Tag Archives: Liquidation

Exposure Draft of the Covid Insolvency Reforms released – just five more days (including this weekend) to make submissions….

I would not ordinarily post a link to something I had not read, but this is a pandemic! The Commonwealth announced its proposed insolvency law reforms just 2 weeks ago and has now released an exposure draft of the amending legislation together with an explanatory memorandum.

Submissions on the draft are due on Monday, 12 October 2020!!! So get cracking! This makes the road runner look slow.

I will make some further comments in the next day or so once i have read it.

Jumping the gun – application to wind up before demand expires invalid

This might sound obvious, but an interesting recent case confirms, for Victoria at least, that a creditor cannot apply to wind up a company relying on a presumption of insolvency before the creditor’s statutory demand expires.  The case is Surdex Steel Pty Ltd v GB Manufacturing Pty Ltd [2012] VSC 90, a decision of Associate Justice Gardiner.

The case considered whether an applicant for an order that a company be wound up in insolvency can rely upon the statutory presumption of insolvency provided by s 459C(2)(a) of the Corporations Act 2001, if time for compliance with a statutory demand has not expired before the winding up application is filed, but has expired by the time the application comes on for hearing.

There are divergent authorities in other jurisdictions.  The surprising view that a winding up application could be commenced before the statutory demand expires arises from an argument regarding the construction of s459C(2)(a) of the Corporations Act 2001.   The sub-section says:

The court must presume that the company is insolvent if, during or after the three months ending on the day when the application was made:

(a) the company failed (as defined by s 459F) to comply with a statutory demand; …

The words “or after” in the section were relied on in a series of cases beginning with a decision of Santow J in Pinn v Barroleg Pty Ltd (1997) 23 ACSR 541, as demonstrating a legislative intention that the expiry of the demand could occur “after” the application to wind up was filed.

Associate Justice Gardiner preferred the other line of authority which focussed on other provisions of the Act that implied that the expiry of the demand must have occurred prior to the application being made.  For example, s459Q(a) requires an applicant for a winding up in insolvency to specify details of non-compliance with the demand. So Palmer J in Woodgate (as trustee for the bankrupt estate of Fenton) v Garard (2010) 78 ACSR 468 read down s459C(2)(a) so that it would not cut across s459Q(a).  Further, sub sections 459C(2)(b) – (f) were noted as alternative triggers giving rise to a presumption of insolvency (eg execution levied against the company on a judgment) which could clearly occur after an application was filed, thereby giving the words “or after” some work to do.

There being no presumption of insolvency in the circumstances, the application was dismissed because no other evidence was available to prove insolvency.

Liquidator’s or Receiver’s lien may be at risk under PPSA in some circumstances

Most commentators, relying on s73 (link) of the Personal Property Securities Act 2009, state that liens are not affected under the PPSA.  Section 73 provides priority to liens and other security interests arising under general law or under statute (called “priority interests”) in some circumstances.

But there are some serious traps for creditors relying on liens under the new regime.

First, if a creditor is relying on a contractual lien to get paid,  that creditor is going to lose out in a priority battle with a secured party holding a security agreement in respect of all assets.  Section 73(1)(a) only provides for protection to an interest arising under general law or under statute, but not a lien arising by agreement.  A lien created by a contract is a security agreement that under the PPSA will require perfection (by registration or otherwise).

So where a logistical services company claimed a lien under its terms of trade over goods in its possession belonging to a customer, they lost out to a receiver appointed over the customer by a bank with a prior registered all assets security agreement:  see McKay v Toll Logistics (NZ) Limited (HC) [2010] 3 NZLR 700 (link); Toll Logistics (NZ) Limited v McKay (CA) [2011] NZCA 188 (link).  There is a good summary of McKay by Leigh Adams at (link).

Second, even if a creditor has a lien under statute or general law, it should be careful before taking a concurrent contractual lien.  It might be argued by a secured party holding a prior registered security agreement that section 73(1) doesn’t apply, because the contractual lien supplants the general law or statutory lien that would otherwise have arisen.  A solution for the lienee would be to ensure that the contractual lien on its terms specifically preserves any general law or statutory liens that may arise, and be created in addition to those liens.

Third, a liquidator or receiver who relies on a “salvage lien” arising under the principles in Re Universal Distributing Co Limited (in Liquidation) (1933) 48 CLR 171 should be careful to check that their lien is protected under s73(1).  It is possible that the terms of a prior registered security agreement could purport to prohibit the grantor “creating” a salvage lien.

A salvage lien does arise under general law, however it could be expected that a receiver or liquidator may well have actual knowledge of the terms of a prior registered security agreement held by a financier.

By s73(1)(e) a lien holder who has actual knowledge that creation of a subsequent priority interest will breach the terms of a secuity agreement does not receive protection of the section.   Further, the section only governs liens arising “in the ordinary course of business” – see s73(1)(b).

Now for many possessory liens arising in the ordinary course of business, the lien holder will be unaffected.  Think classically of a repairer.  A motor vehicle repairer engaged to fix a company vehicle might expect it to be under finance, but would not be likely to check the PPSR and obtain a copy of any prior security interests.

But for a salvage lien, the situation is more difficult.  A liquidator or receiver may well know the terms of a prior ranking secuirty agreement.  There could also be a tricky argument about whether a salvage lien arises “in relation to providing goods and services in the ordinary course of business”.  In my view it probably does not, given that it will arise only once the grantor is insolvent and continuing to trade under the control of an insolvency practitioner.  Until we know the answer by a decided case, the risk remains.

I note the same risk may confront solicitors and accountants holding a lien over a file for unpaid fees, for the same reasons.

These are potentially troubling results.   If one is in a position of having actual knowledge of prior security interests, then before relying on a lien of any complexion, care must be taken to avoid loss of priority to a registered security agreement.

Thanks to Nick Anson of Minter Ellison for comments on this post (link to Nick’s profile).

Regards

Mark

Proposed Law on Phoenix Activity Falls Flat

Proposed legislation to attack directors of companies involved in so called “Phoenix” activity appears to have fallen flat owing to two major bungles in the drafting of the amendments in one of the bills.

The Federal Government has released drafts of two Bills.  The Bills follow pre-election commitments in the Protecting Workers’ Entitlements package announced in July 2010.

Identifying Phoenix Activity

Distinguishing “Phoenix activity” from the legitimate cycle of business failure is sometimes complicated and involves issues of intention.  In the 2009 paper entitled “Phoenix Proposal Paper” (link), the Treasury noted the following:

Defining precisely what constitutes fraudulent phoenix activity is inherently difficult….underlying the distinction between illegitimate, or fraudulent, phoenix activity and a legitimate use of the corporate form, is the intention for which the activity is undertaken. Relevantly, ASIC draws a distinction between businesses that get into a position of doubtful solvency or actual insolvency as a result of poor business practices (for instance, poor record keeping or poor cash management practices) and those operators who deliberately structure their operations in order to engage in phoenix activity to avoid meeting obligations. (emphasis added).

The government’s proposed legislation really does not deal with the difficulty of identifying what is and what isn’t Phoenix activity at all.

Penalising the Directors

The Corporations Amendment (Similar Names) Bill 2012 will expose directors to personal liability for their company’s debts, if:

  • the company’s name is the same as or similar to a company or business name of another company that has been wound up; and
  • the director was also a director of that other company; and
  • the company incurs the debts within five years after the start of the winding up of the other company.

This bill suffers from two major problems.  The first and most obvious problem is that personal liability only applies if the subsequent company has the same or a similar name as the old company.  So a director can escape personal liability simply by choosing a new name that is not similar to the old company or business name.

In my view, the director ought be made liable if the new company is carrying on substantially part or all of the same business as the old company, and the Courts should be given some flexibility in applying that test.  The name alone is a poor indicator.  A list of indicators to be taken into account by the Court could be devised in a similar way as exists in applying other evaluative tests, such as section 425(8).  They might include the assets employed, the customer base, the nature of the business conducted, the name of the business, the premises used and the staff employed among other things.  A defence should be available if the director can show that the old company was given fair value for the business.   Further, the Court should have a discretion to excuse directors who have acted honestly and who in the circumstances ought be excused (as exists in the draft bill) to deal with the issue of intention identified in the 2009 paper I noted above.

The second problem is that the director is liable for the debts of the new company, not the old.  The drafters appear to have copied similar legislation in the UK and in New Zealand.  The idea is to hinder phoenix operators from transferring the name of the business and therefore its goodwill, by restricting the limited liability of the new company.

But in most phoenix cases, the creditors of the new company are not at risk since they are usually trade creditors whom the directors need to keep happy.  It is the old company’s creditors like the ATO and other non essential suppliers who need help.

There are a plethora of articles available on the exposure drafts, including very useful posts by AAR (link), Minters (link) and Carrie Rome-Sievers of the Victorian Bar (link) which goes into some detail about the politics of the bills.

The two problems I have identified have both been drawn to the Federal government’s attention in submissions by various bodies and we can only hope that Canberra will fix them.

Providing Access to the GEERS Scheme

The second bill is the Corporations Amendment (Phoenixing and Other Measures) Bill 2012.  It provides ASIC with administrative power to order that a company be wound up, generally in circumstances where ASIC considers that the company has been ‘abandoned’. This will trigger employees’ entitlements under the Government’s General Employee Entitlements and Redundancy Scheme (GEERS).

The second bill is a welcome development as in the past, employees or other creditors left abandoned in the old company shell had to go to the expense of winding up the shell at their own expense.

Regards

Mark

ATO beaten by trust liquidator in priority battle – twice!

The Commissioner of Taxation is the most common unsecured creditor in insolvent estates and often the biggest.   That is not surprising since Federal tax revenues are currently about 21% of GDP.

In 1993 the Commissioner lost his priority over other unsecured creditors in bankruptcy or liquidation for outstanding group tax and PPS debts.

Since then,  the Commissioner has looked for other ways to gain de facto priority over unsecured creditors.  One method has been to recover tax from directors personally – the “directors penalty notice” provisions of the tax law was also introduced in 1993 partly to compensate the Commissioner for the loss of priority (an excellent paper explaining these provisions in clear terms can be found here, published by Worrells).

Another device given a try by the Commissioner was to garnishee debts owed by third parties to the insolvent company, by notice under section 260-5 of the Taxation Administration Act 1953 (TAA), after a company had gone into liquidation.   A notice under s 260-5 gives the Commissioner the right to recover from a third party an amount that the third party owes or may later owe to a taxpayer who is indebted to the Commonwealth for tax. The remedy given to the Commissioner by s 260-5 is available in respect of revenue obligations, which are given the character of “debts” by force of the TAA itself and without the need for a judicial determination.  The third party must pay the amount demanded in the notice; failure to comply with the notice is a criminal offence.  Upon payment the Commissioner has the right to give to the third party a valid receipt and discharge for money paid in compliance with the notice.   In these respects, a notice under s 260-5 operates in the same manner in which a garnishee order issued by a Court operating to attach a debt.

In effect the Commissioner was issuing notices to round-up debts owed to the insolvent company that would otherwise be collected by the liquidator, putting the proceeds of the debts exclusively to payment of the Commissioner’s debt.   If the debtor responded to the notice and its validity were upheld, then the Commissioner would then restore an effective position of priority, at least as far as proceeds of third party debtors recoveries are concerned.

The Commissioner’s efforts ended badly.

First, the use of garnishee notices in this way was held to be invalid by the High Court (Bruton Holdings Pty Ltd (in liquidation) v Commissioner of Taxation (2009) 239 CLR 346).   In a fairly extraordinary display of litigation muscle by the Commissioner (no doubt because of the potential precedent value of a favourable outcome), no less than six related proceedings were fought in the Federal Court and High Court, over about $470,000 held in a solicitor’s trust account, the debt in question.

Second, the outcome of the final Full Federal Court appeal – Bruton Holdings Pty Ltd (in liq) v Commissioner of Taxation (austlii link) (2011) 193 FCR 442 (FCFCA) (Bruton (no 2)) was that Bruton, the insolvent corporate trustee, was allowed its full indemnity costs of the entire sequence of litigation from the trust’s funds even though it was a bare trustee of the assets.   The Commissioner had argued, unsuccessfully, that a bare trustee is restricted to a “passive role” and that Bruton had no authority to conduct the litigation over the validity of the garnishee notice because, in effect, the ATO was the only unsecured creditor and would get the proceeds of the debt one way or other (no evidence to support this latter assertion was led).  The Full Court rejected that argument – first on the basis that there was some evidence suggesting the existence of other creditors, and secondly by reference to the general duties of any trustee to preserve and protect trust assets when threatened, by litigation.  See in particular paragraphs 19 to 27.

There has been no special leave application:  just an even half-dozen cases on this occasion then!

The introduction to the  joint judgment of Stone, Jacobson & Edmonds JJ in Bruton (no 2) sets out the extraordinary sequence of the litigation:

……….In 1997, by deed of trust, the appellant (Bruton) was appointed as trustee of the Bruton Educational Trust (educational trust). On 10 October 2005, Bruton applied to the respondent (Commissioner) for endorsement as a tax exempt entity as from 1 July 2006. The application was refused, as was Bruton’s objection to the Commissioner’s decision. An appeal from the Commissioner’s decision (objection appeal) was also dismissed.

Piper Alderman was the solicitor for Bruton in the objection appeal. Between October 2005 and February 2007 it was paid $470,000 by Bruton to be held in its trust account in respect of costs and disbursements of the proceedings including the endorsement application to the Commissioner. On 28 February 2007 administrators were appointed to Bruton and on 30 April 2007 the company’s creditors resolved that it should be wound up. By virtue of ss 513B(b) and 513C(b) of the Corporations Act 2001 (Cth) the winding up was taken to have commenced on 28 February 2007.

Clause 10.2(b) of the educational trust deed provided that the office of the trustee was “immediately terminated and vacated” if the trustee went into liquidation. Accordingly, from 28 February 2007 Bruton ceased to be the trustee of the educational trust and became the bare trustee of the assets comprising the trust fund (Fund). As a consequence Bruton was no longer entitled to exercise any power including the investment, management or payment of trust monies arising from the educational trust deed. Its powers were limited to those that under the general law or statute are the powers of a bare trustee.

On 26 March 2007, the Commissioner issued a notice of assessment directed to the trustee calling for payment in the amount of $7,715,873.73 in respect of tax and the Medicare levy for the 2004 income year. Furthermore, after Bruton was wound up, the Commissioner lodged a Proof of Debt with the liquidators of Bruton for the amount stated in the notice of assessment. On 8 May 2007, the Commissioner issued a notice to Piper Alderman pursuant to s 260-5 of Schedule 1 of the Taxation Administration Act 1953 (Cth) requiring the firm to pay $447,420.20 which it held in its trust account on account of the educational trust to the Commissioner.

On 30 May 2007 Bruton instituted proceedings in this Court (primary proceeding) seeking a declaration that the s 260-5 notice was void by virtue of s 500(1) of the Corporations Act. On 2 November 2007 Allsop J declared the notice was void (see Bruton Holdings Pty Ltd v Commissioner of Taxation (2007) 244 ALR 177). On 23 November 2007, his Honour made further orders including an order that Piper Alderman pay the $477,420.20 held in its trust account to the liquidators. The liquidators were to pay that money into an interest-bearing bank account and were restrained from spending that money except, inter alia, to pay expenses incurred by Bruton in respect of the primary proceeding and the appeal proceeding. His Honour ordered the Commissioner to pay Bruton’s costs as well as those of Piper Alderman.

An appeal from Allsop J’s judgment to the Full Court was allowed and Allsop J’s judgment was set aside (see Commissioner of Taxation v Bruton Holdings Pty Ltd (in liq) [2008] FCAFC 184; (2008) 173 FCR 472. Bruton was granted special leave to appeal to the High Court. The High Court allowed the appeal with costs (see Bruton v Commissioner of Taxation [2009] HCA 32. It set aside the orders of the Full Court and in their place ordered that the appeal to the Full Court be dismissed with costs.

A dispute followed between the Commissioner and the liquidators concerning whether the shortfall between the amount of Bruton’s solicitor and client costs and the amount of its party and party costs referable to the primary proceeding, the Full Court appeal, the application for special leave and the appeal in the High Court should be paid out of the Fund. This dispute over the payment of costs was the subject of the proceeding before Graham J (costs proceeding) and is the issue in the present appeal (emphasis added)

Regards

Mark

The Relation Back Day can be manipulated by a prior VA appointment – Reform still required

Liquidators, creditors and directors are very conscious of  the “Relation Back Day” in liquidation.   It is the day on which the six month “preference period” for the recovery of preferences from creditors ends.  It is also the day on which certain longer periods for undoing certain related party transactions involving directors and their associates ends.

The relation back day for any Court ordered winding up is governed by section 513A of the Corporations Act 2001 (Act).   In a case where the Court orders that a company be wound up, and immediately before the making of the order the company was in voluntary administration, the relation back day is taken to be the section 513C day that applies to that administration.  See section 513A(b) of the Act.

Section 513A(a) does not apply, as until a court makes an order to wind up the company, there is no “winding up in progress”:  this  subsection applies to administrations commenced by a liquidator appointing a VA under s436B.

The section allows a director or chargeholder of a company to move the relation back day forward in time by the simple expedient of appointing a voluntary administrator AFTER a winding up application has been filed by a creditor, but before a winding up order is made.  That may allow a preference payment or other vulnerable transaction to avoid attack by the liquidator if it occurred at the very early end of the relevant time period.

This effect has been judicially noted.  For example, in Commissioner of State Revenue v Rafferty’s Resort Management Pty Ltd  (2008) 66 ACSR 199  at [33], [39]-[40] (Austlii link), Austin J considered that he had no power under s447A or otherwise to order that the s 513C day be the date of the commencement of a creditor’s winding up application (which was filed before the commencement of the Part 5.3A administration), notwithstanding the possibility that directors might manipulate the provisions by putting an insolvent company into administration after the commencement of a winding up proceeding.

Austin J said he was reluctant to reach this conclusion given it prevented a number of recoveries that were otherwise available to the liquidators (including against related entities) and because the evidence supported an inference that the directors had deliberately appointed a VA to defer the relation back period.   His Honour’s view was that there was a clear need for law reform especially given the varying and inconsistent consequences regarding unfair preferences and void dispositions of property (under s468 of the Act) depending on which subsection of s513A applies.

There have been calls for reform over the issue – a notable article at the time was published by Middletons (Stephen Hume) (link).  None has yet been forthcoming.

Some judges have attempted to circumvent this result by making an order to terminate an administration, and then delaying the making of the winding up order by some interval.  This approach was employed in St Leonards Property Pty Limited v Ambridge Investments Pty Limited [2004] NSWSC 851.  The winding up order was made one day after terminating the VA, which the Court in that case appeared to think was sufficient.

Regards

Mark