De Facto Director Ordered to Compensate Unpaid Supplier Following Insolvent Trading
Tremco Pty Ltd ACN 000 024 064 v Thomson & Ors [2018] QDC 101
Case Facts
The plaintiff (Tremco) was the principle supplier of waterproofing materials to a waterproofing business (Kadoe). The defendant (Thomson) was the wife of the formally appointed director of this business. In this proceeding, Tremco sought to recover compensation from the wife under s 588M(3) Corporations Act 2001 (Cth) for losses suffered in relation to unpaid debts.
The debt arose from unpaid invoices beginning in March 2010. In November 2010, the defendant’s account was put on hold. By December 2010, the amount owing to the plaintiff totalled $146,410.20.
In 2015 Tremco brought proceedings against Kadoe for the outstanding debts and obtained a judgment in their favour. Subsequently, Kadoe failed to comply with a statutory demand based on the judgement and was wound up in insolvency on 29 April 2015. The defendant’s husband was made bankrupt in June 2015. Tremco sought compensation for the expenses incurred in this process.
Legal Principles
Section 588M(1) sets out several conditions which must be satisfied before compensation under section 588M(3) can be recovered. The condition in dispute in this case was s 588M(1)(a), which imposes a requirement that, in order to recover compensation, a person (a director) has contravened s 588G(2) or (3) in relation to the incurring of a debt by a company. The key question was therefore whether the defendant was a director within the meaning of director as defined in s 9 of the Act during the alleged period of insolvent trading.
Tremco argued that the defendant was a de facto director of the company due to her involvement in the setting up of the company in 2009 and subsequent management position in the company. The defendant disputed this claim arguing that the company was supposed to be incorporated as a trust. The defendant’s argument was that the setting up of the trust had failed and hence the company had not been trading in its own right.
In support of their claim that the defendant was a de facto director, Tremco pointed to several factors. First, that by the defendants own account, she had been responsible for setting up the Company and the Trust. Second that the defendant had significant involvement and control over the day to day operations of the business including a self-identification as the ‘General Manager’.
In response to Tremco’s assertions, the defendant argued that she had only been a conduit on behalf of her husband in setting up the trust and in any event the incorporation of the trust had failed. In regard to her involvement the defendant relied on the case of Re Swan Services Pty Ltd (In Liquidation) [2016] NSWSC 1724, arguing that her role was only as wife who became involved in the affairs of the company to address the emergency of the invalidity of the Trust. This claim was rejected on the basis that her involvement went far beyond emergency assistance and involved conducting the dispute over the alleged invalid trust for the Company over many years.
Decision
Porter DCJ QC held that the plaintiff was entitled to recover for loss or damage under s 588M. His Honour found that the defendant was a de facto director of the company at all times due to the system of shared management; the husband was responsible for onsite activities whilst the wife was responsible for the operational and administrative affairs of the company. His Honour, in reference to the authority of Grimaldi v Chameleon Mining NL (No 2) (2012) 287 ALR 22, noted the presence of several factors leading to this decision:
- the defendant had independent authority to negotiate and manage matters of importance on behalf of Kadoe and could go further and bind Kadoe in relation to those matters;
- The defendant’s husband had little, if any, oversight or involvement in those matters and largely left executive decision making to her in many areas.
With the question of the defendants status settled, his Honour found that the defendant was in a position to determine the solvency of the business and had reasonable grounds to suspect the company was insolvent during the relevant time period.
Federal Budget Introduces Anti-Phoenixing Measures
In the recent federal budget, the Government has vowed to combat illegal phoenix activity by reforming existing corporations and tax laws and granting the Australian Taxation Office additional power. Accordingly, the proposed changes are credited as complementing the work of the Government’s Phoenix, Serious Financial Crime and Black Economy taskforces, with Federal Treasurer Scott Morrison asserting they will ensure small businesses “don’t get ripped off by other businesses who deliberately go bust to avoid paying their bills.”
Illegal phoenixing occurs when a company’s directors allow a business to collapse in order to avoid paying creditors, either through directors resigning or through the business going into administration. All too often the practice results in customers not receiving goods or services they have paid for, lost payments for small businesses and lost wages and entitlements for affected employees. Ultimately, it has an adverse impact on the economy, with illegal phoenix operators gaining an unfair advantage over honest businesses.
Under the proposed budget, the government has allocated $40million to be spent over the next four financial years, introducing new phoenix offences to target those who conduct or facilitate illegal phoenixing. Specifically, these measures endeavour to prevent directors from backdating their resignations, limiting the ability of directors to resign and restricting the ability of related creditors to appoint or remove external administrators.
Moreover, it will expand the ATO’s power to retain refunds where there are outstanding tax lodgements and will extend the Director Penalty Regime to include GST, luxury car tax and wine equalisation tax, making directors personally liable for the company’s debts.
Court Rejects Mossgreen's Art Collection Levy
White, in the matter of Mossgreen Pty Ltd (Administrators Appointed) v Robertson [2018] FCAFC 63
In December 2017 administrators were appointed to Mossgreen Pty Ltd, a well-known Australian auction house and gallery. The administrators sought to recover over $1 million in costs from consignors by charging $353.20 per lot for the return of goods. In some instances this meant that the total value of a consigners property was exceeded by the collection charge, and so many consigners opposed the directions.
Subsequently the administrators applied to the court in March this year, seeking approval for their nominated course of action. They argued that they held an equitable lien over the consigned items and were therefore entitled to recover costs by imposing a levy for the release of items.
At first instance, Perram J dismissed the directions sought, concluding the stocktake did not relate to Mossgreen's property and subsequently did not fall within the administration of their affairs.
On appeal, the court opposed this view, finding that it was within the statutory functions of the administrators to continue to perform the function of holding the consigned items, and as part of doing so, take steps to manage and return the items. It concluded that in certain circumstances, a lien could arise in favour of administrators for costs incurred dealing with claims for the return of items, even where there was no ownership claim by the company under administration.
Despite this, the court ultimately rejected the appeal, arguing that there was no basis for an equitable lien of the kind sought here because:
- Many of the costs incurred related to items which the administrators knew had been abandoned and were of little value;
- If a stocktake were needed, this need arose from a breach of Mossgreen's obligations as a bailee, being the failure to maintain an adequate inventory system for consigned items; and
- Much of the costs had been incurred for the benefit of the general body of creditors, including in relation to the sale of a part of Mossgreen's business. The owners of the consigned items had no interest in this, as they would not benefit from such a sale.
Federal Court: Asset Surplus Not Enough to Save Company from Insolvency
On 25 August 2017, the Deputy Commissioner of Taxation (DCT) filed an application to wind up Tank Sales Sydney Pty Ltd following the company’s failure to comply with a statutory demand issued in June 2017.
The demand related to an account deficit debt under the BAS provisions of the Income Tax Assessment Act 1977 (Cth) and amounted to $269,073.15 as at 16 June 2017. It included administrative penalties and general interest charges under the Taxation Administration Act 1953 (Cth) plus superannuation guarantee charges, and an additional charge for late payment.
Last November the company filed a notice of appearance, contending that it was not insolvent, but suffering a short term cash flow issue. Relevantly, the company argued that its assets outweighed its liabilities.
The matter was heard in the Federal Court on 27 March 2018, where the DCT relied on the judgement of Weinberg J in Ace Contractors & Staff Pty Ltd v Westgarth Development Pty Ltd [1999] FCA 728 to establish its entitlement to a winding up order (unless the Company could rebut the presumption of insolvency.)
In seeking to prove their solvency, the company produced financials in support of their claim - including its 2016 and 2017 tax returns. However the DCT argued that such documents should not be allowed to be admitted to evidence because they were not audited and accordingly amounted to hearsay.
Farrell J accepted the financials, however concluded that little weight could be given to them in the absence of direct evidence to support the values indicated. Moreover, his Honour asserted that where assets cannot be converted into cash within a relatively short time, their disclosure will not prove effective in establishing solvency.
Ultimately, the court ordered that:
-
- Tank Sales Sydney Pty Ltd be wound up in insolvency;
- David Lombe of Deloitte Financial Advisory be appointed the liquidator of the defendant corporation; and
- The Deputy Commissioner of Taxation's costs of proceedings be fixed at $2,897.98.
Queensland Court of Appeal rules that liquidators’ disclaimer trumps environmental protection order
Background
Prior to its winding up, Linc Energy Limited (in liq) (Linc) had owned and operated an underground coal gasification project near Chinchilla. A necessity of that operation was that Linc required environmental authorities issued under the Environmental Protection Act 1994 (Qld) (the EPA).
An Environmental Protection Order (EPO) was issued by the Chief Executive of the Department of Environment and Heritage Protection (Chief Executive) pursuant to section 358 of the EPA on 13 May 2016. The effect of that EPO was that Linc was compelled to comply with its duties arising from the activities undertaken on the land to take all reasonable and practicable measures to prevent or minimise harm arising from the carrying out of those activities.
Shortly after the EPO was issued, the appellant liquidators were appointed to Linc. On 30 June 2016, the liquidators gave notice disclaiming, amongst other things, the land at Chinchilla and the environmental authorities under the EPA which it held for the site. The liquidators contended that the consequence of the disclaimer under section 568(1) of the Corporations Act 2001 (CA) was that they were relieved of the requirements of the EPO, on the basis that they constituted “liabilities… in respect of the disclaimer property” as defined by section 568D of the CA.
The Chief Executive contended that notwithstanding the disclaimer of the property described above, Linc remained bound to comply with the EPO. The liquidators then applied to the Supreme Court of Queensland for a direction pursuant to section 511 CA that they would be justified in not complying with the EPO.
The proceedings at first instance
The liquidators contended, in summary, that they were relieved of their obligations under the EPO issued under the EPA (a Queensland Act) as a result of their disclaimer of the land and associated environmental authorities under section 568(1) of the CA (a Commonwealth Act), because of the operation of section 109 of the Constitution, which provides that:
When a law of a State is inconsistent with a law of the Commonwealth, the latter shall prevail, and the former shall, to the extent of the inconsistency, be invalid.
In opposition to that, the Chief Executive (joined by the Attorney-General for the State of Queensland who had been granted leave to intervene) contended that section 5G of the CA applied such that the provisions of the EPA in fact prevailed over the right to disclaim (and its attendant consequences) under the CA. Relevantly, sub-section 5G(11) provides:
A provision of the Corporations legislation does not operate in a State or Territory to the extent necessary to ensure that no inconsistency arises between:
- the provision of the Corporations legislation; and
- a provision of a law of the State or Territory that would, but for this subsection, be inconsistent with the provision of the Corporations legislation.
Justice Jackson found for the Chief Executive at first instance.
The decision on appeal
The Court of Appeal unanimously decided to reverse the decision below and found in favour of the liquidators.
The Court of Appeal found, in summary, that:
- the obligations arising from the EPO were liabilities in respect of disclaimed property, irrespective of whether the environmental authority itself constituted disclaimed property.
In delivering the leading judgment, Justice McMurdo determined:
Once the land and MDL had been disclaimed, there was no activity which could be carried out by Linc to which the general environmental duty could attach, and for which this EPO could have operated in the pursuit of its stated purpose. The connection between the disclaimed property and the liabilities under the EPO is thereby clear and immediate: the liabilities under the EPO were premised upon Linc’s carrying out activity which it could not and would not carry out, once the land and the MDL had been disclaimed.
- Once disclaimed, section 568D of the CA provided that Linc’s obligations under the EPO, being liabilities in respect of the disclaimer property, terminated. It was not possible to ‘sever’ or selectively terminate some liabilities but not others.
Emphasising that the State had readily admitted and alleged that a consequence of the disclaimer of the land at Chinchilla was that it had passed to the State, Justice McMurdo, found:
It could not have been intended that by a disclaimer of property, a liquidator could cause a company to lose all of its rights and interests in or in respect of the property, but remain burdened by a liability in respect of it. That would be an absurd operation of a law which has a long recognised purpose of enabling the company to rid itself of burdensome obligations. To put the matter another way, as a matter of construction, s 5G cannot displace the effect of s 568D on some or all of a company’s liabilities but not upon the other effects of a disclaimer. Consequently, the appellants are correct in submitting that s 5G(11) could be applied in this case only by impugning the disclaimer itself.
Conclusion
The High Court of Australia dismissed the Chief Executive’s application for Special Leave to Appeal the decision of the Queensland Court of Appeal on 14 September 2018.
As a result, it remains to be seen whether the decision elicits a response from state legislatures or environmental authorities seeking to bind liquidators to remedial actions required under an EPO notwithstanding disclaimer, whether by legislative intervention or by careful phrasing of the EPO to the effect that its requirements do not create liabilities in property capable of disclaimer.The next battleground may well be whether valid disclaimer of property has occurred in particular instances. No express finding was made on that point by Justice Jackson at first instance because the matter had proceeded on the premise that disclaimer had occurred because of admissions made by the respondents. Yet notwithstanding the “unambiguous” admissions made, the respondents sought in the appeal to depart from that position and put in issue the disclaimer, which the Court of Appeal did not permit.
