Cornwall Stodart | Publications

Issue 3: November 2004

Welcome to issue 3 of our new regular series of Reconstruction and Insolvency newsletters. Scheduled to be published regularly, our newsletters will be in addition to the occasional bulletins we publish on "hot topics" for insolvency practitioners.

In this newsletter, we report on some of the more notable decisions that have been handed down recently. If you want to know more about these decisions or if there is a particular case we have not covered, which you wish to know about, please contact:

		John Hutchings Partner T: +61 3 9608 2245 j.hutchings@cornwalls.com.au

		Maralda Hibberd Senior Associate T: +61 3 9608 2241 m.hibberd@cornwalls.com.au

		Sam Monkivitch LAwyer T: +61 3 9608 2257 s.monkivitch@cornwalls.com.au

Hanel's Case Implications

Section 197(1) of the Corporations Act provides that:

"a person who is a director of a corporation when it incurs a liability while acting, or purporting to act, as trustee, is liable to discharge the whole or part of the liability if the corporation:

(a) has not, and cannot, discharge the liability or that part of it; and

(b) is not entitled to be fully indemnified against the liability out of trust assets.

This is so even if the trust does not have enough assets to indemnify the trustee. The person is liable both individually and jointly with the corporation and anyone else who is liable under this subsection."

In Hanel's case, a majority of the judges of the Full Court of the South Australian Supreme Court effectively held that Section 197(1) applies to render the directors of a corporate trustee personally liable to meet the claims of creditors of the trustee whenever the assets of the trust are insufficient to meet the debts owed to those creditors.

Several commentators (including the President of the New South Wales Court of Appeal) have cast doubt on the decision. However, for the time being, it is likely to be followed, at least in the inferior courts: the High Court has held that the decisions of State Supreme Courts on corporations law matters should be followed unless overruled or plainly wrong.

Business services advisors should warn those of their clients who may carry on or intend to carry on business through the medium of a trading trust, of the risk of personal liability of the directors in the event that trust assets are insufficient to meet debts incurred.

In the reconstruction and insolvency context, advisors and prospective appointees should enquire as to whether or not the subject corporation acts as trustee. If so:

the possibility of personal liability of a director in the event of a shortfall to creditors should be addressed when reporting or making recommendations following a review;

if responding to an approach by the directors of a corporate trustee seeking to make an appointment (eg, administration or liquidation) they too should be alerted to the possibility of personal liability - as that risk may affect their decision making.

Corporations who have corporate debtors who are unable to pay by reason of insolvency, should enquire as to whether they are corporate trustees. If so, consideration should be given to a claim against their directors.

Companies Auditors and Liquidators Disciplinary Board ("CALDB")

Disciplinary Panel
The Companies Auditors and Liquidators Disciplinary Board has adopted a new structure in response to the CLERP 9 audit independence changes. The changes are likely to impact upon all practitioners facing disciplinary proceedings, whether auditors or insolvency practitioners.

Previously the disciplinary panel consisted of the chairman and two accounting members who all acted in a part-time capacity. Under the new structure, the panel will consist of 5 members will hold office for 3 years. The 5 members will be drawn from the pool of 14 part-time CALDB members. Significantly, the majority of the new members will be non-accountants.

Donald Magarey, partner at Blake Dawson Waldron, Sydney has been appointed chairman. There are 2 accounting members as well as 2 ‘business members’. The newly appointed business members of the CALDB include lawyers, academics and company directors.

The changes signify a move towards appointment of CALDB members who are independent of the auditing profession.

The Definition of Insolvency

A recent decision of Palmer J the New South Wales Supreme Court in Lewis & Anor v. Doran & Ors [2004] NSW SC608 considered whether the definition of insolvency which now appears in Section 95A of the Corporations Act has changed the pre-existing law arising out of cases such as Sandell v Porter (1966) 115 CLR 666. Section 95A is as follows:

95A(1) A person is solvent if, and only if, the person is able to pay all the person's debts, as and when they fall due and payable.

95A(2) A person who is not solvent is insolvent.

The case concerned a proceeding brought by the liquidator of Doran Constructions Pty Ltd (In Liquidation) against various entities, including the directors, for breaching fiduciary and statutory duties to the company and entering into an uncommercial transaction under Section 588FA of the Corporations Act. The Court was asked to consider whether the company was insolvent at the time the directors entered into the transaction in question or whether the transaction caused the company to become insolvent.

In considering s95A of the Act, Palmer J discussed the decision in Sandell v Porter in which the High Court held that a debtor's ability to pay "from his own moneys", as required by Section 95 of the Bankruptcy Act, included an ability to raise money by sale, pledge or mortgage of his assets. That decision being consistent with earlier authorities concerned with definitions of insolvency which were dependent upon a debtor's ability to pay "from his own moneys".

His Honour considered that the question of a company's solvency may arise retrospectively or prospectively. For example, a question may arise retrospectively where a liquidator is seeking to recover an unfair preference or to set aside an insolvent transaction so that the issue is solvency as at a date prior to the winding up.

The question may arise prospectively where a company is sought to be wound up in insolvency and the company's ability to pay its debts must be determined not only by reference to debts payable as at the date of the application for winding up, but also by reference to the company's ability to pay its debts which will be due for payment sometime in the near future.

Where the Court is considering retrospective insolvency, the Court has the benefit of hindsight which makes the task of assessing insolvency as at an alleged date less difficult.

Where there is a question of prospective insolvency, the Court's task is more difficult, particularly in cases where a company alleges that it will be able to pay its debts only because it claims to have access to funds that a third party is said to be willing to lend without security. In these cases, the Court must speculate that the third party will lend the funds as promised and not change its mind at some future time.

In such circumstances, and applying the Sandell v Porter definition of insolvency, a company would be held to be insolvent as it would not be meeting its debts "from its own moneys" by raising funds to meet its debts by sale, pledge or mortgage of its assets, but rather by an unsecured loan.

Applying the Section 95A definition, Palmer J held that "…the section can work effectively as a definition of both retrospective and prospective insolvency if it is shorn of a gloss derived from the words "from its own moneys". The words "from its own moneys" have acquired a "gloss" in previous decisions that has attached a requirement that money obtained by unsecured borrowings is not treated as the debtor's "own money".

Palmer J went on to suggest that the words "from its own moneys" have been deliberately omitted from the s95A definition, and if the gloss which they acquired in previous decisions is applied to questions of retrospective insolvency, the definition can operate to produce a commercially unrealistic, if not obscured, result.

For those reasons, Palmer J concluded that s95A of the Act has changed the pre-existing law as to the definition of insolvency as stated in cases such as Sandell v Porter. He held that it is no longer necessary in order to assess solvency to ascertain whether the company is able to pay all of its debts "from its own moneys" in the sense that unsecured borrowings are not able to be treated as the debtor's "own money".

Palmer J went on to suggest that "…in my opinion, s95A requires the Court to decide whether the company is able, as at the alleged date of insolvency, to pay all its debts as they become payable by reference to the commercial realities. If the Court is satisfied that as a matter of commercial reality the company has a resource available to pay all of its debts as they become payable, then it will not matter that the resource is an unsecured borrowing or a voluntary extension of credit by another party"