FEDERAL COURT OF AUSTRALIA CORPORATIONS - winding up - conduct of liquidation - liquidator recovered payments of arrears of tax instalment deductions as voidable transactions under s 588FF of the Corporations Law - whether directors liable to indemnify Deputy Commissioner of Taxation - whether defence under s 588FGB(6) of the Corporations Law made out - time at which directors liable to indemnify the Deputy Commissioner Corporations Law, ss 588FF, 588FGA, 588FGB(6) Insolvency (Tax Priorities) Legislation Amendment Act 1993 Smith v Deputy Federal Commissioner of Taxation (1997) 15 ACLC 3, cited LINDSAY BROWNE, NIGEL BOUNDS, GORDON McDERMOTT, TREVOR THOMAS v DEPUTY COMMISSIONER OF TAXATION SG 35 of 1997 deputy commissioner of taxation v ANTHONY STEVEN SMITH, LINDSAY BROWNE, NIGEL BOUNDS, GORDON McDERMOTT, TREVOR THOMAS SG 36 OF 1997 LOCKHART, O'LOUGHLIN and KIEFEL JJ ADELAIDE 6 MARCH 1998 IN THE FEDERAL COURT OF AUSTRALIA SOUTH AUSTRALIA DISTRICT REGISTRY SG 35 of 1997 IN THE MATTER OF AUSTRALIAN COMPANY NUMBER 007 764 249 PTY LTD (IN LIQUIDATION) BETWEEN: LINDSAY BROWNE AND: NIGEL BOUNDS GORDON McDERMOTT TREVOR THOMAS APPELLANTS DEPUTY COMMISSIONER OF TAXATION RESPONDENT IN THE FEDERAL COURT OF AUSTRALIA SOUTH AUSTRALIA DISTRICT REGISTRY SG 36 of 1997 IN THE MATTER OF AUSTRALIAN COMPANY NUMBER 007 764 249 PTY LTD (IN LIQUIDATION) BETWEEN: DEPUTY COMMISSIONER OF TAXATION AppElLant AND: ANTHONY STEVEN SMITH First Respondent LINDSAY BROWNE Second Respondent NIGEL BOUNDS Third Respondent GORDON McDERMOTT Fourth Respondent TREVOR THOMAS Fifth Respondent JUDGES: LOCKHART, O'LOUGHLIN and kiefel JJ DATE OF ORDER: 6 MARCH 1998 WHERE MADE: ADELAIDE THE COURT ORDERS THAT: 1. The appeal in matter number SG 35 of 1997 be dismissed. 2. The appeal in matter number SG 36 of 1997 be allowed in part. 3. The declaration numbered 2 made by Mansfield J on 9 May 1997 in matter SG 3009 of 1996 be set aside (that is the declaration for indemnity as to the amount not recovered by the Commissioner in the liquidation); and there be substituted a declaration in these terms: "2. The cross-claimant be and is entitled to be, indemnified by the cross-respondent in respect of the sum of $131,913.50 together with interest thereon." 4. Otherwise appeal in matter number SG 36 of 1997 be dismissed. 5. In appeal SG 35 of 1997, the appellants pay the respondent's costs of the appeal. 6. In appeal SG 36 of 1997, the respondents pay the appellant's costs of the appeal. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA SOUTH AUSTRALIA DISTRICT REGISTRY SG 35 of 1997 IN THE MATTER OF AUSTRALIAN COMPANY NUMBER 007 764 249 PTY LTD (IN LIQUIDATION) BETWEEN: LINDSAY BROWNE AND: NIGEL BOUNDS GORDON McDERMOTT TREVOR THOMAS APPELLANTS DEPUTY COMMISSIONER OF TAXATION RESPONDENT IN THE FEDERAL COURT OF AUSTRALIA SOUTH AUSTRALIA DISTRICT REGISTRY SG 36 of 1997 IN THE MATTER OF AUSTRALIAN COMPANY NUMBER 007 764 249 PTY LTD (IN LIQUIDATION) BETWEEN: DEPUTY COMMISSIONER OF TAXATION AppELlant AND: ANTHONY STEVEN SMITH First Respondent LINDSAY BROWNE Second Respondent NIGEL BOUNDS Third Respondent GORDON McDERMOTT Fourth Respondent TREVOR THOMAS Fifth Respondent JUDGES: LOCKHART, O'LOUGHLIN and kiefel jj. DATE OF ORDER: 6 MARCH 1998 WHERE MADE: ADELAIDE REASONS FOR JUDGMENT THE COURT These two appeals from the judgment of a judge of the Court (Mansfield J) were heard together by consent. Various issues were raised at the trial and were dealt with by his Honour in his reasons for judgment, but on appeal only two issues were agitated. These issues concern the interpretation and application of ss 588FGA and 588FGB of the Corporations Law. The two sections are to be found in Division 2 of Part 5.7B of the Corporations Law which concerns voidable transactions. The Court is empowered by s 588FF(1) to make orders directing a creditor of a company who received payment of its debt from the company before it was wound up, in circumstances which render the transaction voidable and where the company was insolvent at the time the payment was made, to repay to the company the amount of the benefit received by the creditor (see also s 588FE). Section 588FGA(2) places the Commissioner of Taxation in a special position among the other creditors in the winding up of the company. When an order has been made by the Court under s 588FF against the Commissioner, each person who was a director of the company when the payment was made is rendered by s 588FGA(2) liable to indemnify the Commissioner in respect of any loss or damage resulting from the order for repayment. In this case a company paid moneys to the Deputy Commissioner of Taxation (the respondent in SG35 of 1997 and the appellant in SG36 of 1997) in respect of the company's group tax in liabilities at a time when the company was insolvent. The transaction was an unfair preference and the Court ordered the Deputy Commissioner, pursuant to s 588FF, to pay to the company the amount previously received by it. The company directors (who are the appellants in appeal SG35 of 1997 and the second to fifth respondents in appeal SG 36 of 1997) were held by the learned primary Judge to be liable to indemnify the Deputy Commissioner in respect of loss or damage resulting from the order and the directors appealed from his Honour's order. In finding against the directors the primary Judge held that the directors had not made out the defence which they had raised and for which s 588FGB(6) provides. That subsection states: "588FGB(6) It is a defence if it is proved that: (a) the person took all reasonable steps to prevent the company from making the payment; or (b) there were no such steps the person could have taken." Paragraph (b) of subsection (6) has no application. The directors relied upon paragraph (a) and asserted that in all the circumstances there were no reasonable steps which they could have taken to prevent the company from making the payment of outstanding group tax to the Deputy Commissioner. Thus the first issue which arises in the appeals, and arises only in appeal number SG35 of 1997, is whether the primary Judge erred in rejecting the defence of the directors raised by them under s 588FGB(6)(a). Assuming that the directors were correctly held by his Honour to be liable to indemnify the Commissioner, the question arises as to when the liability crystallizes. The primary Judge held that the directors were not liable to indemnify the Deputy Commissioner until the true amount of his loss or damage, resulting from the order of the Court to repay the preference, was ascertained. This could not be until a later stage in the winding up when moneys were available for distributions to the creditors including the Deputy Commissioner. The Deputy Commissioner's contention was that the liability of the directors was to indemnify as soon as payment was made by the Deputy Commissioner to the company in accordance with the Court's order. We shall refer to the relevant statutory provisions which relate to this question later. This is the second issue and arises in appeal SG 36 of 1997. These in brief are the two issues in the two appeals. It will be necessary to refer later to the relevant statutory provisions in some detail. What we have said thus far is sufficient to explain in an introductory way the points that arise in the appeal. Facts The facts may be briefly stated; there is no contest about them. The company is Adelaide Industrial Equipment Pty Limited (In Liquidation); its principal activity was the supply of industrial equipment. The company was registered as a group employer under s 221F of the Income Tax Assessment Act 1936 ("the Assessment Act") and was therefore obliged to deduct from the salary or wages paid to its employees the taxation payable by those employees, and to pay to the Deputy Commissioner the amount of the deductions by the seventh day of the next succeeding month: (s 221F(5)(a)(ii)) and otherwise to comply with that section. The company was dilatory in remitting tax instalment deductions to the Deputy Commissioner. By November 1994 there were substantial amounts of tax instalment deductions which had become due to the Deputy Commissioner and not paid by the company. From at least February 1992 the outstanding liabilities of the company to the Deputy Commissioner were the subject of frequent communications between them which, as the primary Judge said, "became more intense" during 1994. In 1994 the company took steps to sell its business and informed the Deputy Commissioner of this fact. In late September 1994 the company engaged solicitors to act for it and those solicitors had discussions with an officer of the Deputy Commissioner. It was thought that the solicitors would receive, on behalf of the company, moneys payable to the company upon settlement of the sale of the business. So the Deputy Commissioner served on the solicitors on 5 October 1994 notices in respect of the company's then indebtedness to the Deputy Commissioner given under s 218 of the Assessment Act in the sum of $230,887.86. Notices were also served by the Deputy Commissioner on the solicitors for the company on the same date with respect to sales tax outstanding under the sales tax legislation in the sum of $39,175.20. This notice was given pursuant to s 74 of the Sales Tax Assessment Act 1992. Although sales tax is not directly relevant in this case, the liability of the company to pay sales tax was relied on by counsel for the directors as part of the general matrix of facts in which the reasonableness of the conduct of the directors in the making of the voidable payments to the Deputy Commissioner falls to be determined. Ultimately the company agreed to sell its business to Rapid Forklift Hire Pty Limited and settlement took place on 3 November 1994. Before the settlement, the solicitors for the company had negotiated on its behalf for the purpose of compromising to some extent the indebtedness of the company to some of its creditors, including the Deputy Commissioner. As at 25 October 1994 the company owed the Deputy Commissioner a total sum of $300,747.90 in respect of unpaid tax instalment deductions and unpaid sales tax and additional tax imposed for late payment. Those discussions led to the company and the Deputy Commissioner entering into an agreement to compromise the company's debt to the Deputy Commissioner; the terms of the agreement being embodied in correspondence dated 31 October 1994 and 2 November 1994. Details of the compromise are not important. The essence of the compromise agreement was that the Commissioner would accept a lesser sum from the company in discharge of its tax liabilities. Upon settlement, the purchaser of the business paid the purchase price by a series of bank cheques, including one for $194,000 to the Deputy Commissioner. Later, on 6 February 1995 the Deputy Commissioner received the second payment which the compromise agreement envisaged would make to him of $41,000. The compromise agreement has already been considered by this Court in Smith v Deputy Federal Commissioner of Taxation (1997) 15 ACLC 3. On 5 April 1995 Anthony Steven Smith was appointed administrator of the company by resolution of its directors, and on 9 May 1995 he was appointed liquidator of the company by resolution of its creditors. Mr Smith is the first respondent to appeal SG36 of 1997. He is not a party to appeal SG35 of 1997. Mr Smith did not appear on the hearing of appeals before us as the issues did not concern him. The appeals were argued by counsel for the Deputy Commissioner and counsel for the directors. This sufficiently summarizes the relevant facts, the statement of which has been taken primarily by us from the reasons for judgment of the primary Judge. Primary Judge's Findings It was common ground at the trial and before us that the date of commencement of the winding up of the company was 5 April 1995 and that, for the purposes of the exercise of the Court's powers concerning voidable transactions under s 588FF of the Corporations Law, the relevant period to determine whether payment of the two amounts or either of them constituted a voidable transaction was the six month period commencing on 6 October 1994. The two payments of $194,000 and $41,000 were made within that period. The primary Judge found that these two payments were made when the company was insolvent and were unfair preferences given by the company to the Commissioner as one of its creditors (s 588FA(1)) and therefore voidable transactions. His Honour rejected the defences raised by the Deputy Commissioner (it is unnecessary to recite them as they were not pressed on appeal) and made a declaration that the payment by the company to the Deputy Commissioner and the receipt by it of the sums of $194,000 on 3 November 1994 and $41,000 on or about 6 February 1995 were unfair preferences and insolvent transactions and voidable transactions pursuant to s 588FA, s 588FC and s 588FE of the Corporations Law. His Honour ordered the Deputy Commissioner to pay to Mr Smith as liquidator of the company the sum of $235,000 with interest. As mentioned previously, the Deputy Commissioner had cross-claimed against the four directors pursuant to s 588FGA of the Corporations Law to indemnify the Deputy Commissioner in respect of the loss or damage he might sustain resulting from any order made under s 588FF of the Corporations Law. The cross-claim was required by s 588FGA(1) to be limitedlimitd to that part of the $235,000 which represented the outstanding tax instalment deductions, that is $180,999.07. His Honour found that the directors were liable to indemnify the Deputy Commissioner under the Corporations Law. His Honour rejected the defence of the directors under s 588FGB(6) that the directors took all reasonable steps which they could have taken to prevent the company from making the preferential payments. His Honour found that the defences available under sub-s (6) contemplate circumstances where the payment was made despite the actions of the directors, either because they tried to prevent it, or because it would not have been possible for them to prevent it. The focus of the sub-section is on preventing the payment. His Honour said that it was not to the point that the payment may have reflected a sensible commercial judgment at the time and in the circumstances in which it was made. In his Honour's view that is not the relevant test. His Honour said that he did not think the defence is made out where, on the facts, the directors, far from taking steps to prevent the payment or from being powerless to prevent it, procured it. His Honour did find, however, that the Deputy Commissioner should only be indemnified by the directors for the sum of $180,999.07 less any amount received by the Deputy Commissioner in the winding up of the company. His Honour reasoned that the indemnity created by s 588FGA(2), being an indemnity in respect of any loss or damage suffered by the Commissioner resulting from the Court order under s 588FF, is an indemnity for the ultimate or net losslosos suffered by the Deputy Commissioner. His Honour found that the ultimate loss will only be ascertained once the distribution to the creditors is finally resolved. Since that had not happened his Honour made a declaration that the Deputy Commissioner was entitled to be indemnified by the directors in respect of such part of the sum of $180,999.07 as the Deputy Commissioner did not recover from the company in its liquidation. After the primary judgment had been delivereddevliered the Liquidator repaid $49,085.57 to the Deputy Commissioner. As a result of this payment $131,913.50 is now sought by the Deputy Commissioner from the directors. The Legislation At the heart of the questions involved in these appeals is the Insolvency (Tax Priorities) Legislation Amendment Act 1993 ("the 1993 Act"), which, by amending relevant Commonwealth laws including the Assessment Act and the Corporations Law, abolished the Commissioner's priority for debts in relation to group tax and certain other unremitted amounts which became payable after 30 June 1993. The 1993 Act also included measures to enable the Commissioner to recover the unremitted amounts more quickly through an estimation process and to encourage directors "to face emerging problems as soon as possible" (Second Reading Speech, Hansard, Senate, 19 May 1993 at pp 879, 880). The explanatory memorandum accompanying the Insolvency Tax Priorities (Legislation) Amendment Bill 1993 states that the relevant amendments made "express provision for the Commissioner to take advantage of insolvent trading provisions in Part 5.7B to allow recovery from directors where tax debts are incurred while a company is insolvent." Also with respect to what has become s 588FGA the explanatory memorandum states: "Where the liability of a director is avoided through a preference payment by the company, the position of the Commissioner will be made equivalent to a guaranteed creditor." Before the enactment of the 1993 Act the Commissioner's priority applied to amounts deducted by employers from the salary or wages of their employees and deductions of a similar nature, where those deductions were not paid to the Commissioner. The Commissioner's priority ranks debts for those deductions above all other debts of a person or company in bankruptcy or insolvency. However, as a result of the 1993 Act, those debts due to the Commissioner are to be treated in a similar manner to debts payable to other unsecured creditors, with one important exception. The 1993 Act made company directors liable for debts due to the Commissioner which arose out of deductions made by their company and not remitted to the Commissioner. The 1993 Act also contained defences for directors in recovery proceedings by the Commissioner. The defences are contained in four provisions. "588FGB(3) It is a defence if it is proved that, at the payment time, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it made the payment. 588FGB(4) Without limiting the generality of subsectionsubsction (3), it is a defence if it is proved that, at the payment time, the person: (a) had reasonable grounds to believe, and did believe: (i) that a competent and reliable person ('the other person') was responsible for providing to the first-mentioned person adequate information aboutabouot whether the company was solvent; and (ii) that the other person was fulfilling that responsibility; and (b) expected, on the basis of information provided to the first-mentioned person by the other person, that the company was solvent at that time and would remain solvent even if it made the payment. 588FGB(5) It is a defence if it is proved that, because of illness or for some other good reason, the person did not take part in the management of the company at the payment time." The critical provision here is s 588FGB(6) which provides: "It is a defence if it is proved that: (a) the person took all reasonable steps to prevent the company from making the payment; or (b) there were no such steps the person could have taken." Subsection 7 is relevant. It provides: "In determining whether a defence under subsection (6) has been proved, the matters to which regard is to be had include, but are not limited to: (a) any action the person took with a view to appointing an administrator of the company; and (b) when that action was taken; and (c) the results of that action." Findings on Appeal The defence afforded by s 588FGB(6) Counsel for the directors argued that, on the material before the primary Judge, the directors took all reasonable steps to prevent the relevant payment being made to the Deputy Commissioner and that accordingly the defence under s 588FGB(6) of the Corporations Law was made out. Counsel submitted that the question of what comprises "reasonable steps" must be determined having regard to all of the relevant circumstances existing at the time of payment. Counsel then said that the circumstances were such that in these circumstances the defence had been made out. Those circumstances include the fact that the company derived a commercial benefit from making the payment to the Commissioner; that benefit being the discharge of the company's tax liabilities for a lesser sum. Another circumstance relied upon was the fact that it was an offence to fail to remit group tax to the Commissioner. Counsel argued that the Court should adopt a broad interpretation of s 588FGB(6) and conclude that even on the facts of this case where the directors had actually procured the making of the relevant payments to the Deputy Commissioner nevertheless there were no reasonable steps that they could have taken to prevent the company from making the payments. Counsel for the Deputy Commissioner supported the findings of the primary Judge on this point. Counsel argued that the directors could have prevented the payments by: (a) not entering into the agreement at all; (b) properly consulting with all creditors, and making every effort to obtain and obtaining a proper agreement with all creditors that they would take an equal percentage reduction of their debt such that the payments made to the Deputy Commissioner would not have had a preferential effect; (c) taking steps to appoint a voluntary administrator; (d) going to the Deputy Commissioner and advising him that all other creditors were not to be paid out. The Deputy Commissioner, in those circumstances, may have agreed to accept a lower figure, or may have pressed for the appointment of an administrator or may have moved to wind up the company. Any of those events, would have meant the payments would not have been made. In our opinion the primary Judge was correct. The defences in s 588FGB(2) - (5) cover situations where it is inappropriate to hold a director responsible for a preferential payment, either because the director believed on reasonable grounds that the company was solvent (s 588FGB(3), (4)), or because the director did not take part in the management of the company for some good reason such as illness (s 588FGB(5)). The primary Judge held, and we agree, that the defence under subsection (6) is similarly focused. Thus the defence absolves directors from responsibility for the payment if they could not prevent it being made, having taken all reasonable steps available. If the directors could prevent the payment but do not believe it is commercially prudent to do so, they are responsible for the payment and will not be covered by the defence. Thus the steps suggested by counsel for the Deputy Commissioner were not unreasonable simply because they would have denied the company a commercial benefit. We also reject the argument that those steps were not reasonable because they would result in the directors committing an offence. Even if this factor ought to be taken into account, it does not excuse the directors from failing to take the second option suggested by counsel for the Deputy Commissioner. It follows that the primary Judge correctly held that the defence available under subs (6)(a) is not available to the directors in this case. Timing of the indemnity payment That leaves the question of when the directors become liable to indemnify the Commissioner pursuant to s 588FGA(2). The amount payable to the Commissioner is a debt due to the Commonwealth and payable to the Commissioner and may be recovered in a court of competent jurisdiction by the Commissioner (s 588FGA(3)). Section 588FGA(5) is relevant. It provides: "A person who pays an amount under subsection (2) has the same rights: (a) whether by way of indemnity, subrogation, contribution or otherwise; and (b) against the company or anyone else; as if the payment had been made under a guarantee: (c) of the liability referred to in subsection (1); and (d) under which the person and every other person who was a director of the company as mentioned in subsection (2) were jointly and severally liable as guarantors." In our opinion once the Commissioner pays an amount to the company or liquidator in accordance with a court order under s 588FF, directors of the company at that time become liable to indemnify the Commissioner in respect of the amount of payment; it is that payment that constitutes "the loss or damage resulting from the order" of the Court. Once the directors satisfy the indemnity by paying the requisite moneys to the Commissioner then they are treated as if they were guarantors of a principal debt, have discharged their liability as guarantors and now stand in the shoes of the creditor by way of subrogation or, (as subs (5) of s 588FGA provides) "whether by way of indemnity, subrogation, contribution or otherwise". If a dividend becomes payable in respect of the principal debt previously due to the Commissioner by the company then the directors stand in the shoes of the Commissioner by right of subrogation and they may recover the amount of the dividend payable in the winding up that would previously have gone to the Commissioner. Also, if one of the directors discharges the whole or part of the liability as required by the obligation of statutory indemnity arising from s 588FGA(2), then that director also has a right of subrogation, contribution or indemnity against his or her fellow directors so as to achieve equality between all the directors. We respectfully disagree with the interpretation of s 588FGA adopted by the primary Judge. It is true that it is not until the result of the liquidation is known that the ultimate loss or damage suffered by the Commissioner is ascertained. Nonetheless, in our opinion, s 588FGA(2), when it speaks of the "loss or damage resulting from the order", must be referring to the immediate loss or damage resulting from the Court's order. That is suffered once the payment has been made by the Commissioner to the company or liquidator, and the liability arises then and not later. The Deputy Commissioner has succeeded wholly in appeal SG35 of 1997; and on the one ground of appeal relied on by the Deputy Commissioner of Taxation (the other grounds of appeal having been abandoned) in SG 36 of 1997. The directors should pay the costs of the Deputy Commissioner in both appeals. In the result we would order that: 1. The appeal in matter number SG 35 of 1997 be dismissed. 2. The appeal in matter number SG 36 of 1997 be allowed in part. 3. The declaration numbered 2 made by Mansfield J on 9 May 1997 in matter SG 3009 of 1996 be set aside (that is the declaration for indemnity as to the amount not recovered by the Commissioner in the liquidation); and there be substituted a declaration in these terms: "2. The cross-claimant be and is entitled to be, indemnified by the cross-respondent in respect of the sum of $131,913.50 together with interest thereon." 4. Otherwise appeal in matter number SG 36 of 1997 be dismissed. 5. In appeal SG 35 of 1997, the appellants pay the respondent's costs of the appeal. 6. In appeal SG 36 of 1997, the respondents pay the appellant's costs of the appeal. I certify that this and the preceding twelve (12) pages are a true copy of the Reasons for Judgment herein of the Court Associate: Dated: 6 March 1998 Counsel for the Appellants Mr A J Besanko QC in SG 35 of 1997: Solicitors for the Appellants Kelly & Co in SG 35 of 1997: Counsel for the Respondent Mr F C Brohier in SG 35 of 1997: Mr G Materne Solicitors for the Respondent Australian Government Solicitor in SG 35 of 1997: Counsel for the Appellant Mr F C Brohier in SG 36 of 1997: Mr G Materne Solicitors for the Appellant Australian Government Solicitor in SG 36 of 1997: Counsel for the Second, Third, Fourth and Fifth Respondents Mr A J Besanko QC in SG 36 of 1997: Solicitors for the First Respondent Thomson Playford in SG 36 of 1997: Solicitors for the Second, Third, Kelly & Co Fourth and Fifth Respondents in SG 36 of 1997: Date of Hearing: 11 November 1997 Date of Judgment: 6 March 1998