(2)(b), or subsection 475(1), 497(4) or 530A(1), in relation to the company; and
(b)that failure amounts to less than substantial compliance with the provision concerned;

unless an order applying to the person and that failure is in force under subsection (6).
(6)The Court may order that subsection (4) or (5) does not apply to a person and one or more failures if:
(a)the Court is satisfied that the failures were due to exceptional circumstances or that it is otherwise in the interests of justice to make the order; and

(b) an application for the order is made by the person.
Definitions

(7) In this section:
better outcome, for the company, means an outcome that is better for the company than the immediate appointment of an administrator, or liquidator, of the company.
evidential burden, in relation to a matter, means the burden of adducing or pointing to evidence that suggests a reasonable possibility that the matter exists or does not exist.

Section 588M of the Corporations Act 2001 (Cth)
Recovery of compensation for loss resulting from insolvent trading
(1) This section applies where:
(a)a person (in this section called the director) has contravened subsection 588G(2) or (3) in relation to the incurring of a debt by a company; and
(b)the person (in this section called the creditor) to whom the debt is owed has suffered loss or damage in relation to the debt because of the company’s insolvency; and
(c)the debt was wholly or partly unsecured when the loss or damage was suffered; and
(d)the company is being wound up;

whether or not:
(e)the director has been convicted of an offence in relation to the contravention; or
(f)a civil penalty order has been made against the director in relation to the contravention.

(2)The company’s liquidator may recover from the director, as a debt due to the company, an amount equal to the amount of the loss or damage.
(3)The creditor may, as provided in Subdivision B but not otherwise, recover from the director, as a debt due to the creditor, an amount equal to the amount of the loss or damage.
(4)Proceedings under this section may only be begun within 6 years after the beginning of the winding up.

Relief from liability under s 1317S of the Corporations Act 2001 (Cth)

Section 1317S provides as follows:

Relief from liability from contravention of a civil penalty provision

(1) In this section:
eligible proceedings:
(a)means proceedings for a contravention of a civil penalty provision (including proceedings under section 588M, 588W, 961M, 1317GA, 1317H, 1317HA, 1317HB, 1317HC or 1317HE); and
(b)does not include proceedings for an offence (except so far as the proceedings relate to the question whether the court should make an order under section 588K, 1317H, 1317HA, 1317HB, 1317HC or 1317HE).

(2)       If:
(a)       eligible proceedings are brought against a person; and
(b)in the proceedings it appears to the court that the person has, or may have, contravened a civil penalty provision but that:
(i)        the person has acted honestly; and
(ii)having regard to all the circumstances of the case (including, where applicable, those connected with the person’s appointment as an officer, or employment as an employee, of a corporation or of a Part 5.7 body), the person ought fairly to be excused for the contravention;

the court may relieve the person either wholly or partly from a liability to which the person would otherwise be subject, or that might otherwise be imposed on the person, because of the contravention.
(3)In determining under subsection (2) whether a person ought fairly to be excused for a contravention of section 588G, the matters to which regard is to be had include, but are not limited to:
(a)any action the person took with a view to appointing an administrator of the company or Part 5.7 body; and

(b) when that action was taken; and
(c) the results of that action.
(4)If a person thinks that eligible proceedings will or may be begun against them, they may apply to the Court for relief.
(5)On an application under subsection (4), the Court may grant relief under subsection (2) as if the eligible proceedings had been begun in the Court.
(6)For the purposes of subsection (2) as applying for the purposes of a case tried by a judge with a jury:
(a)a reference in that subsection to the court is a reference to the judge; and
(b)the relief that may be granted includes withdrawing the case in whole or in part from the jury and directing judgment to be entered for the defendant on such terms as to costs as the judge thinks appropriate.

(7)Nothing in this section limits, or is limited by, section 1317QC or section 1318.

Books and records

Section 588E(4) of the Act provides as follows:

(4) Subject to subsections (5) to (7), if it is proved that the company:
(a)has failed to keep financial records in relation to a period as required by subsection 286(1); or
(b)has failed to retain financial records in relation to a period for the 7 years required by subsection 286(2);

the company is to be presumed to have been insolvent throughout the period.

Section 588E(6) of the Act provides as follows:

(6)Subsection (4) does not have effect, in so far as it would prejudice a right or interest of a person for the company to be presumed insolvent because of a contravention of subsection 286(2), if it is proved that:
(a)the contravention was due solely to someone destroying, concealing or removing financial records of the company; and
(b)none of those financial records was destroyed, concealed or removed by the first-mentioned person; and
(c)the person was not in any way, by act or omission, directly or indirectly, knowingly or recklessly, concerned in, or party to, destroying, concealing or removing any of those financial records.

Section 9 of the Act defines ‘financial records’ to include:

(a)invoices, receipts, orders for the payment of money, bills of exchange, cheques, promissory notes and vouchers; and

(b)       documents of prime entry; and
(c)       working papers and other documents needed to explain:
(i)        the methods by which financial statements are made up; and
(ii)       adjustments to be made in preparing financial statements.

The liquidator’s position

The liquidator contends that the relevant period was between 30 September 2009 and 17 December 2012.

The liquidator contends that the company was insolvent at all times during that relevant period for the following reasons:

(a) the company failed to lodge activity statements for the period 1 October 2008 to the date of liquidation;

(b) the company failed to lodge PAYG annual reports and/or income tax returns for the financial years ended 30 June 2007 to 2012;

(c) the failure to lodge assessments as previously set out;

(d) the failure to pay pursuant to the audit carried out by the ATO;

(e) the failure to meet its trading terms with its trade suppliers. The books and records of the company demonstrate that there were a number of reminder letters, overdue notices, final notices, disconnection notices and/or threats of legal action received by the company from its suppliers;

(f) action was taken by a number of trade suppliers to pursue payment of their debts:

(iii) on 22 June 2009, 18 November 2010 and 17 March 2011, the company’s landlord, Austexx Spencer Street Pty Ltd and Austexx Spencer Pty Ltd, issued notices of default to the company;

(iv) on 11 May 2010, Dun & Bradstreet (Australia) Pty Ltd issued a notice of intention to seek instructions to issue a court summons to the company, seeking payment of debt owed to National Foods Australia Pty Ltd, in the amount of $3,493.32. That amount was not paid. As a result, a complaint was filed by National Foods Australia Pty Ltd in the Magistrates’ Court of Victoria;

(v) on 2 August 2010, EC Credit Control issued a final notice to the company, seeking payment of a debt owed to its client, D Borthwick and Sons Pty Ltd, in the sum of $55,852.63; and

(vi) on 7 June 2011, National Foods Australia Pty Ltd filed a complaint in the Magistrates’ Court of Victoria, for an outstanding debt owed by the company in the amount of $2,108.90. On 8 July 2011, the Magistrates’ Court of Victoria granted default judgment for the debt owed by the company plus interest and costs;

(g) the company never prepared income tax returns;

(h) the company never paid any employee superannuation.

In addition to contending that the company was actually insolvent during the relevant period, the liquidator contends that by virtue of the provisions of ss 588E(4) and (6) and ss 286(1) and (2) of the Act, the company is presumed to be insolvent. The liquidator refers to the report prepared by the administrator pursuant to s 439A. The administrator set out:

I have not been provided with any meaningful records in respect of the Company, nor can I confirm that such records were properly maintained and in fact exist. The records made available to me are minimal and do not enable a detailed investigation to be conducted into the affairs of the Company. As such, I am of the opinion that the Company has failed to comply with the requirements of Section 286 of the Act.

The liquidator also relies upon the apparent failure to produce monthly statements as to the company’s balance sheet, profit and loss statements, debtors ledgers, creditors ledgers, financial forecasts, or any records relating to taxation.

The defendants’ position

The company commenced operations in mid-2006.

The company accounts and taxation records were all in order until September 2008.

Mrs Patch was the person responsible for maintaining the accounts and records.

Whilst updating taxation records, Mrs Patch’s computer suffered a catastrophic document corruption, which wiped out all records of supplies, payments, wages and staff entitlements. During that incident, Mrs Patch had been suffering from PTSD and by virtue of that condition and the pressure of business, the task of remediation became overwhelming and continued to fall behind to the point that no tax returns or financial reports were produced. However, it is noted that the company did not lodge PAYG withholding annual reports and income tax returns for the years ended 30 June 2007 and 30 June 2008, and did not lodge superannuation guarantee charge statements for the periods from 1 October 2006 to September 2008.

There was a meeting with an auditor from the ATO on 15 November 2011. In or about August 2012, the company engaged business consultants and accountants, Your Business Angels, to rectify the outstanding statements and clear the debts. That took longer than expected. I note that Mrs Patch did not seek to adduce evidence of the engagement, nor was it properly explained what the terms of the engagement were apart from contending that Your Business Angels had arranged a lawyer to attend court with respect to the winding up application to put forward a rectification plan and seek the approval thereof. Mrs Patch contended that the lawyer failed to attend court as he or she thought there was no utility in doing so.

As to incurring debts and solvency, Mrs Patch contended that the company met all its traders’ debts during operations other than those outstanding at the date of liquidation. The company operated on a 30 day payment cycle. All traders had agreed to this, but in some cases the finance departments involved posted invoices on a weekly basis, thus some invoices were showing overdue stickers. Disconnection notices included in the company’s papers relate to a power company that was not contracted by the company, nor ever supplied to the company.

The rent had not been paid as the company, along with other traders, were in negotiations with Austexx Spencer Street Pty Ltd and Austexx Spencer Pty Ltd to reduce rent and management costs, and to undertake marketing as provided for in the leases. Mrs Patch had been told that the company should not pay rent by the centre manager until the issues were seen to.

The debt to National Foods was under investigation by their finance department. No notice had been given to the company that the debt was being pursued through court. Had notice been given, the company would have been represented at court.

The debt to Borthwick and Sons was dealt with by an insurance claim.

Mrs Patch had no knowledge of the second action by National Foods as only one debt was ever presented. National Foods continued to supply to the company.

Once the taxation issues were resolved, the Braybrook premises would be sold, either to a third party through an existing understanding, or by a market sale to ensure that the tax debt would be paid. If there were to be a delay in the sale then finance could be provided.

Mrs Patch contended that the plans were thwarted by reason of the conduct of Your Business Angels and the lawyer it had engaged.

Mrs Patch refuted completely that the company at any time traded while insolvent. Had there been a requirement for cash advances, then the directors would have made that available.

At no time was the company unable to meet its obligations and the outstanding tax liability would have been cleared had the business continued to trade.

The issues

Before dealing with the issues, I note that the defendants were self‑represented. During the course of the hearing, whether by reliance upon affidavit, by providing answers in cross‑examination, or by making statements from the Bar table, Mrs Patch touched upon matters which might have provided a defence to the proceeding if there had been an evidentiary basis. In any event, I have had regard to the statements and contentions made by Mrs Patch irrespective of whether or not the same had been supported by admissible evidence. To the extent possible, I have re‑examined documents to establish any corroboration of the position which she put forward. I am also grateful for the assistance of Mr Kohn, who although strenuously put forward his clients’ case, withdrew extensive objections to the affidavit material relied upon by Mrs Patch to allow such affidavits to be read subject to the weight to be given by myself. Further, Mr Kohn did not object to me having regard to statements made by Mrs Patch from the Bar table and, sensibly, did not seek to re‑open cross‑examination of her.

I am satisfied that the liquidator has made out all the proofs required under the provisions of s 588G and the two major issues for consideration are:

(vii) whether the company was insolvent during the relevant period; and

(viii) whether Mr and Mrs Patch had a defence pursuant to s 588H(2) that they each had reasonable grounds to expect, and did expect, that the company was solvent at the time and would remain solvent even if it incurred the taxation debts and other debts at that time.

Consideration
Solvency
Deemed insolvency

The purpose of the provisions for deemed insolvency upon the failure to maintain proper records was explained by Siopis J in Trinick v Forgione.[1] Siopis J said:

… to assist a liquidator in bringing recovery actions (including recovery actions against former directors for insolvent trading) when it is necessary to prove insolvency and the company’s financial records are not available.[2]

[1](2015) 106 ACSR 600 (‘Trinick v Forgione’).

[2]Ibid 628 [209].

In Re Swan Services Pty Ltd (in liq),[3] Black J said:

Section 588E(4) of the Corporations Act provides for a presumption of insolvency throughout a period in which a company has failed to keep financial records as required by s 286(1) of the Corporations Act, which requires a company to keep financial records that correctly record and explain the company’s transactions and financial position and performance and which would enable true and fair financial statements to be prepared and audited. The effect of that section is that a company is presumed insolvent throughout the period in which a failure to comply with s 286 of the Corporations Act existed. In order to establish the presumption of insolvency for a particular period, the position must be separately and distinctly proved for that period; and it must be proved either that no documents within the description of ‘financial records’ were kept in that period or that the documents which were kept were ‘deficient as to content’, because they did not correctly record and explain the company’s transactions and financial position and performance (for example, because they did not accurately record the matters purportedly recorded) or would not enable true and fair financial reports to be prepared and audited: Woodgate v Fawcett [2008] NSWSC 868; (2008) 67 ACSR 611; Re SSET Constructions Pty Ltd (in liq) — Sims v Khattar [2010] NSWSC 102; Fisher v Divine Homes Pty Ltd [2011] NSWSC 8; (2011) 85 ACSR 512 at [24]. The liquidator accepts that the presumption under s 588E(4) of the Corporations Act does not arise merely because of a failure to keep or prepare income tax returns, business activity statements, balance sheets or profit and loss accounts: Fisher v Divine Homes Pty Ltd above at [23]. However, the liquidator submits that the financial records maintained by Swan Services and the Companies were deficient to the point that they did not ‘correctly record and explain the company’s transactions and financial position and performance’: Fisher v Divine Homes Pty Ltd above at [24].[4]

[3][2016] NSWSC 1724.

[4]Ibid [127].

The question which I need to consider is not how the records were maintained. Even accepting that the records were kept in a ‘mess’, the question for me to consider is if the records were sufficient to enable the company to record and explain the company’s transactions, financial position and performance. I am satisfied that they were not so maintained. I make that determination for the following reasons:

(a) the answers to the questionnaire referred to in paragraphs 42 and 43 hereof were to the effect that no income tax returns for the company were prepared since the purchase of Caldera. From that time no returns were prepared with respect to the goods and services tax, and from 2006, no superannuation returns were provided;

(b) in answer to question 84 of that questionnaire, Mrs Patch set out that the causes of the failure of the company included the ‘[p]oor maintenance of records’;

(c) during the hearing, Mrs Patch maintained that all the records had been delivered to Your Business Angels and were subsequently provided to the liquidator;

(d) however, in answer to a question I posed about whether the records were proper records and properly maintained, Mrs Patch conceded ‘I am honest to say that those — they were not, and that is my issue’;

It all — I had a computer failure which exacerbated the situation, because all the records were, in fact, in there and up to date, and I felt — and when I had to re‑enter all that documentation I just got further and further behind, and I did not seek the appropriate assistance to do so.

(e) the failure to generate monthly management accounts meant that the company had no idea of its financial performance at any one time;

(f) it has taken this hearing and some ‘detective work’ to establish that the defendants are by far the greatest creditors of the company.

In Fisher v Divine Homes Pty Ltd,[5] Barrett J determined that the totality of the documents that were kept in relation to a particular period was not known. Accordingly, it was not possible to find that the totality did not correctly record and explain the company’s transactions and financial position and performance, or would not enable the true and fair financial statements to be prepared and audited.
[5](2011) 85 ACSR 512.

In this case, I determine that the opposite conclusion must be reached. But for the assessment imposed by the ATO, the records did not enable an assessment of the financial position of the company at any one time. Further, but for the hearing of this proceeding, the records were insufficient to establish the liabilities owed to Mr and Mrs Patch. The company is to be deemed insolvent during the relevant period.

Actual insolvency

As the liquidator was unable to point to any major debts apart from the taxation liability that had been incurred during the relevant period, I sought to be assisted with respect to when the tax liabilities were incurred within the meaning of s 588G(1)(b) of the Act. Section 588G applies, inter alia, if:

… the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt …[6]

[6]Corporations Act 2001 (Cth) s 588G(1)(b) (emphasis added).

As identified in Crema Pty Ltd v Land Mark Property Developments Pty Ltd,[7] s 95A adopts a cash flow approach. Dodds‑Streeton J (as her Honour then was) determined:

Section 95A of the 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. 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:
Insolvency 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.[8]

[7](2006) 58 ACSR 631.

[8]Ibid 652 [141]–[142] (citations omitted).

The liquidator’s insolvency report has categorised the company’s inability to meet its debts, as and when they became due and payable, into two parts: the inability to meet statutory obligations, and the inability to meet trading terms set by trade suppliers. Given the relatively low quantum of trade suppliers noted in the s 439A report and in the RATA, I will concentrate upon the statutory obligations.

When were these debts incurred?

In Powell v Fryer,[9] Olsson J, with whom Duggan and Williams JJ concurred, considered the relevant statutory provisions at [56] through to [73]. His Honour said:
[9](2001) 159 FLR 433 (‘Powell v Fryer’).

The logical commencement point is s 588G. This stipulates that the section applies if:
(a)a person is a director of a company at the time when the company incurs a debt; and
(b)the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and
(c)at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent as the case may be; and
(d)that time is at or after the commencement of [Pt 5.7B of the Corporations Law (that is, 23 June 1993)].

The section goes on to provide that, by failing to prevent the company from incurring the debt, the person contravenes it if:
(a)that person is aware, at that time, that there are such grounds for so suspecting; or
(b)a reasonable person in a like position in a company in the company’s circumstances would be so aware.

It is at once apparent that three particular concepts immediately arise for consideration in relation to those provisions.
The first is what constitutes a ‘debt’ for the purposes of the section. The second is to when a debt is ‘incurred’. The third is as to when a company may be said to be insolvent, within the meaning of the section.[10]

[10]Ibid 442 [57]–[60].

Olsson J concluded that a statutory impost was a debt within the meaning of s 588G.

Olsson J also concluded that the debt was incurred when ‘by its conduct or operations, a company has necessarily subjected itself to a conditional, but unavoidable, obligation to pay a sum of money at a future time’.[11]
[11]Ibid 444 [73].

In the end, I determined that as Mrs Patch conceded that the ATO liability was unable to be paid out of cash flow, it makes no difference whether the ATO liability was considered to be ‘incurred’ at the time each return ought to have been lodged, or at the time that each default assessment was provided to the company. Each of those assessments became due and payable in mid‑2012 on the various dates set out in the statutory demand. Further, the audit carried out by the ATO was not an audit of the books and records of the company but an audit of the information which had been previously advised to the ATO and used as a basis for the estimates.

I am satisfied that all the indicia of actual insolvency are present in this instance. Accordingly, the issue for me to consider whether or not Mr and Mrs Patch were willing to raise funds and had the ability to provide the necessary funds to the company.

Availability of funds

In Barboutis v The Kart Centre Pty Ltd (No 2) (‘Barboutis’),[12] the Court said:

It is now established that, as s 95A does not include reference to payment from the company's own money, in an appropriate case when assessing solvency the court may take into account the company's ability to obtain unsecured loan funds — which might include support in the form of an unsecured borrowing or voluntary extension of credit from a shareholder or associated person. So doing is consistent with assessing ability to pay debts as and when they become due and payable as a matter of commercial reality. As the inquiry is concerned with commercial realities, however, there is a difference between the demonstration of an ability to borrow from an arm's length commercial credit provider and a mere promise of support from a parent company or directors. The capacity to raise funds from external sources must be judged in a practical and businesslike way by reference to the commercial realities of the case. Possibilities are not enough; there must be genuine and realistic availability as a matter of commercial reality.[13]

[12][2020] WASCA 41 (‘Barboutis’).

[13]Ibid [141] (citations omitted).

Mrs Patch contended that the company was always solvent during the relevant period as funds could be raised by either the sale of property or by raising finance against the equity in the property.

In Lewis v Doran,[14] at first instance, Palmer J held that the question of insolvency is:

a question of fact ‘to be ascertained from a consideration of the company’s financial position taken as a whole. In considering the company’s financial position as a whole, the Court must have regard to commercial realities. Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security, and when such realisations are achievable’: Southern Cross Interiors Pty Ltd (in liq) v DCT (2001) 53 NSWLR 213 at 224 (citations of authority omitted); 188 ALR 114; 164 FLR 430; 39 ACSR 305 at 316.[15]

[14](2004) 208 ALR 385 (‘Lewis v Doran’).

[15]Ibid 408 [106].

In the absence of the words ‘from its own monies’ in the definition of insolvency in s 95A of the Act, Palmer J held that retrospective insolvency and prospective insolvency are ‘question[s] of commercial reality having regard to the particular facts of the case’.[16] Palmer J’s view on the consideration of ‘commercial realities’ was not challenged on appeal.
[16]Ibid 409 [111].

Palmer J also held that the court can consider funds made available to the company by a third party without security.[17] This was upheld on appeal. Giles JA, with whom Hodgson and McColl JJA agreed, held that ‘there is no compelling reason to exclude from consideration funds which can be gained from borrowings secured on assets of third parties, or even unsecured borrowings’[18] because the company will have funds from the borrowings to pay its debts as they fall due and are therefore solvent.[19] Giles JA held that if the evidence can establish that the company can obtain funds, even if they were voluntarily provided, then that is sufficient.[20]
[17]Ibid 409 [112], 410 [116].
[18]Lewis v Doran (2005) 219 ALR 555, 579 [109] (‘Lewis v Doran appeal’).
[19]Ibid.
[20]Ibid 580 [111]–[112].

Therefore, if there is sufficient evidence that a company can obtain voluntary funds from a third party, it can establish solvency.

Further, there needs to be a sufficient degree of commitment in providing financial support to the company such that the company can pay its debts as they fall due. In Chan v First Strategic Development Corporation Ltd (in liq) (‘Chan v First Strategic’),[21] Morrison JA, with whom Gotterson JA and Boddice J agreed, held that there needs to be a ‘degree of assuredness that the financial support will be forthcoming and at such a level that one could say the company was able to pay its debts as and when they fall due, rather than being possibly able to do so’.[22] Morrison JA held that a conclusion of solvency can be drawn through sufficient financial support where ‘the financial support was of such a degree of commitment that it was likely to continue, and with the result that the company was able to pay its debts’.[23] When the financial support is provided by a director in circumstances where ‘there is no formalised agreement or understanding’,[24] cogent evidence is required.[25] Chan v First Strategic was followed in Miles v Editshare Asia Pacific Pty Ltd (in liq).[26]
[21][2015] QCA 28.
[22]Ibid [43] (emphasis omitted).
[23]Ibid [43].
[24]Ibid [44].
[25]Ibid.
[26][2020] QCA 78.

However, whether a director can provide financial support to a company may not be sufficient in itself to determine the question of insolvency. In Barboutis,[27] the Court held, that, in the context of prospective insolvency, while there was available financial support from a third party, there were two matters to be noted:

First, this finding is not determinative on the question of insolvency. The Company’s access to further unsecured borrowing from FMA is simply one matter be taken into account as an aspect of the overall commercial reality by which the Company’s solvency is to be judged. Second, the weight to be given to this finding is significantly affected by the lack of information as to the extent of FMA’s capacity to provide further funding to the Company on a deferred payment basis.[28]

[27]Barboutis (n 12).

[28]Ibid [150] (emphasis omitted).

In Barboutis,[29] the Court held that although there was ‘non-payment of the Company’s tax-related liabilities and the consequential issue of the garnishee notices’,[30] there was an alternative reason for this, which is that the company’s bank account was frozen due to another dispute and is therefore weak evidence of insolvency. Further, while the company had access to funds from a third party which would be an unsecured loan on deferred payment terms, it was weak evidence of solvency given the absence of evidence as to the third party's capacity to advance such funds. On the whole of the evidence, including the finding that a specific loan was not a debt presently due and payable, the Court upheld the first instance judgment that the company was not insolvent.[31]
[29]Barboutis (n 12).
[30]Ibid [154].
[31]Ibid [154]–[156].

Therefore, in determining whether Mr and Mrs Patch can prove solvency by way of personal contributions of funds to a company, it is likely that they would need to provide sufficient evidence that they have a sufficient degree of commitment to advancing funds to the company for it to pay its debts and that other factors prove solvency as a matter of overall commercial reality.

While that was the position maintained by Mrs Patch at the hearing, each of the notices provided information about what to do if any difficulty was experienced in paying the outstanding amount, or if there was disagreement with the decisions. There is an element of ‘head burying in the sand’ and I do not accept Mrs Patch’s explanation, particularly given that evidence of the engagement of Your Business Angels was not produced. I cannot confirm the scope of the engagement. Nor can I confirm whether Your Business Angels was required to do anything other than to arrange for the attendance of a lawyer at court for the winding up application.

Further, the contention that there was a willingness to pay the ATO liability is not consistent with the company’s conduct. As referred to in paragraph 46 hereof, from the end of 2010 to mid‑2011, the superannuation funds of Mr and Mrs Patch had been paid into the company’s overdraft account. Given the nature of superannuation funds, Mrs Patch must have realised that the company could not survive without the then injection. Further, given the agreement apparently reached with Mrs Patch on 15 November 2011, I can only conclude that Mrs Patch was aware that the company could not pay the amount from its cash flow.

Subsequently, at no time from the company’s receipt of the ATO’s notice of assessment was there any attempt to pay any amount when the Werribee property was sold.

Even before the actual liquidation of the company, Mr and Mrs Patch had the ability to seek to make payment to the ATO on receipt of the statutory demand. This was not done.

Further, prior to the liquidation of the company, if they had been so willing to pay, a deed of company arrangement could have been proposed to the administrators for consideration by the creditors.

Further, there were other debts owed to employees and trade creditors when the administrators were appointed which had not been paid. This suggests both that Mr and Mrs Patch may not have been sufficiently willing to provide financial support to the company for the company to pay its debts and that the company was insolvent.

After the liquidator’s appointment on 4 February 2013, the CBA advised that the company owed it $206,958.43.

Mrs Patch contended that the Werribee property was sold in 2013 to clear the caveat of Your Business Angels and the mortgage on that property, but no exact date was provided. However, a payment of $136,865.37 was paid into the company’s Better Business Loan of $290,000 account on 4 February 2013, and this essentially paid out this loan facility. Further, a payment of $21,300.92 was paid into the company’s overdraft account on 4 February 2013, and this essentially paid out the account. Accordingly, these payments may have been from the sale of the Werribee property, which means that the sale was on or around 4 February 2013.

As such, by February 2013, three of the accounts with the CBA had been paid out — the two loan accounts for $90,000 and $290,000, and the overdraft account.

In relation to the contingent liability, the receivers and managers of Austexx Spencer Pty Ltd and Austexx Spencer Street Pty Ltd demanded payment of $49,500 pursuant to the bank guarantee in a letter addressed to the CBA dated 7 February 2013. No other information has been provided as to when this amount was subsequently paid to the bank by the company.

In the RATA dated 27 February 2013, there was no reference to the CBA as a secured creditor. Therefore, the debt to the bank, including regarding the contingent liability, may have been discharged by that time.

Further, Mrs Patch contended that the Williamstown property was sold in 2015, but no exact date was provided. The sale allowed the mortgages to be cleared and the remaining balance was used to purchase the current residential property. Mrs Patch contended that the equity in the property was extensive (over $519,000) and could have been accessed if it had to be done, but no loan was actually sought on the property.

Although I accept that there may have been sufficient equity left in the Williamstown property (the personal property of Mr and Mrs Patch), no evidence was adduced to demonstrate that such equity could have been utilised to meet the liability. I make that observation in the context of Mrs Patch confirming that the company could not meet the liability out of cash flow. Mrs Patch, in answer to question 11 of the questionnaire (referred to in paragraphs 42 and 43 hereof), answered that she had not received any salary for the three years prior to liquidation. Further, I have no evidence as to the ability of Mr Patch to service any loans.

Those circumstances demonstrate a lack of ability to meet the liability from their own personal assets. I did not receive any evidence that the CBA or any other bank may have been willing to advance further funds.

In Barboutis,[32] the Court referred to Lewis v Doran[33] in paragraph 142:

The appropriate approach was outlined in Lewis v Doran (the relevant passage being referred to by the master in the primary reasons):

[W]here prospective insolvency is in issue [as it is in the present case] the court, as a general rule, would be sceptical of an assertion that a third party is willing to advance funds unsecured on such terms as would not, in any event, bring about insolvency. Such willingness on the part of a third party would have to be cogently demonstrated, if not as a matter of legal obligation, then as a matter of commercial reality.[34]

[32]Barboutis (n 12).

[33]Lewis v Doran (n 14).

[34]Barboutis (n 12) [142] (citations omitted).

I have taken Mrs Patch’s evidence to be that it was the Williamstown property which had sufficient equity to raise borrowings to meet the ATO’s debts. However, no letter of offer was produced nor any CBA officer called to provide evidence as to the CBA’s terms and conditions which might have been applicable at the time the loan would have been required. Nor did Mrs Patch seek to introduce evidence from any other lender. The omission is relevant to the failure to ‘cogently demonstrate’ that there was an ability to raise the funds. Given the apparent lack of capacity to service borrowings, I cannot be satisfied that a bank would have been willing to advance funds to Mr and Mrs Patch. Given that funds had been previously injected to pay down bank borrowings, I do not know if that were by choice or pursuant to a requirement of the CBA. I suspect that the payments were directed as required by the CBA as superannuation funds had been applied but I do not need to arrive at any conclusion about that given the absence of the ‘cogent demonstration’ of their ability to raise the funds.

Accordingly, I am not satisfied that Mr and Mrs Patch had the ability to raise funds. It follows that it is unnecessary to decide if they were willing to provide funding.

However, for completeness, I note that Mrs Patch maintained a willingness to provide or secure funding. Such willingness is inconsistent with the conduct set out in paragraphs 102 to 105 hereof.

Accordingly, I determine that the company was insolvent during the relevant period.

Defence pursuant to s 588H(2)
Reasonable grounds to suspect the company was insolvent

In Trinick v Forgione,[35] Siopsis J said:

In the case of Australian Securities and Investments Commission v Edwards (2005) 220 ALR 148; 54 ACSR 583; [2005] NSWSC 831 at [249]–[250], Barrett J made the following observations in relation to the approach to be taken in assessing whether an applicant has satisfied the requirements of s 588G(1)(c):
The inquiry relevant to s 588G(1)(c) is not an inquiry concerning the particular director whose conduct is under scrutiny. It is an inquiry into the objectively formed state of mind of a person of ordinary competence. These propositions are supported by cases such as 3M Australia Pty Ltd v Kemish (1986) 10 ACLR 371 and Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699. As Einfeld J observed in the latter case (at 703) questions of the particular director’s knowledge of and participation in the incurring of the debt play no part in this aspect of the s 588G inquiry.
The central word in s 588G(1)(c) is ‘suspecting’. The criterion is one of suspicion, which is something less developed and less well formulated than expectation. The matter was explained by Kitto J in Queensland Bacon Pty Ltd v Rees (1966) 115 CLR 266 at 303; [1966] ALR 855 at 874 in this way:
In the first place, the precise force of the word ‘suspect’ needs to be noticed. A suspicion that something exists is more than a mere idle wondering whether it exists or not; it is a positive feeling of actual apprehension or mistrust, amounting to ‘a slight opinion, but without sufficient evidence’, as Chambers’s Dictionary expresses it. Consequently, a reason to suspect that a fact exists is more than a reason to consider or look into the possibility of its existence. The notion which ‘reason to suspect’ expresses in subs (4) is, I think, of something which in all the circumstances would create in the mind of a reasonable person in the position of the payee an actual apprehension or fear that the situation of the payer is in actual fact that which the subsection describes — a mistrust of the payer’s ability to pay his debts as they become due and of the effect which acceptance of the payment would have as between the payee and the other creditors.[36]

[35]Trinick v Forgione (n 1).

[36]Ibid 643 [314].

I determine that the liquidator has made out that there were reasonable grounds for suspecting that the company was insolvent, or would so become insolvent, as the case may be, for the reasons set out in the following paragraph.[37]
[37]Corporations Act 2001 (Cth) s 588G(1)(c).

I determine that a reasonable person in the position of Mrs Patch would have had reason to ‘suspect’ the company was insolvent due to:

(ix)the failure to prepare and lodge statutory returns;

(x) the failure of the company to maintain proper records;

(xi)the failure to comply with the agreement with the ATO to file outstanding lodgements;

(xii) the absence of cash flow to meet the ATO payments;

(xiii) the absence of cash flow to meet relatively minor creditor claims;

(xiv) the requirement to inject superannuation funds to meet liabilities and reduce the overdraft; and

(xv) that a director of the company, Mrs Patch, was not being paid for her services as the accounts manager.

Did Mrs Patch have a reasonable expectation as to the company’s solvency?

The defence under s 588H(2) of the Act requires ’an actual expectation that the company was and would continue to be solvent’.[38] Although the ‘expectation’ referred to in s 588H is subjective, such expectation must be held on reasonable grounds.[39] A director must establish more than a mere hope of solvency, and there must be reasonable grounds adduced on which the view was formed.[40]
[38]Tourprint International Pty Ltd (in liq) v Bott (1999) 32 ACSR 201, 215 [67] (‘Tourprint v Bott’).
[39]Ibid.
[40]Ibid.

The sole ground put forward by Mrs Patch was her belief that funds could be raised by either sale of property, or raising finance against the equity in the property.

Although the inquiry under s 588H(2) is subjective, the grounds for the expectation referred to in the subsection must be reasonable. By reason of what I have set out at paragraphs 91 to 118 hereof when dealing with the question of solvency, I determine that Mrs Patch could not support any ‘expectation’ on grounds which were reasonable.

Accordingly, I determine that the defence under s 588H(2) is not available to her.

Other defences under s 588H of the Act

I determine that the defence under s 588H(3) would not have been available in any event as I have received no evidence as to what Your Business Angels was required to do. Further, Mrs Patch concedes that she had not relied upon that organisation for insolvency advice but they had been retained to attend to remediation of the company’s records.

I determine that the defence under s 588H(4) is not available as Mrs Patch conceded that she did not stand down from her position as a director, and also conceded that she should have engaged somebody else to attend to the accounts but did not do so.

I determine that no defence under s 588H(5) is available and it was not pressed in any event. The appointment of the voluntary administrators on 23 November 2012 was after the ATO had served the garnishee notice and after receipt of the application to wind up the company. I can only conclude that the action taken to appoint the administrator was merely to seek to stave off the application in the Federal Court by the ATO.

Mr Patch

Both Mr and Mrs Patch concede that Mr Patch had no involvement in the company prior to the need to engage Your Business Angels. It follows that Mr Patch did not discharge his duties as a director.

With respect to the defence under s 588H(2), in Tourprint International Pty Ltd v Bott,[41] Austin J said:

‘Expectation’, as required by s 588H(2) means a higher degree of certainty than ‘mere hope or possibility’ or ‘suspecting’: 3M Australia Pty Ltd v Kemish (1986) 10 ACLR 371 at 378; Dunn v Shapowloff [1978] 2 NSWLR 235 at 249; (1978) 3 ACLR 775 . The defence requires an actual expectation that the company was and would continue to be solvent, and that the grounds for so expecting are reasonable. A director cannot rely on a complete ignorance of or neglect of duty (Metal Manufacturers Ltd v Lewis (1986) 11 ACLR 122 at 129) and cannot hide behind ignorance of the company’s affairs which is of their own making or, if not entirely of their own making, has been contributed to by their own failure to make further necessary inquiries: Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405; Morley v Statewide Tobacco Services Ltd [1993] 1 VR 423; (1992) 8 ACSR 305.[42]

[41]Tourprint v Bott (n 38).

[42]Ibid 215 [67].

Accordingly, the defence is not available to Mr Patch.

Sleeping directors, or directors who fail to take reasonable steps to acquire information about the company’s financial state which could be reasonably required of company directors, will not be able to prove a defence under s 588H(2).

Section 588GA of the Act

In the defendants’ further submissions, Mrs Patch relied upon s 588GA. Mrs Patch submitted:

if the director starts to put together a plan that has a chance of putting the company in a better position … that plan can be implemented and the company turned around, the directors will not have to be concerned about the prohibition on insolvent trading.

I assume that the submission is founded upon the engagement of Your Business Angels. I repeat that I have not received any evidence setting out the terms of that engagement.

In any event, I determine that s 588GA does not have any application as:

(a) the ATO debts were incurred prior to the implementation of any course of action;

(b) alternatively, the ATO debts were not incurred in connection with any course of action; and

(c) the provisions are not available if:

(xvi) there was a failure to pay the entitlements of the employees (in this instance, the superannuation guarantee amounts); and

(xvii) the company had not complied with obligations to provide returns to the Deputy Commissioner.

In any event, if required to do so, I would not be satisfied that such failures were due to exceptional circumstances or that it is otherwise in the interests of justice to make any order excusing the failures as referred to in the previous paragraphs.

Section 1317S of the Act

Although the defendants did not seek to be excused from liability by virtue of the provisions available under s 1317S, as they were self‑represented, it is appropriate that I deal with the issue.

Section 1317S involves three stages of inquiry:

(xviii) whether the applicant for relief has acted honestly;

(xix) whether having regard to all the circumstances, the applicant ought fairly to be excused; and

(xx) whether the applicant should be relieved from liability.

In Powell v Fryer, Olsson J said:[43]

The authorities indicate that a director acts ‘honestly’ (within the statutory meaning of that word) when he acts bona fide in the interests of the company, including the unsecured creditors of that entity: see Marchesi v Barnes [1970] VR 434, Dominion Insurance Co of Australia Ltd (In Liq) v Finn (1988) 7 ACLC 25 at 33–34, Australian Growth Resources Corporation Pty Ltd v Van Reesema (1988) 13 ACLR 261 and Grove v Flavel (1986) 43 SASR 410.

[43]Powell v Fryer (n 9) 450 [111].

Albeit that the liquidator does not contend that Mr and Mrs Patch acted dishonestly, their conduct did not have regard to the interests of all the unsecured creditors of the company.

I am saddened that Mr and Mrs Patch find themselves in the position they are now in. It is clear that Mrs Patch was motivated to found the business of the company and to continue it to provide employment for her disabled son who now resides with Mr and Mrs Patch and their grandchild in modest accommodation when compared to their former Williamstown residence. Both Mr and Mrs Patch are now pensioners. I also note that Mr and Mrs Patch lost three properties and their superannuation funds to prop up the company’s operations.

Further, I note that Mr and Mrs Patch were by far the greatest creditors of the company by reason of the injection of the superannuation funds and the sale of properties to pay down trade creditors and the CBA.

However, in not exercising the discretion under s 1317S, I note as follows:

(a) Mr Patch did not concern himself to discharge his duties as a director by being involved in the management of the company;

(b) Mrs Patch failed to ensure that the records of the company were properly maintained and, in particular, failed to lodge returns required by the ATO;

(c) there was a failure to comply with requests by the ATO to lodge returns;

(d) Mrs Patch failed to ensure that the ATO assessments were met;

(e) Mrs Patch failed to investigate the possibility of raising finance to meet the ATO liability;

(f) Mrs Patch failed to ensure that the company paid its liability on receipt of the statutory demand, or to negotiate with the ATO to come to any sort of arrangement;

(g) Mrs Patch, at the eleventh hour, together with Mr Patch, resolved to appoint administrators to the company without putting forward a proposal for a deed of company arrangement;

(h) the inescapable conclusion from that conduct is that the appointment of the administrators and the subsequent attempt to voluntarily wind up the company was done in an attempt to thwart the application of the ATO to wind up the company in insolvency;

(i) the inescapable conclusion is that Mr and Mrs Patch acted to minimise their personal liabilities. Each had guaranteed the liabilities to the CBA. Mortgages were provided in support of those guarantees. The funds provided from the superannuation funds of Mr and Mrs Patch reduced the CBA overdraft liability. The subsequent sales of properties also were applied to payment of the CBA liabilities. The landlord was paid out after the winding up of the company as that liability was linked to the CBA facilities and personally guaranteed by Mr and Mrs Patch;

(j) the liability owed to Your Business Angels was paid out on the sale of the Werribee property. This was paid as Your Business Angels had lodged a caveat over the property, notifying its interest arising by way of a lien; and

(k) finally, the inescapable conclusion is that the ATO liability was not met as apparently there was no direct personal liability on the part of Mr and Mrs Patch. It is almost as if the ATO was being used as a banker or a resource once the superannuation funds had been utilised to prop up the company.

For the reasons I set out in the previous paragraph, I determine that each of the defendants ought not to be excused.

To the extent that Mrs Patch’s physical condition ought to be taken into regard without consideration of the matters which are set out in paragraph 143 hereof, I determine that that circumstance, if it were a condition to bear upon the discretion, ought not to be taken into account. Mrs Patch conceded that she did not step down from her position as a director and ought to have engaged somebody else to attend to the accounts of the company but did not do so.

Accordingly, I determine that each ought not to be excused pursuant to the provisions of s 1317S.

Conclusion

By reason of the consideration set out in these reasons, I determine that each of the defendants ought to compensate the company in the sum of $101,151.91. However, I decline to order any interest. The liquidator left it to the eleventh hour to file this proceeding. If the proceeding had been filed in a timely manner, there is a possibility that the claim might have had some prospect of being resolved in 2015 when Mr and Mrs Patch sold the Williamstown property. Further, although not directly bearing on the question of interest, I note that Mr and Mrs Patch are by far the largest creditors of the company. They should not be imposed upon any further.

Subject to further submissions, I will make the following orders:

1. Pursuant to s 588M(2) of the Corporations Act 2001 (Cth), the defendants pay the company $101,151.91.

2. The defendants pay the plaintiffs’ costs, including reserved costs, on a standard basis.

[2020] VSC 652

7 October 2020