FEDERAL COURT OF AUSTRALIA Deputy Commissioner of Taxation v Scuttle Clothing Pty Ltd [2011] FCA 496 Citation: Deputy Commissioner of Taxation v Scuttle Clothing Pty Ltd [2011] FCA 496 Parties: DEPUTY COMMISSIONER OF TAXATION v SCUTTLE CLOTHING PTY LTD (ADMINISTRATOR APPOINTED) (ACN 005 565 417) and MARIE ANNE BRERETON File number: VID 109 of 2011 Judge: GORDON J Date of judgment: 9 May 2011 Corrigendum: 20 May 2011 Date of hearing: 9 May 2011 Date of last submissions: 9 May 2011 Place: Melbourne Division: GENERAL DIVISION Category: No Catchwords Number of paragraphs: 25 Counsel for the Applicant: P Fary Solicitor for the Applicant: Australian Taxation Office - Legal Services Branch Counsel for the Administrator of the First Defendant: R Fahey Solicitor for the Administrator of the First Defendant: MRB Lawyers Counsel for the Second Defendant: A Carruthers Solicitor for the Second Defendant: Lewis Holdway Lawyers Counsel for the Supporting Creditor: A Cocolas Solicitor for the Supporting Creditor: McDonald Phillips Lawyers FEDERAL COURT OF AUSTRALIA Deputy Commissioner of Taxation v Scuttle Clothing Pty Ltd [2011] FCA 496 CORRIGENDUM 1. On the front cover of the Judgment, the Solicitor for the Administrator of the First Defendant should read "MSB Lawyers". 2. In paragraph 20 of the Reasons for Judgment, in the fourth line, the word "solvent" should read "insolvent". I certify that the preceding two (2) numbered paragraphs are a true copy of the Corrigendum to the Reasons for Judgment herein of the Honourable Justice Gordon. Associate: Dated: 20 May 2011 IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 109 of 2011 BETWEEN: DEPUTY COMMISSIONER OF TAXATION Applicant AND: SCUTTLE CLOTHING PTY LTD (ADMINISTRATOR APPOINTED) (ACN 005 565 417) First Respondent MARIE ANNE BRERETON Second Respondent JUDGE: GORDON J DATE OF ORDER: 9 MAY 2011 WHERE MADE: MELBOURNE THE COURT ORDERS THAT: 1. The application to wind up Scuttle Clothing Pty Ltd be adjourned to 2:15pm on 19 May 2011. 2. Costs reserved. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. The text of entered orders can be located using Federal Law Search on the Court's website. IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 109 of 2011 BETWEEN: DEPUTY COMMISSIONER OF TAXATION Applicant AND: SCUTTLE CLOTHING PTY LTD (ADMINISTRATOR APPOINTED) (ACN 005 565 417) First Respondent MARIE ANNE BRERETON Second Respondent JUDGE: GORDON J DATE: 9 MAY 2011 PLACE: MELBOURNE REASONS FOR JUDGMENT 1 By way of application filed on 18 February 2011, the Deputy Commissioner of Taxation sought the winding up of Scuttle Clothing Pty Ltd, ACN 005 565 417 (Scuttle Clothing), on the grounds of insolvency pursuant to s 459P of the Corporations Act 2001 (Cth) (the Corporations Act). The evidence in support of the application was the failure of Scuttle Clothing to comply with the terms of a statutory demand made by the Deputy Commissioner of Taxation. The debt at the time of the service of the statutory demand was $652,066.83 which comprised of a running balance account deficit and superannuation guarantee charges for the three months commencing 1 July 2009, 1 October 2009 and 1 January 2010. Each of these, in accordance with the usual provisions, is a debt owed to the Commonwealth and payable to the Commissioner of Taxation. 2 On 13 April 2011, De Gouskos and G Gouskos, trading as A Grade Cutting Services of Sydney Street, Marrickville, filed a notice as a supporting creditor in support of the application for the winding up of Scuttle Clothing. That creditor claims it is owed $18,641.45. Mr Cocolas appeared on behalf of the supporting creditor. 3 Scuttle Clothing was originally registered some time in 1979, and according to the sworn evidence of its sole director and secretary, Marie Anne Brereton, has been in the uniform business for over 35 years, both designing and manufacturing uniforms for schools, hotels, and corporate clients. 4 On Friday 8 April 2011, Scuttle Clothing was put into administration and Mr Colin Roland Tuckwel of AP Insolvency was appointed as administrator. On 14 April 2011, the application for winding up of Scuttle Clothing came before Registrar Burns. On that day, the Registrar ordered that Ms Brereton be joined as a defendant to the proceeding, and further adjourned the hearing of the application to today, 9 May at 2:15pm, to enable an application for a further adjournment supported by an affidavit, to be filed and served on or before 2 May 2011. Ms Brereton was ordered to pay the supporting creditors costs of that day, fixed in the sum of $900. 5 Since that Court appearance, three affidavits have been filed in support of the application to further adjourn the hearing of the winding up application to enable the second meeting of creditors to be held of Scuttle Clothing. The second meeting of creditors to be held pursuant to s 439A of the Corporations Act is scheduled for 16 May 2011. 6 The first affidavit in support of the adjournment is sworn by the administrator, Mr Tuckwel, who confirms his appointment as administrator of Scuttle Clothing, pursuant to s 436A of the Corporations Act and that his appointment was confirmed by the first meeting of creditors held pursuant to s 436B of the Corporations Act on 20 April 2011. Mr Tuckwel then deposes to having received a proposal from the director of Scuttle Clothing for the creditors to consider a deed of company administration (a DOCA). That proposal was received on 29 April. It will be necessary to return to consider some aspects of that proposal in further detail in a moment. Mr Tuckwel concludes, at least at this stage, that the offer would provide a better result for creditors than the result that would be expected in a winding up, and that he would tender a copy of his report to creditors to the Court on or before 9 May. That, in fact, has now occurred. 7 On 4 May 2011, Mr Kieran O'Donovan, a solicitor employed by the solicitors acting for the administrator, swore an affidavit which exhibits a copy of the report to creditors. That report to creditors contains the following facts and information. First, that the main terms of the proposed DOCA were as follows. 1. the company would contribute approximately $516,000 towards a fund described as Deed Funds, which will be payable by monthly instalments of $20,000 from 1 June 2011 to 1 July 2012, and a final balloon payment expected to be in the vicinity of $225,000 to be made on 1 August 2012; 2. the Deed Funds would provide sufficient funds to ensure a distribution to unsecured creditors of 10 cents in a dollar; 3. the Deed Funds available for payment to those unsecured creditors would be distributed to those who had proved their debts; 4. certain creditors would be excluded from participating in distributions from the Deed Funds and those excluded creditors comprised related entities, employees, and their superannuation funds, including the second defendant Ms Brereton, Ms Joanna Shif, Mr Michael Brereton and 6 Bond Street South Yarra Pty Ltd; 5. 6 Bond Street South Yarra Pty Ltd would guarantee payment of the Deed Funds. (Ms Brereton gave evidence that 6 Bond Street South Yarra Pty Ltd is the registered proprietor of the land and building from which the business is conducted.) 6. the debt due to the Australian Taxation office, pursuant to the Superannuation Guarantee Charge Act 1992 (Cth), which was then estimated at some $90,286 would be paid in priority to all other unsecured debts under the DOCA. 7. conditional upon the petitioning creditor discontinuing proceedings commenced prior to the appointment of the administrator, the taxed costs of the proceedings brought by the Australian Taxation Office and the supporting creditor to wind up the company, would be paid in the same priority afforded by s 556 of the Corporations Act, as if the company was in liquidation; 8. upon execution of the DOCA, the control of the assets and undertakings of the company would be returned to the director, and the employees would continue their employment with the company, or be paid their entitlements should they leave their employment. 8 It is important to note, in this context, that the company has been trading while it has been in administration, and continues to trade. In relation to the unsecured creditors, they total some $6.34 million, of which $4.976 million comprises director and related party creditors who as earlier noted will be excluded creditors for the purposes of any receipt of the Deed Funds. The other creditors comprise trade creditors of approximately $500,000, the State Revenue Office of $113,302, and the Australian Taxation Office – although the administrator's report notes that it has now received a proof of debt from the Australian Taxation Office for $926,532.98. 9 Three other aspects of the report are worthy of note. In paragraph 3.5 of the report, the administrator sets out the factors that he has determined contributed to the company's current financial position. First, during the 2009 and 2010 years, the company's premises experienced both significant fire and flood events which caused extensive damage to stock and the company's premises, and left them out of action for several months. Secondly, in September 2010, the overseas factory in Shanghai, which was being used to manufacture garments for the business, suffered a fire, destroying stock. This caused the company to suffer further financially and commercially. 10 Next, that these cash flows issues, along with the impact of the global financial crisis, meant that the company increasingly faced reduced margins and tight deadlines. Finally, delays in processing the insurance claim following the flood damage to the company's premises (which still has not been finalised after 14 months), had placed further pressure on the company's cash flow. 11 Mr Fary, who appeared for the Australian Taxation Office, referred the Court to a number of aspects dealing with the way in which the company had been traded prior to the application to wind the company up and the appointment of the administrator in support of a contention that the application for an adjournment of the winding application should be rejected. For example, he referred to the fact that the administrator noted in his report that it appeared the company may have been trading whilst insolvent for at least 14 months prior to his appointment, during which time there were a number of dishonoured cheques, demand letters from creditors and failed payment arrangements, and that the bank account of the company had been overdrawn on a number of occasions. Further, that the administrator had expressed the view that a liquidator would have an ability to pursue a claim against the director for damages under s 588M of the Corporations Act and that there would appear to be some potential assets available to seek to recover against her. Although that is right, it is important to note that the administrator concluded by saying that, based on his investigations, he was uncertain whether a claim would be likely to provide any significant net return to creditors. 12 In relation to the future prospects of the company, the administrator noted that, if the proposed DOCA was accepted by creditors, control of the company would revert to the director, that the director would continue to trade the company and make contributions towards the Deed Funds. As Mr Fary pointed out, neither the administrator nor Ms Brereton was able to disclose where those contributions would come from. In particular, the administrator noted that the successful outcome of the DOCA was dependent upon the future viability of the company and the ability to raise the necessary finance for working capital purposes and for the deed funds, although he did note that the Deed Funds had been guaranteed by 6 Bond Street South Yarra Pty Ltd. I note that no financial information concerning 6 Bond Street South Yarra Pty Ltd is before the Court. 13 The other affidavit material filed was sworn by the director, Marie Anne Brereton. She also gave viva voce evidence and was cross-examined. In her affidavit, which was filed before the hearing today, Ms Brereton disclosed the possibility of two potential purchasers for the business and that the sale price that she was initially discussing with those purchasers would have enabled her to pay all creditors in full, except for the excluded creditors. However, her affidavit disclosed that when it became apparent that there had been a winding up application filed against the company, the discussions for the sale had cooled off. During her sworn evidence in Court today, she explained that she described those people as potential investors in the business. 14 It is against the background of that evidence that I turn to consider the application for an adjournment of the application to wind up the company under s 440A(2) of the Corporations Act. To grant the adjournment, the Court must be satisfied that it is in the interests of the company's creditors for the company to continue under administration, rather than be wound up. It is accepted that if I am so satisfied, then I am obliged to adjourn the hearing of the winding up application. In the present case, that period of adjournment would be for a period of approximately one week so that the creditors would have an opportunity on 16 May 2011 to consider the course which best commends itself to them when they come to consider the proposed DOCA. 15 As Counsel for the administrator submitted, it is not necessary for the company to prove, as a matter of certainty, that it was in the interests of creditors for the administration to continue but rather there was some sound basis for being satisfied in that regard. In support of that proposition I was referred to two authorities: Deputy Commissioner of Taxation v Victory Solutions Pty Ltd (No 2) (2010) FCA 491, and Deputy Commissioner of Taxation v Victory Solutions Pty Ltd (2010) FCA 476, decisions of Logan J dealing with a similar application. 16 In those cases, his Honour observed that the principles which govern the question of whether a Court should be satisfied that an application for adjournment is in the interests of the creditors for the administration to continue have been discussed in a number of cases, and referred to Deputy Commissioner of Taxation v WPS Motorsport Proprietary Limited (2009) 71 ACSR 640 at [20] to [23]. As his Honour observed, the long and short of it is that s 440A(2) of the Corporations Act means what it says – it is for the person seeking the adjournment to satisfy the court that, in the circumstances of the particular case, it is in the interests of the company's creditors for it to continue under administration, rather than be wound up. 17 Mr Fary for the Commissioner submitted that the question is whether there is some persuasive evidence to convince the Court that the creditors could hope to get more from one form of process than from the other: Creevey v Deputy Commissioner of Taxation (1996) 19 ACSR 456 at 457. 18 In Waste Recycling and Processing Services of NSW v Local Government Recycling Co-operative [1999] NSWSC 507 at [6] Santow J described it in this way – there must be a " … sufficient possibility, as distinct from mere optimistic speculation, that the deferment for the envisaged time was in the interests of creditors". 19 I turn now to consider whether there is persuasive evidence to enable me to determine that the creditors could hope to get more from administration than liquidation, and to assess whether it truly is a sufficient possibility or a mere optimistic speculation. As I have said, the report prepared by the administrator, in addition to the matters I have referred to above, makes two observations and a recommendation. First that the company is insolvent and secondly, that the continuation of its activities in the current circumstances may ultimately result in the company's winding up. 20 However, it goes on to note that the proposed DOCA provides a return of 10 cents in the dollar to the unsecured creditors and the claims of the priority creditors not being compromised under the DOCA. On the other hand, if the company was placed into liquidation, there would be a complete reliance on a successful and solvent trading action in the hope of providing a return to creditors. On commercial grounds, the administrator concludes and recommends that the creditors' interests would be best served by the proposed DOCA. 21 The evidence to support the contention that it is a sufficient possibility, as distinct from mere optimistic speculation, that the creditors would hope to get more from the administration, was the elements of the proposal outlined earlier set out in the administrator's report. That proposal is dependent upon, it would seem, two matters: first of all, the Deed Funds being guaranteed by 6 Bond Street South Yarra Pty Ltd and, secondly, a the veracity of a cash flow forecast which was tendered in evidence through Ms Brereton. That cash flow forecast was provided without any supporting evidence for the forecast gross collections or the forecast increase in the gross collections from $250,000 for the month of June 2011 up to in excess of $400,000 in May 2012. 22 Mr Fary says that I should not accept that evidence as being sufficient evidence to satisfy the test propounded by Santow J in Waste Recycling and that if I should accede to the application for an adjournment it was an unacceptable risk that the company would be insolvent, or would become insolvent, if the company was put back in the hands of the director on the assumption that the creditors accepted the DOCA. 23 In my view, the evidence relied upon by both the administrator and Ms Brereton is a sufficient possibility, as distinct from some mere optimistic speculation. On any view, it just crosses the line. I say that for this reason. Ms Brereton gave evidence that she is of the view that the contracts that she has entered into with a long term client, Mirvac, will provide her with sufficient cash flow to fund at least the initial payments referred to in the cash flow forecast. Secondly, the Deed Funds are to be guaranteed by 6 Bond Street South Yarra Pty Ltd and, although there is a lack of evidence about the financial position of that entity, it seems to me that those two matters are matters which should be put before the creditors at the meeting to be held on Monday. The creditors should be entitled to vote on them. 24 Secondly, I regard that evidence as sufficient to demonstrate the company has, at least in the first few months, capacity to make the payments under the proposed DOCA of $20,000 per month and, if not, the payments will be guaranteed by a third party. Of course, if at the meeting on Monday, 16 May 2011 it is apparent that the Deed Funds will not be guaranteed by 6 Bond Street, South Yarra Pty Ltd, then I would expect the administrator to not recommend that the DOCA would be in the interests of the creditors. 25 In those circumstances, I will grant the adjournment for a period of one week to 19 May 2011 to enable the proposed DOCA to be put to the second meeting of creditors. I certify that the preceding twenty five (25) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Gordon. Associate: Dated: 9 May 2011