Reported Decision : (2003) 21 ACLC 684 New South Wales Supreme Court CITATION : Expile Pty Ltd v Jabb's Excavations Pty Ltd [2003] NSWSC 96 20/09/02, 18/11/02, 19/11/02 HEARING DATE(S) : Written submissions - 26/11/02, 02/12/02, 05/12/02 Oral submissions - 24/02/03 JUDGMENT DATE : 27 February 2003 JURISDICTION: Equity Division Corporations List JUDGMENT OF : Barrett J DECISION : Winding up order refused CATCHWORDS : CORPORATIONS - winding up - application for order for winding up in insolvency on basis of unsatisfied statutory demand - whether statutory presumption of insolvency rebutted LEGISLATION CITED : Corporations Act 2001 (Cth), ss.459C, 459G, 459P, 459S Ace Contractors & Staff Pty Ltd v Westgarth Developments Pty Ltd [1999] FCA 728 Bennell v Netlink Australia Pty Ltd (2002) 42 ACSR 680 Braams Group Pty Ltd v Miric [2002] NSWSC 417 CASES CITED : IOC Australia Pty Ltd v Mobil Oil Australia Ltd (1975) 11 ALR 417 Keith Smith East West Transport Pty Ltd v Australian Taxation Office (2002) 42 ACSR 501 New South Wales Rugby League v United Telecasters Sydney Ltd (1991) 4 ACSR 510 Re P & J Macrae Ltd [1961] 1 WLR 229 Sandell v Porter (1966) 115 CLR 666 PARTIES : Expile Pty Ltd - Plaintiff Jabb's Excavations Pty Limited - Defendant FILE NUMBER(S) : SC 1887/02 COUNSEL : Mr S.D. Epstein SC - Plaintiff Mr D.H. Murr SC/Mr R.W. Tregenza - Defendant SOLICITORS : Baron and Associates - Plaintiff Cadmus Lawyers - Defendant - 15 - IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORPORATIONS LIST BARRETT J THURSDAY, 27 FEBRUARY 2003 1887/02 – EXPILE PTY LIMITED v JABB'S EXCAVATIONS PTY LIMITED JUDGMENT 1 By an originating process filed on 14 March 2002, the plaintiff claims under s.459P of the Corporations Act 2001 an order for the winding up of the defendant in insolvency. The originating process was filed following non-compliance with a statutory demand served by the plaintiff on the defendant on 19 February 2002 in respect of a debt of $107,592.50. An order for extension of time under s.459R was made by Hamilton J on 12 September 2002. Further such orders were made by me at later stages. 2 It is not disputed that, by operation of s.459C(2)(a), the court must presume that the defendant is insolvent. It follows that, unless the defendant affirmatively proves that it is solvent or shows some other good reason to the contrary (without thereby overstepping the limits imposed by s.459S), a winding up order will be made. The proceedings were conducted on the footing that the defendant bears the onus of displacing the statutory presumption of insolvency by proof, to the requisite standard, that it is, in terms of s.95A, able to pay all its debts as and when they become due and payable. The defendant accepted that onus and submits that, on the evidence, it has discharged it. The plaintiff, on the other hand, says that the evidence is insufficient to displace the statutory presumption, with the result that the court must work on the basis that the insolvency ground exists, so that a winding up order should be made. 3 It can be said at once that if, as the plaintiff submits, the statutory presumption has not been displaced, a winding up order must follow, there being no suggestion by the defendant that there is any other basis on which the plaintiff's application can be resisted. The finding of insolvency that the section compels will, unless displaced, compel the making of the order in favour of the plaintiff, as an unpaid creditor, ex debito justitiae: IOC Australia Pty Ltd v Mobil Oil Australia Ltd (1975) 11 ALR 417. This is not a case in which any residual discretion of the court activated by some cogently based preference of a majority of the creditors may intrude: cf Re P & J Macrae Ltd [1961] 1 WLR 229; New South Wales Rugby League v United Telecasters Sydney Ltd (1991) 4 ACSR 510. Nor is it asserted that pursuit of the winding up application constitutes an abuse of process in the very narrow sense relevant in the present context: see Braams Group Pty Ltd v Miric [2002] NSWCA 417 (20 December 2002). 4 Mr Epstein SC, who appeared for the plaintiff, submitted (and I accept) that the authorities governing the operation of s.459C are accurately stated in the judgment of Weinberg J in Ace Contractors & Staff Pty Ltd v Westgarth Development Pty Ltd [1999] FCA 728: "The authorities which govern the operation of s459G of the Corporations Law seem to me to establish the following propositions: • The respondent is presumed to be insolvent and as such bears the onus of proving its solvency: s459C(2) and (3); Elite Motor Campers Australia v Leisureport Pty Ltd (1996) 22 ACSR 235 per Spender J; Commissioner of Taxation v Simionato Holdings Pty Ltd. (1997) 15 ACLC 477 per Mansfield J. • In order to discharge that onus the Court should ordinarily be presented with the "fullest and best" evidence of the financial position of the respondent: Commonwealth Bank of Australia v Begonia (1993) 11 ACLC 1075 at 1081 per Hayne J. • Unaudited accounts and unverified claims of ownership or valuation are not ordinarily probative of solvency. Nor are bald assertions of solvency arising from a general review of the accounts, even if made by qualified accountants who have detailed knowledge of how those accounts were prepared: Simionato Holdings Pty Ltd (supra); Re Citic Commodity Trading Pty Ltd v JBL Enterprises (WA) Pty Ltd [1998] FCA 232 per Heerey J; Leslie v Howship Holdings Pty Ltd (1997) 15 ACLC 459 at 463 per Sackville J. • There is a distinction between solvency and a surplus of assets. A company may be at the same time insolvent and wealthy. The nature of a company's assets, and its ability to convert those assets into cash within a relatively short time, at least to the extent of meeting all its debts as and when they fall due, must be considered in determining solvency: Rees v Bank of New South Wales (1964) 111 CLR 210; Re Tweeds Garages Ltd [1962] Ch 406 at 410 per Plowman J; Simionato Holdings Pty Ltd (supra); Melbase Corporation Pty Ltd v Segenhoe Ltd (1995) 13 ACLC 823 at 832 per Lindgren J; Leslie v Howship Holdings Pty Ltd (supra) at 465-466. • The adoption of a cash flow test for solvency does not mean that the extent of the company's assets is irrelevant to the inquiry. The credit resources available to the company must also be taken into account: Sandell v Porter (1966) 115 CLR 666 at 671 per Barwick CJ (with whom McTiernan and Windeyer JJ agreed); Leslie v Howship Holdings Pty Ltd (supra) at 466; Taylor v ANZ Banking Group Ltd (1988) 6 ACLC 808 at 812 per McGarvie J. • The question of solvency must be assessed at the date of the hearing. However, this does not mean that future events are to be ignored: Leslie v Howship Holdings Pty Ltd (supra) at 466-467. • It is no abuse of process for an applicant to seek to wind up a company presumed to be insolvent by reason of its failure to comply with a statutory demand merely because that company contends that it is solvent, or because there may be alternative means available to the applicant to vindicate its rights: Elite Motor Campers Australia v Leisureport Pty Ltd (supra)." 5 I should also mention at this early stage that the debt the subject of the plaintiff's statutory demand in the sum of $107,592.50 remains unpaid and that there was no attempt by the defendant to have the demand set aside under s.459G on the basis of genuine dispute as to the existence or amount of the debt. That being so, the appropriate course in considering the issue of solvency is to regard that debt as due and payable, with the result that, in considering whether the defendant has discharged its onus of affirmatively establishing its solvency, I must regard the sum of $107,592.50 as representing a valid and immediate claim upon its available financial resources. 6 In some cases, the existence of unchallenged and unpaid debts can be evidence of insolvency (e.g. Bennell v Netlink Australia Pty Ltd (2002) 42 ACSR 680). In this case, the plaintiff's debt has been outstanding for some time but it cannot be regarded as unchallenged, despite the absence of moves to have the statutory demand set aside under s.459G. This is made clear by the evidence of the defendant's external accountant where reference is made to instructions not to record the debt as a liability because it is disputed. Frank evidence has also been given by the defendant's principal about another quite unrelated debt that became the subject of a judgment and a statutory demand in circumstances of dispute resulting in setting aside of the judgment and withdrawal of the statutory demand. 7 Evidence as to the defendant's financial position was given by its principal, Mr Kairouz (he and his wife being the only directors and shareholders), Mr Michael (the external accountant who provides accounting services to the defendant) and Mr Billingham (an accountant retained by the defendant to prepare a report on the defendant's financial position for the purposes of the proceedings). This was supplemented by certain valuation evidence. 8 The defendant's case is that its financial statements (and the evidence generally) show that it has had, and continues to have, a substantial surplus of assets over liabilities. The financial statements also show a history of profitable operation. The plaintiff sought to call into question the soundness of the financial statements as a reliable indicator, for present purposes, of the assets and liabilities position. It did so on the basis that it is by no means clear that any of the balance sheets and accounts in evidence had been formally adopted or signed by the directors of the defendant and that they were, in any event, expressed to be no more than special purpose financial reports prepared merely for use by the members of the company. It was said (and I accept) that the statements had not been prepared or presented in a way which would give any external recipient the measure of comfort or assurance that would be derived from formally adopted and audited accounts. I also accept that the description of the defendant's bookkeeping procedures given by Mr Kairouz (including matters as basic as the insertion of details on cheque butts) makes it clear that the main determinant of the accounts is information provided by Mr Kairouz. 9 Against this, however, there is evidence from Mr Michael, the external accountant retained by the defendant, about book-keeping practices within the defendant's organisation and the part that both the defendant's book-keeper and Mr Michael himself play in the gathering and checking of raw data. That evidence will be referred to presently. It is clear to me that, although the defendant's accounting and book-keeping systems are unsophisticated, they should not be regarded as haphazard; and that a reasonable measure of confidence may be placed upon the financial statements. 10 The defendant's central case is, in any event, not wholly dependent on the financial statements. Its primary contention is that it is solvent because it has the ability to raise funds in the short term sufficient, when added to immediately available liquid assets, to cover debts due or to become due in the short term. This is, of course, a perfectly acceptable way of establishing solvency. Reference need only be made to the following observation of Barwick CJ (with whom McTiernan and Windeyer JJ agreed) in Sandell v Porter (1966) 115 CLR 666 which, although made in relation to a bankruptcy provision, is of equal pertinence here: "Insolvency is expressed in s.95 as an inability to pay debts as they fall due out of the debtor's own money. But the debtor's own moneys are not limited to his cash resources immediately available. They extend to moneys which he can procure by realization by sale or by mortgage or pledge of his assets within a relatively short time -relative to the nature and amount of the debts and to the circumstances, including the nature of the business, of the debtor. The conclusion of insolvency ought to be clear from a consideration of the debtor's financial position in its entirety and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity. It is the debtor's inability, utilizing such cash resources as he has or can command through the use of his assets, to meet his debts as they fall due which indicates insolvency. Whether that state of his affairs has arrived is a question for the Court and not one as to which expert evidence may be given in terms though no doubt experts may speak as to the likelihood of any of the debtor's assets or capacities yielding ready cash in sufficient time to meet the debts as they fall due." 11 I therefore approach this case on the basis that the defendant must prove that its assets are such that, having regard to its financial position in its entirety, the defendant can, in the "relatively short time" to which Barwick CJ referred, raise through borrowing such an amount of money as, when added to any cash on hand or otherwise immediately available, satisfy both the debts presently due and payable and those that will become due and payable in the same relatively short time. This is the essence of the "cash flow" test of solvency the overriding relevance of which to cases such as the present was confirmed by the Court of Appeal in Keith Smith East West Transport Pty Ltd v Australian Taxation Office (2002) 42 ACSR 501. 12 The first step, therefore, is to determine the amount of the debts presently due and payable and those that will become due and payable in the short term. According to the defendant's own evidence (including the accounts already mentioned), such items as at 30 September 2002 totalled $454,784: Bank overdraft (No 2 account) $128,634 Bank overdraft (No 3 account) 3,863 Loans to shareholders 21,205 Trade creditors 235,469 Provision for income tax 65,613 13 The plaintiff's debt of $107,592.50 is not included in this total of $454,784. For the reason I have stated, the total should be increased by that sum. It then becomes $562,376. 14 A further item to be considered is a sum of $466,186, being a bank loan shown as a non-current liability. I infer from its description as a non-current liability that this debt is not payable for at least twelve months. I therefore do not regard it as a debt that needs to be considered in a direct sense in relation to the issue of solvency. However, as will be seen presently, it does have a direct effect on the quantum of the assets to which the defendant may resort for the purpose of obtaining funds to meet its immediate and short term liabilities. 15 According to the way in which the defendant presented its case, the central question is whether the defendant has the ready capability to raise, by borrowing and by getting trade receivables, sufficient funds to cover the total of $562,376 to which I have referred. The defendant's contention is that it is able to raise in the short term $821,339, less a factor necessary to obtain discharge of bank security. This figure of $821,339 comes from calculations recorded in Mr Billingham's affidavit of 18 November 2002 "on the basis of the financial accounts of the defendant as at 30 September 2002". There are three elements to the total of $821,339. First, it is said that land and buildings independently valued at $310,000 will support borrowings of $263,500 (being 85% of valuation); second, plant and equipment owned (as distinct from leased) having a value of $650,000 is seen as the source of borrowing or other financing to 50% of its valuation to yield $325,000; and, third, trade debtors recorded in the accounts at $517,420 (but taken into account at $465,678, representing a discount of 10% to book value) are seen as being available as security for credit to the extent of $232,839 (or 50%). Mr Billigham deposes that the indicated financing to valuation ratios are achievable in the marketplace. 16 The total of these three components is the $821,339 to which I have referred, but it is recognised that because the defendants' bankers have both a fixed mortgage of the land and buildings and a floating charge over assets generally, the $821,339 could not be raised without paying out the bank. The three separate items of bank debt already mentioned (being $128,634, $3,863 and $466,186 – total $598,683) must, in a notional sense, be deducted from the $831,339 to produce a net figure that might properly be regarded as achievable through a program of borrowing. And because that notional exercise of paying out the bank would take care of the bank components of the aggregate of $562,376 of immediate and short term liabilities in respect of which the funds raised would be used, those bank components (being $128,634 and $3,863 – total $132,497) should be deducted from that aggregate. 17 When these adjustments are made, the aggregate to be covered by the assumed financing program is $429,879 (i.e., $562,376 less $132,497) and that financing program itself is seen as capable of raising the $821,339 referred to by Mr Billingham, less the total bank debt of $598,683, that is, a net $222,656. 18 I accept that a net $222,656 could be raised by a borrowing program such as Mr Billingham describes. What, then, is the source of the remaining $207,223 required to cover the adjusted current liabilities? The answer, the defendant submits, is that recoveries from trade debtors in the ordinary course will more than take care of that balance. As I have said, the balance sheet at 30 September 2002 shows trade debtors of $517,420 and, for the purposes of the notional financing exercise I have just described, Mr Billingham discounted them by a factor of 10% to $465,678. Mr Billingham's work in relation to debtors as at 31 March 2002 included checking the reliability of the then debtors figure of $200,000. He was satisfied as to the existence and quality of the debtors, the median age being less than 60 days. Mr Billingham does not testify to having conducted the same checking in relation to debtors as at 30 September 2002 but the general reliability of the defendant's sysyems in that respect may be taken to be shown by Mr Billingham's earlier work. 19 The important point made by Mr Murr SC for the defendant is that, even if the trade debts are used as security in a financing exercise of the kind envisaged by Mr Billingham, it will be the company itself that comes to enjoy their proceeds of those debts as and when they come in. On the basis that the company operates a continuing business properly viewed as a going concern, there will be an ongoing generation of new trade debts so that there is no need to regard those existing at the time of any financing transaction of the kind under discussion as put beyond the company's enjoyment by that transaction. In short, the company will have the benefit of receipts from book debts as and when generated from time to time in the ordinary course as well as the benefit of being able to obtain credit on the security of those book debts. 20 I accept this approach as showing, on the balance of probabilities, an ability of the company to obtain cash in the timeframe with which the present solvency inquiry is concerned to the extent of $465,678 as the proceeds of book debts and a further $222,656 by way of borrowing (a total of $688,334) – provided that there are no grounds for concluding that any of the assets that would be used as security for such further borrowing will not be available. 21 In relation to land and buildings, the figure of $310,000 is supported by independent valuation. There is also an independent valuation of plant and equipment made by Mr Ian Arthy of Steers Pty Ltd, auctioneers and valuers. The plaintiff submits, however, that grounds exist for calling in question the availability of plant and equipment to the extent of $650,000 envisaged by Mr Billingham's calculation. It submits, in particular, that the defendant has failed to prove one important and necessary element, being the defendant's ownership of the plant and equipment to which a figure of $650,000 is attributed. 22 The defendant put into evidence the valuation of plant and equipment made by Mr Arthy. That attributes a combined value of $1,206,200 to the items set out in it. Mr Kairouz testified that certain of the items listed in the valuation are no longer owned by the defendant. These account for a total of $125,000, with the result that the valuation is put forward only in relation to the remaining items representing a combined value of $1,081,200. The valuation may be accepted as suitable evidence of the existence of the items with which it deals and of the unencumbered value of those items. But the plaintiff points to two pertinent factors calling in question the proposition that the defendant has the full financial benefit inherent in the remaining items in the valuation: first, questions as to the ownership of some such items; and second questions as to the value of the defendant's interest in light of financing arrangements. 23 Before the hearing began, the plaintiff served on the defendant a notice to produce (which became Exhibit A) requiring, in respect of each item in Mr Arthy's valuation shown at $5,000 or more, the defendant's records showing its acquisition of and title to the item. This was covered by paragraph 8 of the notice to produce. The hearing occupied 20 September, 18 November and 19 November 2002. On the first of those days, Mr Kairouz was extensively cross-examined about the circumstances of the defendant's acquisition of various items in Mr Arthy's valuation. He had a good recollection of having been involved in the various acquisitions, although his recollection of details was not good, particularly when it came to original financing arrangements and subsequent pay-outs. He nevertheless gave on 20 September 2002 prompt and confident answers in relation to whether the various items were owned or leased by the defendant. He did so by reference to the inventory attached to Mr Arthy's valuation. The items Mr Kairouz identified as leased accounted for $444,000 on the valuation. Those he identified as owned accounted for $637,200, including various items of office furniture and equipment. Owned items valued at $637,200 are sufficient, except for $12,800, to play the $650,000 role envisaged for them by Mr Billingham's calculation of 18 November 2002, assuming the assertion of ownership is made out. 24 As to documentary proof of ownership, the plaintiff failed to produce anything but Roads and Traffic Authority certificates of registration in a number of cases. It may readily be acknowledged that such a certificate does not establish ownership by the party registered. For example, a leased vehicle (that is, one owned by a finance company and held by the defendant under a chattel lease) would quite properly be registered by the Roads and Traffic Authority in the name of the defendant. But the fact remains that Mr Kairouz was precise and definite in his evidence as to which items were owned, as distinct from leased. He recalled, for all, the circumstances of acquisition. Added to this is the fact that Mr Michael, the external accountant retained by the defendant, testified to the procedures he has adopted over the years in relation to the treatment of plant and equipment in the accounts. After reference had been made to Mr Arthy's valuation, the cross-examination of Mr Michael continued as follows: "Q. Apart from the valuation what, if any, information is available to you relating to the figures shown in the statements for plant and equipment? A. Sorry? Q. Is there any information that you have been given, apart from the valuation, casting light on the balance sheet figures for plant and equipment? A. Plant and equipment is just – under the history costs system, you record it at cost. That is just the accumulation of ten, fifteen years of equipment. The problem is, over the time, a lot of that would have been depreciated. The asset value still exists. The only way you can really judge the accuracy of that is to do an independent valuation. Q. But are there records you have about costs, records you have seen about costs of the plant and equipment? A. I would have; there will be over the years, yes. Q. What are those? A. Sorry? Q. What are those records? A. Just payment the company makes towards purchase of them. Q. As recorded in the cheque butts and then written into the bank statements; is that the procedure? A. That's right, yes. I understand up to a few years ago, all these were done on a yearly basis. It is only when GST came in that these computer systems were in place with quarterly reports and such things." 25 This must be understood in the light of an earlier passage in the cross-examination: "Q. I am suggesting when you prepare financial statements for Jabb's Excavations you perform no verification or validation procedures? A. Well, I do, actually, yes. Q. What are those? A. What are those? Q. Yes? A. Okay. The way the company's records are kept by a young girl in the office – she is very good with her computer system – I go along, go through and I will check the balances of bank reconciliations. If I know they are correct, I know all the deposits and expenses have been accounted for, I will go through and check her records, deposits and payments. Now what I don't check is the invoice that matches the payment, if that is what you are talking about, but I will check every three months, on a quarterly basis, we do the Business Activity Statement, I check – that is basically what I check. Q. No more than that? A. If needs be. If I need to go to the invoice and see if there is any GST on the invoice, I will ask. Q. When would you be likely to do that? A. On a quarterly basis, I do that. Q. Check the invoices for GST? A. No, sir. I said if there is an invoice I need to check for GST I will ask Bernadette to get the invoice out to see if there is any GST on the invoice." 26 This evidence is, to my mind, enough to counter the suggestion that ownership of items of plant and equipment in cases where only a Roads and Traffic Authority registration certificate has been produced rests on no more than the say-so of Mr Kairouz. The defendant's book-keeping system, although not sophisticated, has, on Mr Michael's evidence, a methodical quality in which a key part is played by an employee described by the external accountant as "very good with her computer system". That accountant himself plays a part by way of his quarterly questioning and, as necessary checking for the purpose of preparing GST business activity statements. 27 I also refer, on the question of ownership of plant and equipment, to the evidence of Mr Billingham. He devoted some effort to obtaining details of the lease commitments, although it must be said that such information as was given to him as having been obtained specially from the leasing companies came via Mr Kairouz who said he had obtained it from those sources. Nevertheless, I regard it as sufficiently reliable to confirm the split between leased equipment and owned equipment. And that, in turn, is sufficient to dispel the possibility that a mere certificate of registration in respect of a particular vehicle not placed by Mr Kairouz within the leased category relates to a leased vehicle rather than a vehicle that is owned. 28 These conclusions in relation to plant and equipment are sufficient to confirm, on the balance of probabilities, the viability of the financing program envisaged by Mr Billingham in his affidavit of 18 November 2002 and that, in turn, is sufficient to warrant a conclusion by the court that the defendant is able to pay its debts as and when they become due and payable, that being, in any event, the opinion expressed by Mr Billingham, an experienced accountant who was retained to examine the defendant's financial position. 29 When I say "is able" I am, of necessity, referring to a position shown as at a past date by reference to evidence of matters as they existed in the past. In this particular case, the proceedings were protracted. By the time the substantive hearing commenced before me on 20 September 2002, the proceedings had been on foot for just over six months. It become clear on 20 September 2002 that the one day allocated would not be enough and that two further days would be needed. Because of other cases that had been scheduled, I could not accommodate the need for those two further days until 18 and 19 November 2002. On that occasion, however, further evidence was given by Mr Kairouz, and the whole of the oral evidence of both Mr Billingham and Mr Michael was given. In addition, Mr Billingham's further affidavit (the affidavit of 18 November 2002) which has played a central part in my assessment provided refreshed information, as did up-dated financial statements as at 30 September 2002. I am satisfied that the evidence remains a reliable basis for the assessment of solvency called for in this case. 30 The result of the proceedings is that the presumption of insolvency created by s.459C(2)(a) is displaced by evidence sufficient to prove that the defendant is able to pay its debts "as and when they become due and payable" (s.95A), so that the defendant is not "and insolvent company" as referred to in s.459A and an order that it be wound up in insolvency may not be made. 31 The originating process filed on 14 March 2002 is therefore dismissed. I will hear the parties on costs at a time to be fixed. ********** Last Modified: 02/28/2003 DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. 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