New South Wales Supreme Court CITATION : Austin Australia Pty Ltd v De Martin & Gasparini Pty Ltd; Austin Australia Pty Ltd v A & G Scaffolding & Rigging Service Pty Ltd [2007] NSWSC 1238 HEARING DATE(S) : 17/10/07 JUDGMENT DATE : 2 November 2007 JURISDICTION : Equity Division Corporations List JUDGMENT OF : Barrett J DECISION : Separate question answered CATCHWORDS : CORPORATIONS - winding up - preference recovery proceedings - separate question as to solvency during relevant period - definition of solvency considered - matters pertaining to solvency examined LEGISLATION CITED : Corporations Act 2001 (Cth), Part 5.3A, ss.95A, 588FA, 588FC, 588FF Evidence Act 1995, s.79 Box Valley Pty Ltd v Kidd (2006) 24 ACLC 471 Crema Pty Ltd v Land Mark Property Developments Pty Ltd (2006) 58 ACSR 631 Expile Pty Ltd v Jabb's Excavations Pty Ltd (2003) 45 ACSR 711 Hymix Concrete Pty Ltd v Garritty (1977) 2 ACLR 559 CASES CITED : Keith Smith East West Transport Pty Ltd v Australian Taxation Office (2002) 42 ACSR 501 Lewis v Doran (2004) 50 ACSR 175 Lewis (as liquidator of Doran Constructions Pty Ltd) v Doran (2005) 54 ACSR 410 Noxequin Pty Ltd v Commissioner of Taxation [2007] NSWSC 87 Project Construction & Development Pty Ltd v Ellison [2002] NSWSC 366 (1) Austin Australia Pty Limited - First Plaintiff Keiran William Hutchison and John Raymond Gibbons - Second Plaintiffs De Martin & Gasparini Pty Limited - First Defendant Chadwick Building Systems Pty Limited - Second Defendant Stegbar Pty Limited - Third Defendant Steelscope Pty Limited - Fourth Defendant Corkjoint (Aust) Pty Limited - Fifth Defendant Edwin S. Scott t/as Dalton Plumbing & Roofing Services Pty Limited - Sixth Defendant Mastercut Concrete - Seventh Defendant Piling Contractors (Qld) Pty Limited - Eighth Defendant Steel Foundations Contracting Pty Limited - Ninth Defendant Sydney Re-Roofing Pty Limited - Tenth Defendant Timberite Building Supplies Pty Limited - Eleventh Defendant Transylvanian Timbers Pty Limited - Twelfth Defendant Buildup Interior Pty Limited - Thirteenth Defendant Conceal Concrete Waterproofing Pty Limited - Fourteenth Defendant Budget Stairs Pty Limited - Fifteenth Defendant (2) Austin Australia Pty Limited - First Plaintiff Keiran William Hutchison and John Raymond Gibbons - Second Plaintiffs A & G Scaffolding and Rigging Pty Limited - First Defendant Delta Pty Limited - Second Defendant Fanelec Pty Limited - Third Defendant Going Up Lifts Pty Limited - Fourth Defendant PARTIES : IP Corporation Pty Limited - Fifth Defendant Jones & Jones Master Plumbers Pty Limited - Sixth Defendant Epic Construction Pty Limited - Seventh Defendant Murphy, McCarthy & Associates Pty Limited - Eighth Defendant Northern Structures NSW Pty Limited - Ninth Defendant San Marcos Formwork Pty Limited - Tenth Defendant Specpipe Technology Pty Limited - Eleventh Defendant Absolute Contracting (NSW) Pty Limited - Twelfth Defendant Carron Concrete Services Pty Limited - Thirteenth Defendant FIFA Group Tiles Pty Limited - Fourteenth Defendant NDA Engineering Limited - Fifteenth Defendant Osbuild (Aust) Pty Limited - Sixteenth Defendant Robinson's Reliable Plumbing Pty Limited - Seventeenth Defendant F & B Skrobar Engineering Pty Limited - Eighteenth Defendant The Austral Brick Co Pty Ltd - Nineteenth Defendant Boral Bricks Pty Limited - Twentieth Defendant Boral Constructions Materials Group Pty Limited - Twenty first Defendant Boral Windows Systems Limited - Twenty second Defendant Crane Australia Pty Limited - Twenty third Defendant Higgins Coatings Pty Limited - Twenty fourth Defendant Neumann Steel Pty Limited - Twenty fifth Defendant Onesteel Trading Pty Limited - Twenty sixth Defendant Dean Mann t/as PK Ceilings - Twenty seventh Defendant Delta Pty FILE NUMBER(S) : SC (1) 2114/06; (2) 6478/06 COUNSEL : Mr A.P. Spencer/Ms R. Graycar - Plaintiffs SOLICITORS : Gadens - Plaintiffs IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION CORPORATIONS LIST BARRETT J FRIDAY, 2 NOVEMBER 2007 2114/06 AUSTIN AUSTRALIA PTY LIMITED & ANOR v DE MARTIN & GASPARINI PTY LIMITED & 14 ORS 6478/06 AUSTIN AUSTRALIA PTY LIMITED & ANOR v A & G SCAFFOLDING & RIGGING SERVICE PTY LIMITED & 26 ORS JUDGMENT 1 In each of these proceedings, the liquidators of Austin Australia Pty Ltd ("Austin") seek orders under s.588FF of the Corporations Act 2001 (Cth) for the payment of money to Austin by each of several defendants. The claims are based on the proposition that each defendant was party to a transaction with Austin which involved receipt by the defendant in question of an "unfair preference" within the meaning of s.588FA and was an "insolvent transaction" within s.588FC. 2 In each proceeding, it was ordered on 2 May 2007 that the following question be determined as a separate question: "Whether the First Plaintiff [that is, Austin] was insolvent at any time between 30 June 2003 and 31 December 2003 and, if so, for what period or periods." 3 I heard submissions on the separate question on 17 October 2007. On that occasion, submissions were made on behalf of the liquidators only. Each defendant in each proceeding either consented to the making of the orders sought against it or, on the question of insolvency, did not wish to be heard. Several took a position of neutrality but on the footing that it is for the plaintiffs to prove insolvency at the material time. 4 Austin was engaged in a business of providing consulting, design, engineering and construction services. The present liquidators were appointed administrators under Part 5.3A of the Corporations Act on 31 December 2003. The period to which the separate question relates is accordingly the period of six months ending on the day which is, by operation of Division 1A of Part 5.6, the "relation-back day" (as defined by s.9) in relation to the winding up. 5 In relation to the separate question, the liquidators rely on affidavits of one of the liquidators, Mr Hutchison, and a report prepared by him. The report is tendered as opinion evidence. I am satisfied that Mr Hutchison has specialised knowledge based on his training, study and experience which forms the basis of his opinion evidence and that it is accordingly admissible under s.79 of the Evidence Act 1995. The fact that Mr Hutchison is one of the liquidators of Austin and a party to the proceedings does not render his opinion evidence inadmissible: Project Construction & Development Pty Ltd v Ellison [2002] NSWSC 366. 6 In addressing the separate question, I must begin with the provisions of s.95A of the Corporations Act: "(1) A person is solvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable. (2) A person who is not solvent is insolvent." 7 The two approaches commonly taken to the question of solvency are described, in summary terms, as the balance sheet test and the cash flow test, with the latter being predominant. That this is the correct approach was recognised by the Court of Appeal in Keith Smith East West Transport Pty Ltd v Australian Taxation Office (2002) 42 ACSR 501, among other cases (see, for example, Expile Pty Ltd v Jabb's Excavations Pty Ltd (2003) 45 ACSR 711; Lewis (as liquidator of Doran Constructions Pty Ltd) v Doran (2005) 54 ACSR 410; Box Valley Pty Ltd v Kidd (2006) 24 ACLC 471). The effect and implications of s.95A are, in my respectful view, accurately reflected in the following passage in the judgment of Dodds-Streeton J in Crema Pty Ltd v Land Mark Property Developments Pty Ltd (2006) 58 ACSR 631 at p.652: "Section 95A of the Act enshrines the cash flow test of insolvency which, in contrast to a balance sheet test, focuses on liquidity and the viability of the business. While an excess of assets over liabilities will satisfy a balance sheet test, if the assets are not readily realisable so as to permit the payment of all debts as they fall due, the company will not be solvent. Conversely, it may be able to pay its debts as they fall due, despite a deficiency of assets." 8 As I said in Noxequin Pty Ltd v Commissioner of Taxation [2007] NSWSC 87, the emphasis must be upon the extent of cash and other liquid assets (by which I mean assets readily convertible into cash), compared with the quantum of debts due and payable and to become due and payable in the immediate future. A comparison between the two can be made only as at a particular point but a state of solvency requires that, at each such point, the cash and liquid assets be sufficient to cover the debts due and payable and to become due and payable in the immediate future. But it is going too far to say that insolvency exists if there is, at a particular point, insufficiency. Such insufficiency is indicative of insolvency but is also consistent with the possibility of a temporary lack of liquidity. The indication of insolvency will be confirmed if the insufficiency represents an "endemic shortage of working capital": Hymix Concrete Pty Ltd v Garritty (1977) 2 ACLR 559. 9 An inquiry into whether insolvency existed at a particular time is generally assisted by searching for what Palmer J, in Lewis v Doran (2004) 50 ACSR 175 at p.191, described as "the usual indicia of insolvency": 1. a history of dishonoured cheques; 2. suppliers insisting on COD terms; 3. the issue of post-dated or "rounded sum" cheques; 4. special arrangements with creditors; 5. inability to produce timely, audited accounts; 6. unpaid group tax, payroll tax, workers compensation premiums or superannuation contributions; 7. demands from bankers to reduce overdraft and other evidence of deteriorating relations with bankers; 8. receipt of letters of demand, statutory demands and court processes for debt. 10 I shall, in due course, consider these "indicia" as they apply to the present case. First, it is appropriate to refer to Mr Hutchison's analysis of the all-important matter of Austin's cash position. 11 In making that analysis, Mr Hutchison had regard in particular to bank statements and monthly management accounts as relevant to the period December 2002 to December 2003. He prepared a table comparing the cash available, as disclosed by bank statements, plus any collectable debtors with current creditor commitments (including unpresented cheques). Noting that Austin did not have a provision for doubtful debts in its monthly management accounts, Mr Hutchison applied a provision of 5% which, for reasons he gave and I accept, may be taken to be a reasonable provision. Mr Hutchison's opinion, based on his analysis, is that Austin did not have enough cash on a month-by-month basis to cover its accounts due and payable from March 2003 to November 2003. The deficit grew from $3 million in June 2003 to more than $7.3 million in November 2003. Mr Hutchison also concluded that Austin was unable to generate enough funds from operations to cover its monthly payment obligations during the months preceding the appointment of administrators. 12 The table to which I have referred is Table 7.1.2 to Mr Hutchison's report. It shows available cash compared with current case requirements, calculated in the way I have outlined. Mr Hutchison explained in his evidence how Table 7.1.2 had been prepared. The starting point for each month was the cash balance shown by the bank statements (Austin had no overdraft facility, so the bank account balances were always credit balances). From that was deducted unpresented cheques from prior months. As I shall mention presently, these were significant – in fact, for each of the months January 2003 to December 2003, prior months' unpresented cheques very substantially exceeded the credit balance in the bank account. There was then added a figure for prior months' debtors, being the balance sheet item (current assets) less both retentions and the provision to which I have referred. Creditors as per the balance sheet (current liabilities) were then deducted. For each month from and including March 2003, the result was a deficiency as follows: March 2003 $ 4,769,780 April 2003 3,428,770 May 2003 4,960,030 June 2003 3,046,174 July 2003 5,537,066 August 2003 5,931,260 September 2003 4,910,502 October 2003 4,849,543 November 2003 7,238,571 December 2003 7,385,878 13 The adjustment for unpresented cheques requires particular comment. At the end of November 2003, there were between 600 and 700 cheques that had been drawn but not presented. A listing of them is exhibited to Mr Hutchison's affidavit. They totalled $7,891,004.08, the vast bulk being for individual sums substantially less than $100,000.00. Of the total, $1,181,981.28 was comprised in cheques that had been released to payees but, in the ordinary course, remained unpresented (or unpaid) at month's end. The very significant balance of $6,709,022.80 represented cheques that had been drawn but not released to payees. The inference to be drawn is that these were deliberately held back. A similar pattern is evidence in relation to each month going back to July 2003. 14 In Table 7.1.3, Mr Hutchison shows "cash burn", as disclosed by the trading account only. The cash burn (net amount of cash expended on a monthly basis) exceeded available cash for each of January, March, April, May, September, October and December 2003. 15 An analysis of aged debtor balances undertaken by Mr Hutchison shows that the percentage of Austin's debtors outstanding for over 120 days steadily increased from April 2003 to November 2003, from 4% to 22%, but with a reduction in August 2003. Mr Hutchison observes that this indicates increasing difficulty in obtaining payments from debtors; and that it is unlikely that debts outstanding for more than 120 days would have been collectable in full. No provision was raised. Any provision would appropriately have been greater than the 5% applied by Mr Hutchison. 16 As far as profit and loss are concerned, management accounts show accumulated losses of $1,413,020 for the period November 2002 to November 2003. This was before any write off for bad debts, any provision for doubtful debts and any other adjustments. Allowing for a 5% debt provision or cost overruns (or both) and a write-down for capitalised legal expenses, the figure would, on Mr Hutchison's calculation, have been $3,797,480. This does not include contract losses which management minutes show were not recognised in the accounts. In Mr Hutchison's opinion, problem contracts and disputes represented significant unrecognised losses. 17 An assessment of Austin's financial position in April 2003 made by its financial controller, Mr Gale, is in evidence. It is contained in a memorandum from Mr Gale to the chief executive, Mr Gervay, dated 11 April 2003: "I need to ensure that you are fully aware of my concerns regarding the current financial position of the company. As you know: · we have incurred significant trading losses in the last three months as projects have finalised; · at the same time we have increased our investment in our disputes/claims; · we have no access to funding sources to cover these matters. Consequently our trade creditors have been put under great pressure. As of today, our cash position is desperate. We have many sub-contractors and suppliers who are in arrears and who are threatening a range of actions, from withholding supply to notifying our clients of the issue. I recognise that many businesses face temporary difficulties. I believe that our problems go beyond any definition of temporary. The only prospect of additional cash in the short term is from settlement of our disputes, but we know: · Qantas will not settle quickly; · Auburn is in arbitration and it will be many months before we have a decision on the matter; · Grand Reef is a very fluid situation. Our equity base is also depleted from the trading losses already booked and it will diminish further if these disputes settle below book value. The severe erosion of our equity will affect our banking relationship and our other capabilities. I doubt, for instance, whether we will be able to get Home Owner's Warranty for Hillsdale because we will be expected to provide updated financial data by the time we have to lodge our application. In addition, there remain issues which have yet to be fully recognised: · the ultimate loss on Alexis; · the final outcome on Victoria Gardens. These would appear to be worse than the estimates that we are currently using by at least $0.5 million. The Donvale project in Melbourne is also of great concern: our most recent invoice was rejected in part and there appears every prospect of a looming dispute. Tom, I have notified you of many, if not all, of these issues on several prior occasions. Whilst I respect your optimism for the future, that optimism does not generate funds. Indeed, we fail to meet every projection which flows from that optimism, and the situation only gets worse. The company's balance sheet needs to be strengthened. We have few options as to how this is done. In my view, you have to consider whether you are able or willing to support Austin by using your personal means. This is entirely your decision. If you choose to support the company, you need to act quickly and I am happy to assist in that exercise. It is important that you have no doubt as to my position on these matters. I hope you understand that I am having great difficulty in serving as an officer of the company at this time. I should like to discuss this with you, to see if we can find a solution that works for us both." 18 I have noted that Austin did not have any bank overdraft facility. It did, however, have two facilities against which it was able to obtain the issue of performance bonds. By May 2003, those facilities had been fully utilised, with the result that new work undertaken was confined to work not requiring a performance bond. 19 I have also mentioned capitalised legal expenses. These were included as "unbilled work in progress" when there was little, if any, prospect of full recovery. In a similar way, work done on unapproved variations was included in "work in progress" without regard for any likelihood that the variations would be approved and paid for. In both these areas, assets were overstated. 20 In evidence is a quantity of material about legal proceedings, ranging from proceedings in the New South Wales Court of Appeal to claims under common money counts in the Magistrates Court of Queensland, the District Court at Penrith, the Local Court at Orange, the Local Court at Parramatta, the District Court at Sydney and the Melbourne Magistrates Court. There are also five statutory demands under the Corporations Act and a significant number of letters of demand. All these processes and demands relate to the period relevant to the present inquiry. 21 Austin's principal bank was Westpac Banking Corporation. In September 2003, Mr Gervay and Mr Gale met with officers of Westpac following transfer of responsibility for the relationship within the bank to Mr Reynolds. According to a letter from Mr Reynolds to Mr Gervay dated 8 September 2003, that transfer was a response to Austin's having provided to the bank financial and trading information for the six months to May 2003 which caused the bank to conclude that shareholders' funds had reached "a dangerously low level". The letter referred to Mr Gervay having reported further losses in June and July 2003 and an expectation of profit for the period Augusts 2003 to April 2004. The letter referred to the bank's decision to commission a review of Austin's financial position by external accountants. 22 I return now to the "indicia of insolvency" identified by Palmer J in Lewis v Doran (above) and consider them in turn, using the same numbering: 1. There is no real evidence of dishonoured cheques. As I have mentioned, however, cheque issue was managed in such a way that large numbers of cheques were held back. 2. There is evidence of suppliers having insisted on COD terms. My attention was drawn to COD supply of welding services in August 2003 and bricks in November 2003. 3. I was not taken to evidence of post-dated cheques, but the practice of holding back cheques involves the same strategy and the same effect. As to "rounded sum" cheques (indicating a likelihood of part payment only), I was directed to a significant number of examples in July, August, September, October and November 2003. 4. As for special arrangements with creditors, there are examples of instalment arrangements with DMG and Pioneer (the latter negotiated under threat of recovery proceedings) in July and December 2003 respectively. 5. Mr Gale's memorandum (see [17] above) is probably the best illustration of difficulties with timely production of audited financial information. 6. In relation to unpaid group tax, payroll tax, workers compensation premiums or superannuation contributions, I was referred to Mr Hutchison's finding that, as Austin accounted for GST on an accrual basis, it was claiming GST credits for payments made to creditors, even though the payments had not been made (because the cheques had been held back). This resulted in underpayment of GST. 7. The deteriorating relationship with Westpac has been mentioned. 8. The numerous debt recovery actions and statutory demands have been mentioned. 23 In the light of the evidence to which I have referred, Mr Hutchison reached a conclusion expressed as follows in his report: "From my analysis of the affairs of Austin as detailed in this report, it is my opinion that the company was insolvent from at least March 2003 and continued to be insolvent until my appointment as Administrator on 31 December 2003." 24 I am satisfied that, at each and every point during the period to which the separate question relates, cash and other liquid assets of Austin were always insufficient to meet debts due and payable and to become due and payable in the immediate future. I am also satisfied that the insufficiency was not a temporary or transient problem but a deep-seated and continuing disability. Profitability did not exist so as to represent a source of likely eventual resolution. Nor is there evidence that there were external sources on which Austin could draw. There was an endemic shortage of working capital and an inability to pay debts as and when they fell due. I am thus of the view that Mr Hutchison's opinion is well founded and supported by the evidence, so far as the period covered by the separate question is concerned. 25 My own review and assessment of that evidence, as well as the analysis, discussion and conclusion in Mr Hutchison's report, lead me to answer the separate question as follows: "Yes, Austin Australia Pty Limited was insolvent at all times during the period commencing 30 June 2003 and ending 31 December 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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