Director reprimanded for failing to comply with PAYGW obligations
In the matter of Deputy Commission of Taxation v Thomas Wilson [2018] NSWDC 302, the New South Wales District Court found against a company director for failing to comply with his duties. In doing so, Mahoney SC DCJ refused to mitigate on the basis of the director’s ‘difficult’ co-directors, asserting that there is no reprieve available to directors who fail to uphold their obligations.
In April 2015, Global Piling Contractors Pty Ltd was incorporated, with Mr Wilson, Mr Wheatley and Mrs Wheatley appointed as directors. Mr Wilson and Mr Wheatley each owned a 50% share in the company.
According to Mr Wilson, it was agreed at the time of incorporation that the directors were not employees of the company and thus would not receive salaries. Rather, they would draw money by way of dividends. In fact, the company was to have no employees, but would instead engage the services of contractors as required.
However, in 2015 the company withheld monies due to the Deputy Commissioner of Taxation on two occasions, before lodging Business Activity Statements which identified two amounts withheld for PAYG tax on employee salaries. The PAYG tax was never paid. Accordingly, in February 2016, Mr Wilson was issued with a Director Penalty Notice (DPN) for failing to remit PAYGW to the value of $111,798 to the ATO.
At trial, Mr Wilson submitted that from the time of incorporation until he received the DPN, he believed the company had systems in place to ensure it complied with its taxation obligations and remitted all amounts due to the ATO. He asserted that he thought those sums would be limited to GST and upon receiving the DPN, he did not understand that the amounts claimed were on account of taxes withheld by the company for wages paid to employees.
Moreover, Mr Wilson submitted that upon receiving the DPN, he phoned Mrs Wheatley who informed him that the amounts claimed in the DPN were on account of taxes withheld from wages paid to workers and not remitted to the ATO. Mr Wilson was also informed that Mr Wheatley had been hiring employees, rather than engaging contractors - a decision which he submitted he had not previously been made aware of. Further, Mr Wilson was informed that both Mr and Mrs Wheatley had also received a DPN and that ATB Partners would be engaged to formulate a payment plan with the ATO.
On 22 February 2016, at Mr Wilson’s request, a meeting of the company was held to discuss the outstanding taxation liability and the company’s ability to pay it. With no involvement in the day-to-day running of the company, and concerned that the company was insolvent, Mr Wilson was apprehensive about his exposure as a Director under the DPN. He subsequently moved a resolution that the company enter into voluntary administration. However, Mr and Mrs Wheatley contended that the company was simply experiencing a ‘temporary lack of liquidity’, and consequently dismissed the motion. They also rejected a secondary resolution by Mr Wilson that the directors convene a general meeting of the members of the company for the purpose of appointing a liquidator.
Mr Wilson subsequently sought legal advice on how to put the company into administration or cause the company to be wound up to avoid liability under the DPN. Mr Wilson was informed that he alone could not put the company into the administration, and that in order to avoid liability under the DPN, the company would need to pay its outstanding taxation liabilities. Mr Wilson was also advised that he could apply to the court for a winding up order but that it would be a difficult process and that by the time an application was heard in court, the time for compliance with the DPN would likely have expired.
In August 2016, Mr and Mrs Wheatley agreed to appoint an administrator, who the court subsequently appointed as a liquidator.
In September 2018, the matter was brought before Mahoney DCJ, with the Deputy Commissioner of Taxation alleging that pursuant to section 255-45 of the Taxation Administration Act, it had a prima facie entitlement to the debt due by virtue of an evidentiary certificate. However, Mr Wilson relied on the statutory defence under s 269-35. Accordingly, the court was required to determine whether Mr Wilson had taken “all steps which were reasonable, having regard to the circumstances of which the defendant, acting reasonably, knew or ought to have known, to ensure that the directors complied with the section.”
Having considered the test in Saunig, the court held that the Mr Wilson had failed to take all reasonable steps, concluding that he “failed to inform himself of the way in which the company was being managed and operated.” In doing so, Mahoney DCJ held that Mr Wilson ought to have known that the company was incurring a tax liability by way of PAYGW. His Honour also concluded that there were further steps available to Mr Wilson, including calling another meeting to persuade his co-directors to appoint an administrator or to have brought an application for leave to wind up the company. Mr Wilson was therefore ordered to pay the debt in the amount of $111,798 plus interest, pursuant to section 100 of the Civil Procedure Act 2005.
Ultimately, this case serves as a warning to other directors that they cannot claim ignorance to satisfy the objective test and absolve their duties as a director.
Federal Court sets aside statutory demand in respect of unpaid legal costs issued during the period in which costs may be assessed
The recent Federal Court of Australia decision of Rusca Bros Services Pty Ltd v Dlaw Pty Ltd, in the matter of Rusca Bros Services Pty Ltd (No 2) [2019] FCA 1865 serves as a timely reminder that a statutory demand may be at risk of being set aside when issued in circumstances where a statutory period for assessment of costs comprising the debt claimed has not yet expired.
Background
Rucsa Bros Services Pty Ltd (Rusca) engaged Dlaw Pty Ltd trading as Doyles Construction Lawyers (Doyles) to act on their behalf in a dispute with Lendlease Building Pty Ltd (Lendlease) connected with construction works at RAAF Tindal in the Northern Territory in about September or October 2017.
Throughout the course of the retainer, Doyles rendered invoices to Rusca totalling $500,529.79. Rusca paid a total of approximately $300,000 to Doyles between about October 2017 and about March 2018.
In April 2018 a director of Rusca sent an email to Mr Doyle of Doyles expressing surprise at the size of the recent invoice given the significant fees already paid to that point and stating that Rusca would need to go through each of the bills to ensure that they were reasonable.
On 8 May 2018, Rusca requested that Doyles provide it with an itemised invoice for all of the bills rendered by Doyles to Rusca. By section 187(3) of the Legal Profession Uniform Law (NSW) (LPUL) Doyles were required to provide the itemised bill within 21 days of the request. The equivalent provision in Queensland, secion 332 of the Legal Profession Act 2007, provides that a firm must provide an itemised bill within 30 days of such a request.
Also on 8 May 2018, Rusca received a statutory demand from Doyles dated 7 May 2018 seeking payment of a total sum of $191,022.15 being the unpaid balances of 3 invoices issued in February, March and April 2018 less funds held in trust.
On 25 May 2018, Rusca filed an application to assess the costs charged to it by Doyles over the course of the retainer.
As at the date of the hearing, whilst the costs assessor had completed his assessment of the costs, his fees had not been paid and neither Rusca nor Doyles had taken steps to obtain the costs assessor’s Costs Determination (the equivalent of a certificate of assessment in Queensland).
Statutory Demand
Rusca applied under sections 459H and 459J of the Corporations Act 2001 (the CA) to set the statutory demand aside.
The grounds relied upon included, relevantly:
- as the legal costs comprising the debt the subject of the Demand were the subject of an assessment application, there was a statutory prohibition on proceedings to recover the costs and the debt the subject of the Demand was not presently due and payable; and
- Doyles had failed to give an adequate estimate of total legal costs at the commencement of the retainer and as a result, was not permitted to commence or maintain proceedings for recovery of its costs until the costs had first been assessed. This also constituted a statutory prohibition on proceedings to recover the costs and for this reason as well, the debt the subject of the Demand was not presently due and payable
In ordering that the Demand be dismissed, Markovic J referred to section 198(7) of the LPUL. That section provides that once an application for costs assessment has been made:
the law practice must not commence any proceedings to recover legal costs until the costs assessment has been completed.
There are similar provisions in other jurisdictions in Australia. The Queensland equivalent is section 338 of the Legal Profession Act 2007 (LPA), which is identical to section 198(7) of the LPUL save that a law practice may commence proceedings with the leave of the court.
Her Honour cited authority to the effect that:
if a statute prohibits commencement of proceedings to recover a debt, then so long as the statutory prohibition remains in place the debt is not “due and payable” and consequently cannot found a statutory demand.[8]
Her Honour held that:
the statutory prohibition in s 198(7) means that the debt the subject of the Demand can no longer be said to be immediately “due and payable” as required by s 459E of the Act. This is because the debt the subject of the Demand cannot presently be enforced by action by the commencement of any proceeding for recovery. That is so even if the Demand was served prior to the commencement of the Assessment Application. While the debt might have been due and payable at the time of service of the Demand because there was no prohibition on the commencement of a proceeding for recovery at that time, that status changed as soon as the Assessment Application was filed.[9]
After determining that the costs assessment application was not complete because the Costs Determination had not been obtained, in the result her Honour held that:
the Assessment Application is not complete. As that is the case, it follows that Doyles is precluded by s 198 of the LPUL from taking steps to recover its costs and, in those circumstances, the debt the subject of the Demand is not due and payable and the Demand should be set aside pursuant to s 459J(1)(b) of the Act.
Other grounds relied upon
Her Honour also dealt briefly with other grounds relied upon by Rusca in order to set aside the Demand, including, relevantly, the contention that Doyles had failed to provide a proper estimate of legal costs at the commencement of the retainer.
Her Honour held that Doyles had failed to give sufficient costs disclosure (noting that the estimate given at the outset ultimately comprised 2% of the total costs billed) and that by operation of section 178 of the LPUL, Doyles could not commence or maintain proceedings to recover the legal costs until they had been assessed, with the result that the costs the subject of the Demand would not be payable until they had been assessed.
There are also equivalents to section 178 of the LPUL in other Australian jurisdictions. The equivalent provision in Queensland is section 316 of the LPA, which provides that a client “need not pay the legal costs unless they have been assessed” in circumstances where adequate disclosure has not been made.
Conclusion
The key takeaways for practitioners from the decision are:
- If a client files a competent application for costs assessment after a statutory demand has been issued in respect of unpaid legal costs, the statutory demand is liable to be set aside pursuant to section 459J(1)(a) of the CA on the basis that the costs the subject of the statutory demand are not “due and payable” until the costs assessment process is complete.In Queensland, a client may apply for assessment of costs without leave within 12 months of receiving the final bill or request for payment, so the period of risk extends for at least that length of time; and
- A court may be prepared to in effect ‘look behind’ a statutory demand issued in respect of unpaid legal costs to determine whether adequate disclosure has been made for the purposes of the applicable statutory regime and if it determines that it has not, the statutory demand may be set aside as a result.
When is a Release a release?
Deeds are a very common legal instrument that are used for almost infinite purposes. Deeds are a special kind of binding promise or commitment to do something made under seal. Accordingly, deeds are seen as particularly solemn promises and may attract special legal consideration if breached.
Commonly, deeds will be used when settling disputes or ending relationships such as partnerships or employment. Often a deed will contain a clause that acts as a bar to bringing future or further legal proceedings. As a result, there is a perception that action will be prevented even when unscrupulous conduct of a party later comes to light. However, a recent Queensland Court of Appeal decision demonstrates that this may not always be the case.
The decision of Wichmann v Dormway Pty Ltd [2019] QCA 31 concerned a former office manager who had diverted the employer’s money into her own accounts. Upon discovering that an amount of $2,809.42 had been diverted, the employer terminated the employee despite her offer to repay the money. As part of the termination procedure, the parties entered into a deed of release containing the following clauses purporting to bar future action:
Recital E stated:
The parties have agreed to settle all matters effective from the 30 April 2018, relating to the employment and the cessation of the employment of WICHMANN, and any matters arising therefrom, save as to any statutory rights concerning superannuation or worker’s compensation, or the subsequent enforcement by either party of the terms of this deed; and without any admissions of liability by either Party; as set out herein.
Clause 4.2 stated:
In consideration for the agreements herein, DORMWAY hereby releases and discharges WICHMANN from all causes of action, actions, suits, arbitrations, claims, demands, costs, debts, damages, expenses and legal proceedings whatsoever arising out of or in any way connected with:
- The Employment or its termination or any circumstance relating to its termination; or
- Any matter, act or circumstances occurring between the date of termination of the Employment and the date of this agreement; save as to any unlawful act; and
- Whether arising under statute, common law or equity,
Or any of these which DORMWAY now has or had the right to bring against WICHMANN at any time hereafter, but for the execution of this agreement; save as to any matter relating to the enforcement of this deed.
Shortly after executing the deed, the employer discovered that the former employee had actually diverted a total amount of $321,593.85 to her own accounts. The employer sued the former employee for recovery of this money and successfully obtained judgment in their favour. The employee appealed this decision asserting that the judgment was based in an error of law on the basis that the clauses must be taken to have the effect of barring action in regard to her misappropriation, regardless of whether disclosed or not.
The Court of Appeal rejected this argument noting that as the above clauses were in general terms and did not identify specific conduct, it was the responsibility of the employee to demonstrate the release applied to the specific claims against her; it was not for the employer to demonstrate that they would not have entered into the deed had they known of the true extent of misappropriation. As the employee had knowingly not disclosed the extent of her misappropriation to her employer, her duty of good faith was breached. This gave rise to an entitlement to avoid the deed and recover any money paid under it.
Additionally, it was arguable that the employee had committed common law fraud, which would allow the entire deed to be set aside, a relevant argument but not one that the employer had made.
With these conclusions, the Court dismissed the appeal ordering costs against the employee.
From this case several principles in relation to deeds become apparent:
- When entering into a deed both parties should take steps to disclose all relevant information;
- A deed will not protect against unconscionable behaviour simply because it has been executed;
- Non-disclosure of information may give rise to allegations of fraud or inducement which may result in the setting aside of a deed;
- A party relying on a deed must establish that the terms apply to the situation facing them, it is not enough to simply rely on broad general terms.
High Court of Australia abolishes ‘Chorley Exception’
In 2018 we provided an update in respect of the matter of Pentelow v Bell Lawyers Pty Ltd [2018] NSWCA 150.
In that decision, the New South Wales Court of Appeal held that the ‘Chorley exception’ applied to barristers as well as to solicitors.
The Chorley exception is an exception to the well-established rule that a self-represented litigant is not entitled to professional costs for acting for him or herself in legal proceedings and provides that self-represented litigants who are solicitors are entitled to recover professional costs for work they have undertaken in legal proceedings.
In December 2018, the High Court of Australia granted special leave to appeal that decision and on 4 September 2019, allowed the appeal and overturned the decision of the New South Wales Court of Appeal.
Significantly, in doing so the High Court effectively abolished the Chorley exception in Australia.
Background and proceedings below
The case involved Janet Pentelow, a barrister who brought proceedings in both the Local Court and Supreme Court of New South Wales, seeking to recover unpaid fees following a dispute with her client (who had been her instructing solicitors). Although the Supreme Court awarded costs in Ms Pentelow’s favour in respect of both proceedings, the costs assessor later rejected in its entirety that part of the costs claimed by Ms Pentelow for preliminary work that she had undertaken herself prior to engaging legal representation, such as drafting the originating process and her affidavit of evidence.
During a subsequent review by the Costs Review Panel, Ms Pentelow’s claim for costs relating to work that she had undertaken was again disallowed on the on the basis that, relevantly, the Chorley exception did not extend to barristers. Ms Pentelow subsequently appealed to the District Court of New South Wales, however was unsuccessful on the same basis and thus sought judicial review of the decision pursuant to s69 of the Supreme Court Act 1970 (NSW).
In the New South Wales Court of Appeal, Beazley ACJ (with whom Macfarlan JA agreed) held that the Chorley exception extended to the work undertaken by a self-represented barrister, so long as that work was not expressly proscribed by the Bar Rules. Significant in Beazley ACJ’s reasoning was the fact that there was now significant overlap in the work undertaken by both solicitors and barristers and the costs of each may be assessed under the same costs assessment processes.
The decision in the High Court of Australia
On appeal, Keifel CJ, Bell, Keane and Gordon JJ commenced their analysis by noting that:
the Chorley exception is not only anomalous, it is an affront to the fundamental value of equality of all persons before the law. It cannot be justified by the considerations of policy said to support it.
Their Honours considered the rationale expressed to underlie the Chorley exception, which is that the professional skill and labour exercised by a solicitor litigant may be measured by the law, whereas the “private expenditure of labour and trouble by a layman cannot be measured”.
After noting that there was no reason in principle why the reasonable value of the time of any litigant could not be measured (citing the example of valuing the provision of labour in a quantum meruit claim), their Honours went on to note that:
there is an air of unreality in the view that the Chorley exception does not confer a privilege on solicitors in relation to the conduct of litigation… A privilege of that kind is inconsistent with the equality of all persons before the law.
There were only two previous decisions of the High Court of Australia in which the Chorley exception is referred to: Guss v Veenhuizen [No 2] and Cachia v Hanes (Cachia Decision).
The majority noted that because the existence of the Chorley exception in Australian common law was not in question in either decision, those decisions did not bind a later court to accept the application of the Chorley exception.
Furthermore, the majority in the Cachia Decision was critical of the decision in Chorley, describing it as “somewhat anomalous” and stating that the justification for the exception was “somewhat dubious”.The majority in Bell Lawyers noted that those criticisms “substantially undermine[d] the authority of the decision in Chorley” and that the possibility of a solicitor profiting from their participation as a litigant “is unacceptable in point of principle.”
Their Honours also cited the following statement of the majority in the Cachia Decision:
If the explanation for allowing the costs of a solicitor acting for himself are unconvincing, the logical answer may be to abandon the exception in favour of the general principle rather than the other way round.
Their Honours concluded that:
There is no compelling reason for this Court to refrain from taking the “logical step” identified in Cachia. The Chorley exception is not part of the common law of Australia.
The remaining judges agreed that the appeal should be dismissed. Both Gageler J and Edelman J agreed with the majority that the Chorley exception did not form a part of the common law of Australia. Nettle J, however, found only that the Chorley exception did not extend beyond solicitors to barristers.
Practical consequences
It is unclear how common it is for legal practitioners to undertake legal work in litigation on their own behalf.
The most likely example may be circumstances in which a sole practitioner or firm undertakes debt recovery proceedings on its own behalf. The apparent consequence of the decision is that a sole practitioner cannot recover legal costs from its opponent for work of this type. Whilst that may lead to an increase in firms outsourcing their own debt recovery, that outcome is consistent with the majority’s view that as a matter of policy, it is better that legal work be undertaken with sufficient professional detachment.
Where an incorporated legal practice (ILP) undertakes legal work such as debt recovery proceedings on its own behalf, it appears that the firm remains capable of recovering legal costs from its opponent, due to the legal detachment between the litigant (the ILP) and the practitioner undertaking the work (an employee of the ILP). Comments made by the majority, however, suggest that this position may be subject to review in future, in particular in respect of ILPs with a sole shareholder and director.
Phoenix company wound up following 'fictitious joint venture'
In insolvency and restructuring there is a special emphasis placed upon behaviour known as “phoenix activity”. Phoenix activity is where a new company is created to continue the business of an existing company. Typically, this will involve a company entering into a transaction with another related entity for the sale of its assets. This allows business to continue, however the new company will not have any of the liabilities that the original business had such as obligations to creditors, the ATO or employees.
While there are several legitimate and legal forms of restructuring or reorganising a company, it is particularly unwise to simply enter into such a scheme without first checking its legality. The consequences of doing so are very severe including: liability for a breach of directors’ duties, ASIC penalties, penalties under the Director Penalty Regime of the Taxation Administration Act 1953, and breaches of the Fair Work Act 2009 if the scheme involves the avoidance of employee entitlements.
The recent case of Yeo v Alpha Racking Pty Ltd [2019] FCA 1338 provides a guideline of circumstances that indicate phoenix activity is occurring. The case concerned an application bought by the liquidators of a company known as Alpha Storage. The application sought the winding up of a company known as Alpha Racking as well as the appointment of the plaintiff liquidators as its provisional liquidators. This application was bought due to a suspicion that the assets of Alpha Storage were wrongly being transferred to Alpha Racking for the purpose of defeating creditors.
After reviewing the evidence presented by the liquidators O’Bryan J concluded that a strong case that the directors of Alpha Storage were engaged in a plan to strip the assets of Alpha Storage and transfer them to Alpha Racking had been established. His Honour held at [34] that the phoenixing activity included:
(a) the creation of a false joint venture agreement between the companies;
(b) attempts to have customers pay Alpha Racking — and not Alpha Storage — money they owe to Alpha Storage;
(c) the creation of what appear to be false financial records, including financial statements, for Alpha Racking and Alpha Storage;
(d) the transfer of staff from Alpha Storage to Alpha Racking; and
(e) the setting up of a new financial accounting package for Alpha Racking and the transfer to it of “open” purchase orders that are the property of Alpha Storage.
At [35] his Honour explained how the evidence of the case indicated phoenix activity was taking place:
First, Alpha Storage has issued invoices to third parties, showing that it was a trading entity and not a “labour hire” firm.
Second, security interests have been registered in the name of Alpha Storage on the Personal Property Securities Register and finance agreements exist between Alpha Storage and various financiers (ANZ Bank, Macquarie Leasing Pty Limited, Toshiba, PCP Finance), again showing that Alpha Storage was conducting a trading business.
Third, a “LinkedIn” page gives a description of the business activities of Alpha Storage and there is no reference to a joint venture.
Fourth, the debt owed to the Commissioner of Taxation includes a significant liability for GST which indicates that Alpha Storage operated a significantly sized business.
Fifth, there is no reference to a joint venture in any of the documents provided to or obtained by the liquidators, including the financial accounts and taxation documents of Alpha Storage.
Sixth, the partner from BDO Melbourne who was responsible for preparing Alpha Storage’s accounts and tax returns confirmed that no mention was ever made of a joint venture arrangement and that Alpha Storage traded in its own right.
Seventh, the documents evidencing the lease for the Dandenong South and Brisbane premises are in the name of Alpha Storage. These documents post-date the purported joint venture agreement. Further, the leasing agent of the Dandenong South premises was unaware of any joint venture.
Based on the above findings, his Honour agreed that a strong prima facie case of serious misconduct and potential fraud in the conduct of Alpha Racking’s affairs had been established. The application was therefore granted.
In addition to the Yeo case, the ATO and ASIC also include information on the warning signs of phoenix activity including:
- the company fails and cannot pay its debts
- the company changes its name to its Australian Company Number (ACN) and a new company is registered, often with a similar name to the old company
- the directors or former directors transfer the assets from the old company to the new one for less than market value
- the new company operates the same or similar business as the old company, sometimes from the same premises, using the same assets
- the new company often uses the same bank account, advertising material, websites or contacts details as the old company
- the people involved in managing the old company control the new company, either as the directors or controllers.
Brisbane man cops jail time for $1.2M tax fraud
A 51-year-old Brisbane man has been sentenced to 7 years in prison and ordered to pay $1.2 million in reparations after he was convicted of fraudulently obtaining and attempting to obtain more than $1.2 million from the ATO.
On 22 March 2019, Stephen Mungomery appeared in the Brisbane District Court which heard that between March 2009 and October 2012, he lodged 46 Business Activity Statements (BAS) on behalf of his wife’s business, Gourmet Providores. In doing so, Mr Mungomery included expenses incurred by his sole trader entity Epicure Consulting and Training Solutions.
In attempting to substantiate his claims, Mr Montgomery produced 24 invoices issued by Epicure Consulting. The invoices accounted for 92% of all expenditure and totalled $13,767,466 in sales - including $5 million for website development and $2.6 million for franchise development.
However, those invoices bore no commercial reality and were never actually paid. In fact, the court heard that the initial Gourmet Providores website was actually created by another company for $7,885. The franchise development claims were also held to be fraudulent.
Mr Mungomery was subsequently jailed for 7 years and ordered to repay the money to the ATO.
ATO Assistant Commissioner Peter Vujanic asserted that this case signals a warning to all Australian’s that those caught breaking the law will be held accountable, even if it means pursuing an action in the criminal justice system.
Progressive Reforms – Recent developments in Australian directors’ liability
Until recently, Australia had some of the strictest insolvent trading laws in the world. Those laws were designed to lift the corporate veil, so that those in control of a corporation could be held liable for debts incurred while the corporation is unable to pay its debts as and when they are due. Section 588G of the Corporations Act 2001 imposes a duty on a director to prevent insolvent trading. It is designed to act as a deterrence on directors incurring debts when the corporation is insolvent. It imposes personal liability and, in severe cases, there are criminal sanctions.
While this act still applies, in 2015 the Australian Productivity Commission recommended reforms to Australia’s corporate insolvency regime, designed to enable restructuring of economically viable companies with less emphasis on punishing for financial failure.
The recommendations of the commission were to restrict formal company restructuring procedures to those businesses that were capable of being economically viable in the future. They also recommended the introduction of a safe harbour defence to allow directors to explore early restructuring options without liability for insolvent trading, and a restriction on the enforcement of Ipso facto rights in certain circumstances.
These changes have now been legislated and have commenced operation. One of the main reasons for their recommendation and implementation was empirical data suggesting that insolvent trading cases were not so extensive, with those cases that do proceed to trial, often weighted heavily in favour of the liquidator plaintiff as against the defendant director.
Following corporate failure, directors are often penniless and pursuing them is not economic. It is therefore not unsurprising to find that reported cases of insolvent trading are not extensive in the more than 40 years since Australia has had insolvent trading laws, in one form or another.
The commission sought to address the tension between the desirability for strong insolvent trading protection on the one hand and encouraging a business restructure while the corporation is in financial distress on the other.
Safe harbour reforms
One of the ways they have achieved this is via the implementation of safe harbour reforms. The object of the reforms is to encourage directors to pursue restructuring opportunities that will deliver a better outcome to key stakeholders.
A safe harbour applies from the time the directors, who suspect insolvency, start to develop and implement a course of action that is reasonably likely to lead to a better outcome for the corporation than immediate administration or liquidation. It also operates as an exception to the insolvent trading provisions of the Corporations Act 2001, providing directors protection from any personal liability for debts that are incurred directly or indirectly in connection with the course of action.
Directors can still be liable for insolvent trading if they continue to incur debts while the corporation is insolvent, but safe harbour, if implemented correctly, can provide a defence to insolvent trading, thereby encouraging restructure and turnaround solutions as opposed to liquidation and personal liability.
Safe harbour rules require directors to take an active role in the restructure, while acting honestly and genuinely. They must also use up-to-date financial information to assess the likely outcome of restructure and comply with obligations to pay employee entitlements when they fall due. Meeting all of the company’s taxation reporting obligations, while properly maintaining books and records is also a requirement.
Under safe harbour rules, directors must engage with key stakeholders to develop and implement the restructuring plan. Once it becomes clear that a corporation is not viable, the protection of safe harbour will cease. Protections are not absolute and will require extensive advice and planning as well as consultation with key stakeholders. Their object is to encourage a restructure if it is reasonably likely to lead to a better outcome for the corporation.
Safe harbour does not appear to protect against other breaches of the Corporations Act 2001 and a liquidator may well still be entitled to pursue a creditor for an unfair preference, i.e. where the creditor is paid when the corporation is insolvent and the creditor receives more than they would if the corporation was wound up.
Ipso facto reforms
These reforms introduce a stay on parties being able to enforce rights against a corporation which goes into administration, has a receiver appointed or enters into a scheme of arrangement. The aim of these reforms is to preserve the going concern value of a corporation by creating a moratorium on enforcement of certain clauses in commercial contracts.
Without these reforms, a restructure may be jeopardised because the going concern value of a corporation can be destroyed by enforcement action. The new provisions introduce a stay on enforcing contractual rights including termination rights where the corporation goes into administration, has a receiver appointed or enters into a scheme of arrangement.
The stay is expressed to be a restriction on the ability to enforce a right that arises by reason of an express provision of a contract, agreement or understanding. The court maintains an overriding discretion to lift a stay, if that is appropriate in the interests of justice.
Conclusion
The Safe Harbour and Ipso facto reforms are significant changes to the corporate insolvency and restructuring landscape in Australia. They promote or seek to promote maximising the opportunity for preserving a going concern to assist with a corporate restructure in appropriate circumstances. The reforms present a useful step towards dispelling the long-held view that insolvent trading in Australia is focused on punitive outcomes rather than promoting entrepreneurship.
This article is an excerpt from the IR Global Australasian Guide. A full copy of the publication can be accessed here.
UK case reignites debate on the correct extent of judicial intervention
A recent decision in the United Kingdom has shed light on the topical issue surrounding the proper extent of judicial intervention. The case of Serafin v Malkiewicz & Ors [2019] EWCA Civ 852 ensued after Mr Serafin appealed an earlier decision on a number of grounds, including that the trial judge had exercised unfair judicial treatment against him.
Mr Serafin was a Polish immigrant who relocated to London where he subsequently engaged in a number of small business ventures, including a food business, which he launched in 2008. In 2011, a bankruptcy order was issued in relation to that business, with the Official Receiver finding Mr Serafin had engaged in misconduct by disposing of £123,743 whilst insolvent. As a result, Mr Serafin was made subject to a five-year Bankruptcy Restrictions Undertaking (BRU) in 2012.
In October 2014, Mr Serafin was the subject of an article published in Nowy Czas, a magazine popular among London’s Polish community. The article was entitled ‘Bankruptcy Need Not Be Painful’ and Mr Serafin contended that it contained serious defamatory allegations about him that amounted to a character assassination. He subsequently brought an action against the magazine’s editor and co-publishers, complaining of 14 different defamatory allegations.
The matter was heard over a 7-day period, after which Justice Jay found that many of the allegations were in fact ‘seriously defamatory’. Despite this, his Honour dismissed the claim in its entirety after finding some of the allegations to be untrue. Mr Serafin subsequently appealed the decision on five grounds, including that the trial judge had shown him ‘unfair judicial treatment’.
On appeal, counsel for Mr Serafin asserted that the judge’s interventions were accusatory, with the judge acting as an advocate for the defendant’s case rather than a neutral umpire. Mr Serafin also argued that the judge ought to have considered that there was an inherent risk of unfairness on the basis that he was an unrepresented litigant who was not legally qualified and did not have English as a first language, whilst his opponent was a very experienced silk.
In doing so, Mr Serafin tendered evidence that Justice Jay had formed a prejudicially adverse view of his evidence and character. The evidence included comments made by his Honour that Mr Serafin was “fundamentally untrustworthy” and warning Mr Serafin that “you will lose” and “I will hold things against you.” His Honour also told Mr Serafin “your reputation is already starting to fall apart, because you are a liar and you do treat women in a frankly disgraceful way.”
Furthermore, when counsel for the defendants suggested that the judge ask Mr Serafin which parts of the article he maintained were false, Justice Jay quipped, “I would not even bother, Mr Metzer, I think we have got to assume every point is lies.”.
On appeal, the court held that it was wrong for Justice Jay to “descend into the arena and give the impression of acting as an advocate”. In doing so, it concluded that it was “immediately apparent…that the Judge’s interventions during the Claimant’s evidence were highly unusual and troubling” and that his Honour “used language which was threatening, overbearing, and frankly, bullying”.
In deliberating this ground, the court considered Michel, which notes that not all departures from good practice render a trial unfair. However, having regard to the ‘nature, tenor and frequency of the Judge’s interventions’, the court concluded that an appeal was warranted.
In allowing the appeal, the court declared that Justice Jay “not only seriously transgressed the core principle that a judge remains neutral during the evidence, but he also acted in a manner which was, at times, manifestly unfair and hostile to the Claimant”.
Ultimately, this case reinforces that the role of a judge is to determine the dispute of the parties impartially and that one should not engage in bullying or unnecessary intervention. Although a UK case, it reflects trends in the Australian legal system, with almost two thirds of Victorian barristers reported to have been bullied from the bench. The rising number of instances such as this certainly begs the question of whether Queensland ought to create a Judicial Commission as has been done in New South Wales.
The scope of judicial intervention is a complex topic, which requires an open debate.
Failure to Disclose Debt May Jeopardise Consent Order
A recent finding of the Full Court of the Family Court of Australia serves as a timely reminder that a failure to disclose an asset or debt in a consent order may result in orders being set aside, regardless of whether that asset or debt is in the name of an individual, or the name of an ex-partner.
In the matter of Trustee of the Bankrupt Estate of Hicks & Hicks and Anor [2018] FamCAFC 37, the court was required to determine whether an appeal should be allowed on the basis that the primary judge erred in dismissing an application to set aside consent orders.
Specifically, the case involved Mr and Mrs Hicks, a husband and wife who, during their marriage, had acquired a number of properties between them. Mr Hicks also engaged in a number of business ventures, including a commercial deal to secure a $560,000 investment by Mr S in an enterprise known as U Pty Ltd.
Following their divorce, the couple filed an Application for Consent Orders for property settlement, in which neither party disclosed any liability to Mr S or identified him as a person who may be entitled to become a party to the case - something the application required.
Consequently, the Trustee of the Bankrupt Estate sought to have the final consent orders set aside.
At first instance, Mrs Hicks asserted that although there was a miscarriage of justice, the consent orders should not be set aside. The primary judge found in favour of Mrs Hicks, concluding that the debt was not incurred for a matrimonial objective and thus ruling that she had no involvement in Mr Hicks debt to Mr S. His Honour also contended that the trustee of bankruptcy would find itself in no better position if the order were set aside.
At trial, the Trustee subsequently argued that the consent orders should be set aside. In doing so, the Trustee asserted that the parties to the consent orders had sought to defeat a creditor by not disclosing that Mr S was suing Mr Hicks for $606,000 or notifying Mr S of the orders they proposed.
Thus, the court concluded that the Trial Judge had not taken into account the likely outcome of the property settlement proceedings in the event that the orders were set aside. Ultimately, the court held that the debt of $606,000 was incurred during the marriage and the projects which were linked to the loan were intended to benefit the marriage. On these grounds, the court allowed the appeal, ordering the proceeding be partially remitted for rehearing on the basis that there was a miscarriage of justice pursuant to s79A(1)(a) of the Family Law Act 1975 (Cth).
Expert determination – does ‘according to law’ mean free from legal error?
A common form of alternative dispute resolution is to have a dispute decided by an expert. The advantages of this method are that it is usually faster and less expensive than taking your dispute to court. Another advantage is you can appoint an expert with specialist knowledge of the industry that a judge may not have.
One important question regarding this process is how accurate the expert has to be in applying. The general consensus is that unless the expert has legal training, their determination may not be a truly accurate representation of the law. A recent case in the New South Wales Supreme Court does however provide guidance on this issue.
The case of Lainson Holdings Pty Ltd v Duffy Kennedy Pty Ltd [2019] NSWSC 576 concerned a challenge to an expert determination of a building contract dispute. A clause in the contract provided that before proceeding to court or arbitration:
(i) Any dispute or difference whatsoever arising out of or in connection with this contract shall be submitted to an expert in accordance with, and subject to, The Institute of Arbitrators & Mediators Australia Expert Determination Rules.
A dispute arose and was duly referred to an expert who found in favour of the builder. This determination was then challenged by the landowner on the basis that the expert had made an error of law when making their determination. The landowner argued that under Rule 5.1 of Arbitrators & Mediators Australia Expert Determination Rules, the expert was obliged to reach a decision free from legal error.
Hammerschlag J rejected this argument. His Honour found that in the context of the Expert Determination Rules “… the words ‘according to law’ mean in the manner which the law requires a person in the position of the Expert to go about the mandated task, so as to give it contractual efficacy; for example, honestly, without bias or collusion, and while not intoxicated”.
His Honour further commented that the landowners interpretation place an immense burden on experts and would be commercially inconvenient as “[i]ts acceptance would have the consequence that the Determination is, in effect, subject to appeal on any and every question of law determined or legal precept relied on by the Expert, which, if determined or seen differently, would lead to a different result”.
His Honour concluded by stating that the expert determination process is “… no more than a private contractual mechanism to which parties agree and which, as is dealt with above, does no more than create binding contractual obligations. It has no statutory backing as a process. It is not a process which resolves any dispute by the exercise of judicial, quasi-judicial, administrative, statutory or other power or jurisdiction.”
Ultimately, this decision highlights that the expert determination process is not judicial in nature and will therefore be unlikely to be held to the same standards as a Court or Tribunal. As the process is not deemed to be judicial, participants will generally not have any form of appeal from a determination unless this is provided for in their contract.
