Tolcher v John Danks and Son P/L - [2007] NSWSC 1207

No judgment structure available for this case.

CITATION: TOLCHER & ORS v JOHN DANKS AND SON PTY LTD [2007] NSWSC 1207

HEARING DATE(S): 2-3/10/2007

JUDGMENT DATE :
1 November 2007

JURISDICTION: Equity

JUDGMENT OF: Bryson AJ at 1

DECISION: (1) Give judgment for the plaintiffs for $140,000.00 with costs; (2) Reserve further consideration of interest.

CATCHWORDS: CORPORATIONS - liquidation - unfair preferences - in June 2005 the company (hardware store) renegotiated repayment of its debt to its major supplier of hardware stock - about $300,000 owing: repayments $7,000 per week and stock purchases COD - weekly payments thereafter meant that debt was falling but ageing - additional charges for franchise fees interest and services but not for goods - administration on 21 February 2006, liquidation on 21 March 2006, claim to recover weekly payments from 22 August 2005 onwards $140,000 as unfair preferences - issues of insolvency and suspicion of insolvency as of June 2005 and later - decision on facts - judgment for $140,000 as unfair preference.

LEGISLATION CITED: Corporations Act

CASES CITED: Cooks Constructions Pty Ltd v Brown (2004) 49 ACSR 62
Rodgers v Rumortex [1999] NSWSC 658
Sandell v Porter (1996) 115 CLR 666

PARTIES: Raymond George Tolcher - First Plaintiff
Robert William Whitton - Second Plaintiff
Waddell & Son Pty Ltd (In Liq) - Third Plaintiff
John Danks and Son Proprietary Ltd - Defendant

FILE NUMBER(S): SC 4797/2006

COUNSEL: S. Golledge - Plaintiffs
R.D. Marshall - Defendant

SOLICITORS: Nash O'Neill Tomko Lawyers - Plaintiffs
Braye Cragg Solicitors - Defendant

IN THE SUPREME COURT
OF NEW SOUTH WALES
EQUITY DIVISION
CORPORATIONS LIST

BRYSON AJ

1 November 2007

4797/2006 RE: WADDELL & SON PTY LIMITED (IN LIQUIDATION)
TOLCHER & ORS v JOHN DANKS AND SON PTY LIMITED

JUDGMENT

1 BRYSON AJ: Waddell & Son Pty Limited (the company) was formed in New South Wales on 11 June 2003. The company operated as trustee of the Waddell Family Trust, a trust of $100 settled on 11 June 2003. The company agreed to purchase a business at Kotara in June 2003 and commenced trading on 5 December 2003 as a hardware retailer at Northcott Drive Kotara under the business name Home Timber and Hardware, Kotara. The business included supply of timber and power tools, paints, gardening and landscaping equipment, pool and outdoor living supplies; with in-store customer service to home renovators and handymen. In or about February 2006 it extended its business and purchased a hardware retail business at Redhead. Its directors and members from incorporation were Mr Robert Waddell and his son Mr Jason Waddell; they were the only shareholders and each held one share. The company gave National Australia Bank Limited a fixed and floating charge over all its assets in December 2003, registered on 6 January 2004.

2 In November 2003 the company applied to the defendant John Danks and Son Pty Ltd for a monthly credit account, supported by personal guarantees of Mr Robert Waddell and Mr Jason Waddell; and a credit account was opened. It was not unusual, at any time after February 2004, for the company's account with the defendant to operate outside the repayment terms specified on the tax invoices, which required payment within 30 days from the month following the month in which the invoice was rendered. The company entered into a franchising agreement with the defendant on 5 December 2003, under which its business at Kotara was treated as a member of the hardware marketing and buying group identified and marketed under the names HOME HARDWARE and/or HOME TIMBER AND HARDWARE. The franchising agreement established a business relationship with the defendant for purchases of stock, participation in marketing and promotional programs, trading identification and Group signage. The company agreed not to be a member of any other hardware marketing group, and agreed to stock all the Group house branded products and the designated range of core stock products in all departments. The agreement did not provide for exclusive dealing in the purchase of trading stock, and did not entitle the defendant to receive financial information from the franchisee. The Redhead store was part of a different marketing group referred to as Thrifty-Link.

3 On 22 February 2006 the company went into administration by resolution of its directors, and the first two plaintiffs Mr R.G. Tolcher and Mr R.W. Whitton became its Administrators. They are insolvency practitioners in the firm Lawler Partners Business Recovery and Insolvency of Hunter Street Newcastle. They became its Liquidators when on 21 March 2006 the company was placed into Creditors Voluntary Winding-up by a meeting of creditors; it remains in liquidation, and is the third plaintiff. Mr Robert Waddell became bankrupt on his own petition on 23 March 2006 and Mr Jason Waddell on 14 November 2006.

4 The plaintiffs sue to recover 20 payments each of $7,000 made approximately weekly from 26 October 2005 until 23 December 2005; and on 27 January 2006 and 6 February 2006. These continued a series of weekly payments of $7,000 which began in June 2005; the 20 payments sued for are the ones which fell within six months ending on the Relation-Back Date, 22 February 2006. The claim is that each payment was an unfair preference occurring at a time when the company was insolvent during the Relation Back Period.

5 Provisions of the Corporations Act which bear on the entitlement to recovery include s 588FA:

6 Section 588FC provides:

(ii) an act is done, or an omission is made, for the purpose of giving effect to the transaction; or

7 Section 588FE includes:

Corporations Amendment (Repayment of Directors’ Bonuses) Act 2003

8 I also set out parts of s 588FF(1):

9 Section 95A defines solvency:

10 I was given a careful and full citation of authorities dealing with the operation of these provisions. In my opinion s 95A states a different and more stringent test for solvency than the test considered by Barwick CJ in Sandell v Porter (1996) 115 CLR 666 at 670-671. It is I think plain that the questions for decision are questions of fact, and I dispose of the issues before me on that basis.

11 The principal issues appearing from the Originating Process and the Grounds of Opposition are these. It is admitted that the payments were made. It is not admitted that the company was insolvent when they were made and it is not admitted that the defendant received more payments than the defendant would have received if the payments were set aside and the defendant proved in the winding up. It is denied that each of the payments separately constituted an unfair preference, an insolvent transaction or a voidable transaction. The defendant alleges that it became a party to the payments in good faith, and that at that time the defendant had no reasonable grounds for suspecting that the company was insolvent, any reasonable person in the defendant’s circumstances would have had no such grounds are so suspecting and the defendant provided valuable consideration and has changed his position in reliance on the transactions.

12 The defendant relies on s 588FG(2) which provides:

13 Mr Tolcher and Mr Whitton formed the view early in their Administration that there had been poor financial control and inadequate record-keeping. The company’s financial statements should be understood with Mr Tolcher’s evidence about the basis on which they were prepared; his evidence showed some respects in which they were plainly inadequate. They relate on their face to the Waddell Family Trust of which the company was trustee; the company had no other significant affairs. The financial statements show and it is clear that the company had no significant capital; it had only the Trust Settlement sum of $100. It did not ever own any real property, or significant tangible property other than the trading stock, plant and equipment. The financial statements show trading profit for the period to 30 June 2004 at $182,734, net loss at $33,365, and that year closed with a deficiency in share capital and reserves of $33,265. In the balance sheet at 30 June 2004 the most significant assets were trade debtors, stock on hand, plant and equipment and the goodwill of the business at Kotara at cost $251,474. The stock was valued at cost price, and not at the lesser of cost and net realisable value; plant and equipment were also valued at cost. Loans by the directors which were unsecured and totalled $456,625 were listed as Current Liabilities. Non Current Liabilities included $162,000 owing to National Australia bank referred to as “Market Rate Facility” and $220,996 owing to Perpetual Trustees Ltd referred to as “Business Loan”.

14 In the financial statements for the year to 30 June 2005 the net loss for the year is shown as $13,208 bringing accumulated losses to $46,573 and deficiency in share capital and reserves to $46,473. Inventory plant and equipment continued to be valued at cost and the goodwill of the business at Kotara continued to be valued at cost $251,474; intangible assets in the balance sheet also included goodwill of the business at Redhead valued at cost $23,818. The directors’ loans had become drawings by the directors referred to (in an obscure way in the financial statements) as negative directors’ loans. Under Current Liabilities the directors’ loans had become liabilities of the directors to the company totalling $108,683, a movement from loans by the directors in the previous year to loans to the directors adverse by $565,308 in terms of current assets which dealings between the directors and the company made available to it. Current Liabilities were shown at a total of $500,378. The credit from National Australia Bank Market Rate Facility had fallen and the credit from Perpetual Trustees Business Loan had risen, leading to an increase of non-Current Liabilities over the previous year of $127, 382. The stock on hand had fallen from $601,452 at 30 June 2004 at $521,804 at 30 June 2005, a fall of $79,648. On the face of these documents, the company’s original deficiency of working capital, and of capital of any kind, became significantly worse during that year. Solvency was dependent on successful trading, control of debtors, and availability of long-term loans. Where a company's balance sheet is in this state, with an evident overall and continuing deficiency of capital, the conclusion that the company was insolvent at some particular time is more readily reached, although it must be shown by evidence.

15 The company’s external accountant Mr Shamia gave this explanation for the movement in the Directors’ Loans.

From my knowledge of the internal book-keeping practices of the Third Defendant, together with information provided to me by the directors of the Company, while there were, during this period, increases in the loans to directors attributable to drawings being made on those loans by the directors, those drawings were not to the full value recorded in the financial statements. Some payments made by the Company, which were unable to be identified due to the poor quality of the internal book-keeping of the Third Plaintiff, were automatically journalled to the Directors Loans in the financial statements. This practice of automatically journaling unidentifiably payments to the Directors’ Loans results in an non-representative inflation of what otherwise appears to be the drawings made by directors on their loan accounts. The treatment of those transactions as loan advances to the directors (which were ultimately non-recoverable due to the directors’ personal bankruptcies) depleted the Third Plaintiff’s operating capital. If, in the alternative, those payments had in fact been allocated as expenses, those payments would have increased the trading losses of the Third Plaintiff, which would have similarly depleted the Third Plaintiff’s working capital resources.

16 This shows not only that the accounts were unreliable but also that it is likely that many expenses were not accounted for and that the company’s trading position and position overall were worse than might be supposed from the financial statements. For an undercapitalised company, that so much money should according to its books have been lent to directors, or in some way treated as an obligation of the directors to it, is an indication that its circumstances were very severe. Whatever else the company might be doing with available resources, it was in no position to finance the directors in any way. These observations are not neutralised by Mr Shamia’s explanation.

17 Having regard to the company’s inadequate capitalisation and in the nature of its assets, there is no reason to suppose that any sources of finance not referred to in the financial statements were available. The most obvious and in practical terms of the only possible source would be finance provided by the directors and shareholders themselves; the indications are that far from their providing the company with further finance, they moved from being large Current Liability creditors in the year to 30 June 2004 to being significant debtors in the year to 30 June 2005. Mr Shamia’s evidence shows that what underlies this movement is masked, but the movement tends to show that there was no feasible further finance from them. With hindsight this is reinforced by their bankruptcies. The company’s overdraft facility with National Australia Bank was at most times close to fully drawn; not always, but the undrawn bank credit was not at any time sufficient to meet the company’s debts to the defendant, let alone to its creditors generally. In October 1995 National Australia Bank declined to increase the overdraft limit. A handwritten alteration in the financial statements suggests that at some stage later than the preparation of the financial accounts Perpetual Trustees Ltd’s business loan may have been refinanced by Edward Fleming Duncan and Audrey Gweneth Duncan; they put in a proof of debt claiming over $400,000. There is no evidence in detail establishing what arrangements were made, and I do not regard refinancing by them as recorded or proved by the handwritten alteration on the financial statements.

18 The valuation of the stock at cost in the balance sheet is doubtful; but there is no evidence on which a finding could be based that the stock had some other and lower value. Even accepting the stock value at cost the balance sheet shows a severely undercapitalised business. Until the end of May 2005 the company had relatively ready access to credit and stock, and can be taken to have been fully stocked, yet it was then in sufficient difficulty to seek a radical renegotiation of its dealings with the defendant. Its difficulties were not attributed to shortage of stock or difficulty in obtaining access to stock.

19 The effect of the net loss in the balance sheet is not dispelled by pointing out that in calculating net loss, depreciation at $17,091 was treated as an expense. Depreciation is an element which has reality in a company's affairs. In any event if depreciation were disregarded, the effect would be that the company's operations were at practically marginal profitability. This conclusion, like all conclusions relating to the accounts, is under the shadow of Mr Shamia's explanation of the directors’ loans.

20 On behalf of the defendant was contended that the correct reading of the balance sheet is that at 30 June 2005 the company's working capital position was positive. This conclusion depends on treating the asset referred to as directors’ loans as of full value; in my opinion there is no reasonable ground for accepting this. It is a striking anomaly that, in the state the company's affairs were in, large sums were treated in its accounts as owing to it by its directors. If they had their face value they would have been called in.

21 Mr Joe Behoff was the defendant’s Credit Manager of the New South Wales and Queensland debtor portfolios in the relevant period in 2004 and 2005. Mr Behoff did not give significant evidence in the proceedings (although he made one short affidavit) and was not available for the defendant to produce and give evidence at the time of trial as late in 2005 he retired from the defendant’s employment, and he returned to Germany. However it can be inferred from the correspondence in evidence that he gave close attention to supervising the company’s credit account. Mr Jason Waddell as Managing Director/Sales Manager referred very often and in writing to the state of payments to the defendant on account of purchasers. A long series of communications in evidence (Ex A/11-90) shows continuing close attention to reporting to Mr Behoff the state of payments and intentions about making payments. When a payment was made by Direct Debit Mr Waddell always told Mr Behoff about it straight away. The opening communication in this series, dated 3 June 2004, shows that payments to the defendant were in arrears, but were not significantly so. Mr Waddell said in that communication that the company had a slight cash-flow problem and payments would return to normal over the next six weeks, the normal pattern being payment on the last day of each month and on the 15th of each month. On 16 July 2004 Mr Waddell explained late payment of money due on 30 June and 15 July; there was a balance outstanding which he said would be paid no later than 25 July. This detailed reporting became the pattern. On 18 August he explained the late payment of moneys due on the 15th of that month, and on 14 October he explained the late payment of moneys due on the 15th of that month. There were similar communications on 16 November and 24 November. On 1 December 2004 Mr Jason Waddell explained that he had paid the outstanding September 2004 purchases balance. On 15 December 2004 he explained his payments and his intentions as to payments, which would see the October 2004 purchases paid for by 1 January 2005. On 18 January 2005 he explained his intentions for paying off outstanding November 2004 purchases balance by 1 February 2005 and gave an explanation in terms of pursuing outstanding large debtors.

22 Close attention to reporting payments continued, sometimes day by day. The message of 24 January 2005 to Mr Behoff says among other things “I will ring you tomorrow and let you know how much we can direct debit tomorrow afternoon. We are expecting some larger debtors payments tomorrow, and we are furiously chasing the rest of our very overdue smaller debtors!” The pattern of communications continued, with detailed explanations about the 16th of each month about the expected course of paying moneys falling due that month. A message on 4 April 2005 showed that outstanding January 2005 purchases had been paid for, the final payment on that day. Similar communications continued throughout April and May. Notable in this correspondence is the frequency of references to telephone conversations between Mr Jason Waddell and Mr Behoff. From the frequency of these references and the detail in which Mr Jason Waddell reported payments and plans for making payments and explanations of what was being done to produce further payments I infer that Mr Behoff kept close supervision on the accounts and kept Mr Jason Waddell fully aware of Mr Behoff's requirement for a flow of payments.

23 Not having any entitlement to financial information, or any actual reports apart from those in Mr Jason Waddell's communications, which were not comprehensive financial statements, the defendant depended heavily on what Mr Waddell told Mr Behoff and on impressions formed by its officers on visits to the store and in conversations with directors.

24 The communications I have been reviewing dealt with amounts outstanding on what were referred to by Mr Jason Waddell as Warehouse Accounts and Chargeback Accounts. The pattern shown by the correspondence is that, while payments for these were persistently late, they were not seriously late, and that charges for Warehouse Accounts and Chargeback Accounts were consistently being met, in circumstances for which Mr Jason Waddell consistently gave explanations. The Warehouse Accounts refers to purchases of goods from the defendant: Chargeback Accounts were accounts maintained by the defendant with other suppliers on which the company was authorised to make purchases: the suppliers looked to the defendant for payment and the defendant made Chargeback charges to the company. These however were not the only debts to the defendant which the company was incurring. The defendant also made charges to for other significant items; levies, which were contractual payments relating to the franchise agreement, service fees which appear mostly to be interest, and other relatively small charges including charges for catalogues.

25 Miss Fiona Hudson, who became the defendant’s National Credit Manager in October 2005, did not work in the defendant’s organisation before that time and did not take part in the more significant events. Mr Behoff was under her supervision. Ms Hudson’s evidence about events before her appointment is largely based on analysis of the defendant’s accounting records and documents. Her analysis (Annexure C to her affidavit of 17 November 2006) shows that the total indebtedness of the company to the defendant rose steadily throughout the period of the correspondence I have reviewed, notwithstanding the attention Mr Waddell gave to payments for stock purchases and charge backs. In her analysis the company was operating outside the credit terms approved by the defendant from the end of December 2004 onwards. Her analysis shows that the total due as 30 June 2004 was $122,454.71; that after a small fall, the total rose steadily, and by 30 April 2005 had reached $296,010.91.

26 In his message of 30 May 2005 (Ex A/47-48) Mr Jason Waddell after dealing, not in a clear way, with his intentions for payments due for Warehouse Accounts and Chargeback Accounts in May, went on to make this statement about the company’s position:

· We will be this week, direct debiting up to $50’000.00 into Danks account, & would like to ask if we can come up with a weekly payment scheme together, to get this debt back under control as soon as possible, while still being able to trade through.

· We would also like to know, if we could make small COD stock purchases from the Danks warehouse to fill small customer orders, until this situation is under control.

· Two very large bad debtors, which we are still trying to get payment out of. Both these are out past 120 days.

· Purchase & renovation of the Redhead hardware & Building supplies, back in January 2005.

· Gala Day in February, the costs & stock purchases, way outweighed the takings on the day. We are still clearing some of this stock purchased.

· Because of the Gala day, stock purchases in January & February were up by $100k, compared to our average normal monthly stock purchases, which we have paid for over the last few months.

· Our stock purchases in March are also up by $50k & we are reviewing why this is so, along with putting a weekly stock purchasing management system in place, to stop us over ordering stock. JW, RW & MW are keeping a close eye on this situation.

· At the end of February & running into March, we had four catalogues all running at the same time, along with the Gala Day, which has never happen before. One of these sales was the Big One Sale, which is the biggest sale bill of the year!

· Overall, the market has dropped off, particularly in the retail sector, & we have certainly only just felt this over the last two months, in February this year we were 15% up in sales, verus the same period for last year. Currently we are 0.6% up, verus the same period from last year. We have lost more or less 15% turnover in the space of two months due to this market down turn. JW is now full time out on the road chasing business, to turn this around.

· We are now currently driving excess costs out of the business by reducing business overtime expenditure, running costs of company vehicles by car-pooling & reducing Company director’s takings from the business.

· We have also cut costs in Catalogue participation & distribution, by cutting back our catalogue participation from 24 to 12 catalogues per year, halving our marketing costs. We are looking closely at the return on investment of these catalogue sales as well, for both stores.

· Over the last month, we have introduced a new Margin management project currently almost finished throughout both stores, which we are already starting to see results of. This project will deliver $100k plus profitability to the bottom line, without increasing turn over for the next 12-month period. It will take our gross profit margins at Kotara from 30.91% to 35%.

· We have also cancelled our weekly newspaper advertising to drive costs down.

· We have reviewed all outstanding small supplier credits owed, & have cleared most of these to concentrate on paying the Danks outstanding account.

27 This is the closest approach to a comprehensive statement by a director which can be found in the evidence. In summary it means that the company needed a scheme of weekly payments to get its debt to the defendant into control. It had cleared most (not all) other debts to suppliers. Mr Waddell sought to make an arrangement for small COD stock purchases, showing that he did not expect to be able to make stock purchases on credit. He explained how the cash flow had worsened and gave reasons, including two very large bad debtors, an overall drop off in the market, and other significant difficulties. The purchase and renovation of the Redhead business would naturally make demands on capital; Mr Waddell put this forward as part of the reasons why the company's cash flow had worsened. He described significant changes to business over the last month “to correct this situation,” the situation being that $300,258.01 was outstanding to the defendant. Calculations made much later by Ms Hudson show that the debt at the end of May was even higher, and was at its high point. As well as cutting costs and changing management methods to raise profitability, the changes he referred to included clearing most outstanding small supplier credits “to concentrate on paying the Danks outstanding account.” In two messages on 31 May 2005 Mr Jason Waddell asked Mr Behoff for approval for some small COD stock purchases; this showed that he did not expect to get further credit. The form of this request is striking. One would not usually think that one needed permission to make small COD stock purchases, and the request suggests that he anticipated some difficulty. A message from Mr Waddell on 9 June 2005 (Ex A/52) shows that $173,856.49 was due on Warehouse Accounts and Chargeback Accounts in May, that $30,000 had been paid in two payments, and about $143,856.49 was outstanding; no particular proposals were made for paying this.

28 There followed a meeting at the Kotara premises on Tuesday 14 June 2005 between Mr Jason Waddell and Mr Robert Waddell, and on behalf of the defendant Mr Joe Behoff, Mr Jeff Aylwood who was the defendant’s Regional Sales Manager for the region including Kotara, and Mr Ian Back, who was the defendant’s Home Group Manager for New South Wales. Mr Back’s responsibilities included reviewing sales performance and payment performance and assisting with sales programmes for franchisees, marketing was his primary focus and finance was not. Mr Back’s concerns naturally included monitoring sales of the defendant’s products to each franchisee and observing whether franchisees bought their core product lines only from the defendant so as to maintain the defendant’s sales level; but also so as to observe whether movement away from the defendant as main supplier indicated that the franchisee was undergoing financial difficulties or other difficulties. Mr Back gave accounts of events in two affidavits and in his oral evidence. Neither Mr Behoff nor Mr Aylwood was available to give evidence at the hearing. In the absence of any other witness and of any notes, two messages written by Mr Jason Waddell on 16 June 2005 have strong claims for attention when finding facts about events at the meeting.

29 Mr Jason Waddell’s fax message of 16 June 2005 (Ex A/55) says among other things that he asked Mr Behoff “… to please ensure that all backorders & any outstanding orders are deleted of our accounts, so that we can start placing COD orders next week with a clean slate? And that we have a no backorder policy set up our account.” He went on to say that he expected to receive $23,425.90 supplier credits through the Chargeback Account for returned goods. This shows clearly that he knew he could not expect any further supply of goods on credit from Danks.

30 The accompanying letter of 16 June 2005 was according to its terms intended to be a binding document and Mr Behoff was asked to sign it, although it does not appear that he did so. The letter says:

As per our conversation on Tuesday, 14th June 2005, following is the outline of our payment scheme agreed by both parties, to reduce & pay in full our current outstanding debt to John Danks & Son Pty Ltd.

1. We agree to pay a minium payment of $7000.00 per week to John Danks & Son Pty Ltd., until our debt is paid in full. This payment will be sent via a direct debit, & a fax confirmation will be sent each week. If & when, we can increase that weekly payment at any time, with extra muntries, we will.
2. Until our outstanding debt is paid in full, we will purchase warehouse stock only on a COD basis.
3. We agree that if we do not keep to the agreement payment scheme mentioned that we would be unable to purchase stock from the Danks Warehouse.
4. We understand that we are unable to purchase charge back stock through the John Danks & Son Pty Ltd. account.
5. We agree to receive only one delivery per week from the John Danks warehouse, which has been nominated to be every Thursday. We also understand that our orders must be placed by Tuesday afternoon, & payment organised via direct debit before delivery can be confirmed.
6. We wish to have no backorders for stock purchases.

7. We wish to have all outstanding backorders & orders for Home Timber & Hardware – Kotara & Redhead Hardware & Building Supplies deleted for the John Danks & Son system. Therefore, we have a clean slate to place orders.

8. We would like to review this payment scheme in September 2005, & look to increase our minium weekly payment from $7000.00 to $10,000.00, once some smaller outstanding creditors have been paid out in full.

31 Mr Back explained in detail what he said was the effect on his mind of each element in the explanations Mr Jason Waddell gave. It was Mr Back’s evidence in his second affidavit that at the meeting of 14 June he said "We would propose still giving you credit so that you can buy stock and continue to trade. However, what we would want to do is have a situation where you pay back double the amount for each credit that is given." Mr Behoff then said to the effect that as the company would be buying $3500 worth of stock per week, the defendant would require $7000 a week to be paid off. Mr Jason Waddell said, in response "I have budgeted and know we can afford to pay you $7,000.00 per week plus we can pay you cash on delivery for customer orders."

32 If this exchange meant that the defendant agreed that the company could buy $3500 worth of stock per week on credit if it paid $7,000 per week of its debts, that is not the arrangement that emerged. It is notable that there is no reference to such an arrangement in Mr Waddell's letter, and if he had such an advantage available to him, it is likely that he would have taken it. Mr Back's evidence on this, which was the subject of cross-examination, was not at all confident. Mr Back's evidence was based more on knowledge about Mr Behoff and the practice of seeking a two-for-one arrangement than on any actual recollection of the arrangement which had been made. I am not satisfied that there was any such arrangement. Paragraph 2 of Mr Jason Waddell’s letter of 16 June 2005 is to a completely different effect.

33 The series of weekly payments of $7,000 per week began within a few days, and the payments which the plaintiffs reclaim in these proceedings are part of the series.

34 In my finding the conduct of the directors leading up to and at the meeting, and the terms of the messages of 16 June 2005, show, in a clear way, that the company was not solvent, when the definition in s 95A is applied. The defendant had been the company’s major supplier since it began in business, it owed the defendant about $300,000, and the matters discussed at the meeting and the arrangements which emerged from that showed that it was fully understood that the credit terms on which the company had been acquiring the stock which was the life blood of its business were not going to continue; that it was only to obtain goods from the defendant COD. The debt of $300,000 had all fallen due or was very soon to fall due in accordance with the previous credit terms; the credit terms were not to continue and the $300,000 was to be paid off at $7,000 per week; which would take about ten months to catch up. References to other creditors and to repayment to them in Mr Jason Waddell’s letters of 30 May and 16 June 2005 show that the company had other creditors which it could not pay forthwith and contemplated paying over an extended period. Explanations were made in terms of the company’s difficulty in collecting debts due to it, and payment out of smaller creditors, or altering arrangements with them; and credit was to be raised by returning goods acquired on Chargeback.

35 It must have been obvious to all at the meeting and to anyone who read the letters of 30 May and 16 June that the company’s supply arrangements with the defendant for goods and services central to the company’s business had fallen to pieces because it could not pay for them. Nobody at the meeting could reasonably have seen things any other way. Insolvency was the whole meaning and purpose of the meeting and of the arrangement; if the company had been able to pay more the defendant would have insisted that it pay more. Cash flow problems, and what on the face of them were clear explanations why there were cash flow problems, had been the continuing theme of the correspondence throughout the first months of 2005. The company’s inability to pay its major supplier was what the meeting was about. The whole event, the subject matter under discussion, the references to the company’s difficulties greater and less and the arrangement which was the outcome demonstrate, just as clearly as a plain language admission in the terms of s 95A would demonstrate, that the company was not able to pay all its debts as and when they became due and payable, in particular was quite unable to pay its major supplier. The defendant had the choice between accepting payment over the best part of a year of money which was overdue or more or less forthwith, or losing a franchise outlet and customer; and the defendant chose the former.

36 Some indicia of insolvency which are found from time to time are absent; there is no large file of letters of demand or Local Court summonses, and there were no attempts at execution by bailiffs. Although this is so, the indications in the circumstances that the company was insolvent are clear, to my mind.

37 Overall the correspondence which Mr Waddell sent to Mr Behoff makes it the only reasonable view available that the company was trading in a state where it was continually under difficulty in making payments to its major supplier, in circumstances of constant scrutiny where the difficulties needed to be explained. In view of the terms of his explanations, it should have been understood by Mr Behoff, and in my finding based on inference it was understood by Mr Behoff that the company was at the margin of insolvency throughout 2005; and when Mr Waddell’s explanation arrived at the end of May in the terms in which it was made and the defendant's officers found themselves engaged in the meeting of 14 June, the conclusion that the company was insolvent was in my finding not resistible to any reasonable mind.

38 The defendant's counsel contended to the effect that it had not been shown that the company was insolvent by and at June 2005. It is correct that there is no clear and cogent proof of that fact which can be attributed to any particular date. However my finding is based on the cumulative effect of such indications as there were, and most particularly on the information stated by Mr Jason Waddell shortly before and at the meeting of 14 June, and by the terms of the arrangement which he then made. A company which was solvent as defined would not need to make and would not ask to make such an arrangement, particularly on the basis that its major supplierwith which it had a franchise arrangement would only give it goods COD. The overall conclusion that the company was insolvent, both on an objective view and in terms of what must reasonably have been understood by the defendant's officers, is to my mind quite clear.

39 Statements rendered by the defendant are unusually detailed (in a way I have not been seen before) in that every payment is appropriated to a particular invoice or other charge. Except where payments were allocated specifically to recent purchases of goods, older charges in the account were treated as paid off by whatever money came to hand and was allocated to them. This enables it to be seen that after 16 June 2005 deliveries of goods were paid for within a few days, in practical terms contemporaneously with delivery. The exceptions where there was not a prompt payment appropriated to a delivery of goods are minor and do not change the picture overall.

40 With small exceptions purchases of stock from late June onwards were paid for either COD or substantially contemporaneously with delivery of the stock; supply of services continued, the total indebtedness to the defendant fell fairly steadily, and continued to fall after 22 August 2005; the weekly payments began to overtake the additional charges for services which were being made, and the amount of the debt steadily fell. The age - period overdue – of the large overdue part of the debts to the defendant increased steadily, but the defendant was advantaged over other unsecured creditors, for some of whom the debts owing at the Relation Back Date were incurred well before August 2005. Late in the period the relative advantage to the defendant increased, as it received weekly payments on account of its debt whereas the general body of debts aged, so that a majority of them were more than three months overdue when Administration began.

41 Defendant's counsel made detailed observations about what these proofs of debt should be taken to show. The picture they show is not in my mind highly concrete or well detailed, but overall there is a clear picture of a large body of unsecured creditors, significantly overdue well into the period for which the payments to the defendant conferred a preference on it.

42 These arrangements should not in my opinion be classified under s 588FA(3) which relates to a continuing business relationship as described in paras 3(a) and (b); the relationship did not have the characteristic that the level of the company's net indebtedness was increased and reduced from time to time; it was basic to the arrangement that there was to be a steady reduction, notwithstanding that further charges for services were made. There is no analogy with a running account because of the exclusion of purchases of stock from the continuing business relationship; stock purchases were under a different business relationship on the COD basis. For this reason I do not think that all the transactions from the time of the June arrangement onwards are required by subsection 588FA(3) to be treated together as if they constituted a single transaction.

43 There is no reason to find that the levies and service charges were valued at less than the amounts charged for them. There were advantages to both sides in the continuance of the franchise arrangement which they represented. Continuing provision of some services does not alter the overall characterisation of the arrangement as one under which a past debt was reduced by regular weekly payments while goods were made available only COD and not on a running account.

44 The plaintiff did not present proofs which neatly or clearly established grounds for reliance on the presumption of insolvency stated in s 588E(3). In my finding however it appears by proofs which are not altogether precise but which are well past the balance of probabilities that the company was insolvent in the period from the end of May 2005 through June and still was insolvent when the series of payments was made. Agreeing to make the series of payments, acceptance of the severe COD limitation to trading and never raising the subject of increasing the payments and accelerating repayment, which when completed would bring escape from COD trading are bases for inferring that the company remained insolvent; and the state of its affairs as revealed at the time it went into administration, during which it had a large body of unsecured creditors whose debts were significantly aged supports my finding that the state of insolvency continued.

45 Business was not conducted wholly in accordance with the letter of 16 June 2005. From August 2005 to January 2006 almost all purchases of stock were COD; minor exceptions relate to PL invoices and form only a small part of the purchases. There were a number of Chargeback purchases but these too are only a small part of the purchases, minor exceptions. Charges for service fees continued, principally interest, levies relating to the franchise and other small charges. Ms Hudson’s analysis showed that at the end of August 2005, approximately when the payments under challenge commenced, the company’s indebtedness to the defendant was $278,205 93; by 31 December 2005, which is approximately when the weekly series ended (and there were two later, out of time) the debt was $190,600.56. Mr Tolcher established that the debt owed to the defendant when he was appointed Administrator was approximately $181,000. The series of payments meant that the debt to the defendant was falling steadily; it was also aging.

46 Mr Back visited the Kotara store in the two months following the meeting of 14 June 2006; to his observation the stock position was consistent with what it had been earlier, and the business was being carried on in the usual way. On these later visits Mr Back did not investigate the company's affairs in detail and was given information in generalised terms. Mr Back was of the view that debts had been cleared up but this was not based on specific information, rather on the state of supply of stock which he could see in the store. His evidence was that after June 2006 he was satisfied that the company was on the road to recovery, and after two or three months, meaning by August, he regarded trade with the company as under control, that the crisis had passed and it would only be a matter of time for the account to be back in normal terms. He says "I was aware that [the company] continued to order stock and be given credit for it …” but what he says he was aware of is not correct; with very minor exceptions, credit was not given for stock after the June meeting. Dealing with the period about August and September 2005 Mr Back said "As the defendant had agreed to have arrears paid by instalments, and as other suppliers had been cleared up, my suspicion that [the company] was unable to pay any of its debts later than when they were due had been erased. As far as I was aware, the survival of the [the company] depends upon what terms the defendant imposed. That situation changed in January 2006.” As evidence shows, on a visit to the Kotara store in early January 2006 he saw clear signs of deterioration and concluded that the company was probably beyond saving.

47 There is in my view nothing in the evidence which can have indicated to Mr Back, or to a reasonable person conducting the defendant's affairs, that the company’s solvency had improved by August. The only concrete things that had happened since June were that the company continually paid weekly instalments of $7,000, and had purchased goods COD at a moderate rate. The suggestion for renegotiation of the amount of weekly payments after paying other creditors had not been taken up. Overall, there were no indications which to a reasonable mind would indicate that the situation had improved. The defendant does not claim to have made any enquiry about the subject.

48 The September 2005 review of the payment scheme indicated in paragraph 8 of the letter of 16 June 2005 did not take place; so far as appears, neither party brought it under consideration. There was no increase in the minimum weekly payment above $7,000; and if the defendant’s officers were of the view that the condition about smaller outstanding creditors being paid out in full had been met, or that for some other reason the company’s affairs had improved to the point where the weekly payment could be increased, they would probably have sought an increase in payments.

49 A Running Balance Account Statement by the Australian Taxation Office (Ex B 96 and following) shows that at 22 June 2005, approximately when weekly payments began, the company owed the Australian Taxation Office $71,848.26. In the balance sheet of 30 June 2005, a few days later, $70,645 is shown under current liabilities as a debt to the ATO. When the Relation Back Period commenced on 22 August 2005 the debt to the Australian Taxation Office was $57,027.43. Late in 2005 the company negotiated an instalment arrangement with the ATO. The instalment arrangement brought some regularity to a long-standing state of arrears in paying taxation obligations. The company made payments of $2000 per week to the ATO, and the payments increased on 21 October 2005 to $5,000 per week; and current PAYG and GST were paid in addition. On the Relation Back Date 22 February 2006 the debt to the ATO was $24,303.63 (disregarding a dishonoured payment). Later charges brought the final balance of the Running Balance Account to $28,899.51. In view of the strength of the position of the Australian Taxation Office and the potential liabilities of directors, arrears in payment of taxation have special significance as indications of insolvency.

50 Mr Tolcher made an analysis of the company’s Creditor Trial Balance as at 28 February 2006 with a view to establishing the ageing of creditors. The company’s Creditor Trial Balance was severely defective because it showed the defendant as a creditor for negative $210,566.01 whereas Mr Tolcher’s own estimate is that it was a creditor for positive $181,000. The need to adjust this shakes confidence in other entries in the Creditor Trial Balance; however it is evident that most of the company’s debts were in arrears for more than 90 days. Mr Tolcher’s calculations, adjusting only for the error relating to the defendant, suggest that 77.5% in value of the debts were aged greater than 90 days; this cannot be treated as a precise indication, but it is evident that there were significant arrears in payments to unsecured creditors.

51 The debts of the company in liquidation included unpaid superannuation of $21,757.99 of which $13,447 99 related to the financial year ended 30 June 2005.

52 In the circumstances I am satisfied that each weekly payment in the series sued for was an unfair preference within the meaning of s 588FA(1); each one resulted in the defendant receiving from the company more than the defendant will receive if the transaction is set aside and the defendant proves for an unsecured debt. I am satisfied in terms of s 588F that each of these transactions was an insolvent transaction; that the company was insolvent at least from the beginning of the series of weekly payments in June. Each of these payments is a voidable transaction within the meaning of s 588FE. Even if all the payments from June onwards were required to be treated as if they constituted a single transaction, that transaction constituted an unfair preference within s 588FA.

53 In relation to the defence under s 588FG(2), the burden of proof which lies on the defendant, it is unfortunate that the defendant was not in a position to call or did not call either Mr Aylwood or Mr Behoff to give evidence. For each of them his actual state of mind in his respective circumstances is relevant to paras 2(a) and (b) and to the state of mind of a reasonable person in those circumstances. There is no positive indication in the evidence of bad faith, or lack of good faith, in the sense that anyone on behalf of the defendant contrived to gain an unfair advantage, or otherwise intended to exploit the situation unfairly.

54 I do not doubt Mr Back's sincerity in giving his evidence, but in my finding the view which he took of the company’s position in June 2005 and again two or three months later in August and September was not a reasonable view to take, given the indications before him. In my finding, Mr Back's thinking was not directed to whether the company was solvent, but was directed to whether the company's business could survive and the business relationship could continue. There are good reasons why his mind was not directed to the question of solvency associated with the tasks he was engaged on, but any reasonable mind, acting with the information before Mr Back in June 2005 and directing itself to the question of solvency, must have seen that the company was insolvent.

55 Mr Back did not have any close involvement in supervising the state of the company's account; he heard from Mr Behoff from time to time, but not systematically. Mr Behoff’s contact with Mr Back suggests that there had probably been an earlier period of close supervision and control by Mr Behoff and his staff; and Mr Jason Waddell's correspondence bears this out. Mr Behoff prepared reports for the Board of Directors who had the responsibility of calculating the defendant's bad debt provision. Each month Mr Behoff gave a report on Nursed Accounts meaning accounts that were considered as a financial risk. He did not treat the company's account as a Nursed Account in his reports from June 2005 to December 2005.

56 There had been months of unsuccessful attention to credit collection and the debt had reached a historically high position; and Mr Jason Waddell's letter of 30 May came after that.

57 Mr Aylwood left the company's employment in somewhat strained circumstances when he was unhappy about a promotion decision. However evidence and a concession established that he is probably available within New South Wales; it was open to the defendant to compel his attendance if the defendant wished to do so. Mr Behoff made one affidavit which is very short and does not deal well with the facts to which paras 2(a) and (b) refer. After making the affidavit he retired and returned to Germany where it should be inferred he still was at the time of the trial. No file note or other record of a view or opinion held by Mr Behoff about the state of the company's solvency or the prospects of collecting its debts has been found; or in any event none was put into evidence. In relation to the character of the litigation and the amount involved I do not think that the defendant was open to adverse comment for not bringing Mr Behoff back from Germany to give evidence; his absence is reasonably explained. However the position remains that information and knowledge of Mr Behoff and of Mr Aylwood are relevant to the question whether they had reasonable grounds for suspecting that the company was insolvent, and also whether a reasonable person in their circumstances would have had grounds for so suspecting. They much more than Mr Back had responsibility for and control over concerns about credit at the time. Deficiency of evidence of this kind was the subject of observations in Cooks Constructions Pty Ltd v Brown (2004) 49 ACSR 62 – see [19]-[23].

58 Counsel for the defendant contended to the effect that after the defendant had made a series of payments, from June to August, in accordance with the arrangement made in June, the regular course of payments was a source of comfort to the defendant relating to its solvency. There is not in fact any evidence that anyone on behalf of the defendant drew this conclusion. This line of reasoning is negated by the circumstances that in June it was held out to the defendant that there would be an increase in the rate of weekly payments when other creditors were repaid, yet this was never brought under attention again. In any event in view of the indications which were before the defendant in June, no significant degree of comfort could be given to it by this circumstance. In support of this submission counsel referred to the decision of Windeyer J in Rodgers v Rumortex [1999] NSWSC 658; in my opinion his Honour's observations in that case were directed to the facts before him, and there is no significant principle established by that case.

59 The defendant has not, in my finding, shown on the balance of probabilities, in relation to any one or all of the challenged payments, the facts in paras (b) or (c) of s 588FG.

60 In my view it is appropriate to order, in accordance with powers in s 588FF(1)(a) that an amount equal to all the payments sued for be repaid to the company. I will give a judgment which has that effect. I will ask the parties to deal with the question of interest.

61

My orders are:

(1) Give judgment for the plaintiffs for $140,000.00 with costs.
(2) Reserve further consideration of interest.

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Citations

Tolcher v John Danks and Son P/L [2007] NSWSC 1207

Cases Citing This Decision

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Cases Cited

3

Statutory Material Cited

1

Mulherin v Bank of Western Australia Ltd [2006] QCA 175

Central Mortgage Registry of Australia Ltd v Donemore Pty Ltd [2004] NSWCA 105

CITATION:	TOLCHER & ORS v JOHN DANKS AND SON PTY LTD [2007] NSWSC 1207
HEARING DATE(S):	2-3/10/2007
JUDGMENT DATE :	1 November 2007
JURISDICTION:	Equity
JUDGMENT OF:	Bryson AJ at 1
DECISION:	(1) Give judgment for the plaintiffs for $140,000.00 with costs; (2) Reserve further consideration of interest.
CATCHWORDS:	CORPORATIONS - liquidation - unfair preferences - in June 2005 the company (hardware store) renegotiated repayment of its debt to its major supplier of hardware stock - about $300,000 owing: repayments $7,000 per week and stock purchases COD - weekly payments thereafter meant that debt was falling but ageing - additional charges for franchise fees interest and services but not for goods - administration on 21 February 2006, liquidation on 21 March 2006, claim to recover weekly payments from 22 August 2005 onwards $140,000 as unfair preferences - issues of insolvency and suspicion of insolvency as of June 2005 and later - decision on facts - judgment for $140,000 as unfair preference.
LEGISLATION CITED:	Corporations Act
CASES CITED:	Cooks Constructions Pty Ltd v Brown (2004) 49 ACSR 62 Rodgers v Rumortex [1999] NSWSC 658 Sandell v Porter (1996) 115 CLR 666
PARTIES:	Raymond George Tolcher - First Plaintiff Robert William Whitton - Second Plaintiff Waddell & Son Pty Ltd (In Liq) - Third Plaintiff John Danks and Son Proprietary Ltd - Defendant
FILE NUMBER(S):	SC 4797/2006
COUNSEL:	S. Golledge - Plaintiffs R.D. Marshall - Defendant
SOLICITORS:	Nash O'Neill Tomko Lawyers - Plaintiffs Braye Cragg Solicitors - Defendant