Reported Decision : 66 ACSR 398 New South Wales Supreme Court CITATION : Martin John Green in his capacity as liquidator of Arimco Mining Pty Limited (in liquidation) v CGU Insurance Limited & Ors [2008] NSWSC 825 HEARING DATE(S) : 14/07/08-18/70/08, 21/07/08-24/07/08, 28/07/08, 4/08/08-5/08/08 JUDGMENT DATE : 18 August 2008 JURISDICTION : Equity Division Commercial List JUDGMENT OF : Einstein J DECISION : Parties to bring in short minutes of order. CATCHWORDS : Insurance - Insurance Contracts Act - Directors and Officers liability - Insolvent trading claim under section 588 M Corporations Law brought by the plaintiff in his capacity as liquidator - Section 6 (4) Law Reform Miscellaneous Provisions) Act - Non-disclosure /misrepresentation - Relevant test that of the reasonable insured not the prudent insurer - Knowledge requires considerably more than "suspicion" or "belief" - Matter must be known to insured at the time to be a matter relevant and known to insured or a reasonable person to be relevant to the decision of insurer whether to accept the risk and if so on what terms - Legislative history of sections 21 and 28 of Insurance Contracts Act - Dangers posed by litigation proceeding through benefit of hindsight - Finding that had proper disclosure been made insurer would not have issued a policy without an insolvency exclusion - Terms of settlement reached by liquidator with directors of directors agreed to entry of judgment against each of them in the amount of $15,000,000, liquidator agreeing to receive far smaller amounts from directors presently - Terms of settlement include agreement by liquidator to discharge judgment if either the (1) proceedings terminate in favour of the liquidator or (2) liquidator reaches a compromise of the proceedings against insurer or (3) proceedings terminate in favour of the insurer - Finding that liquidator contracted for the entry of judgment but relevantly agreed not to enforce the judgment and agreed to discharge it in any event - Liquidator alleged to have approbated and reprobated - Section 588G (2) (b) of Corporations Law - Reasonable grounds for suspicion of insolvency - Belief in insolvency on the grounds of balance of probabilities not the test Company Law Review Act 1998 (Cth) LEGISLATION CITED : Corporations Act 2001 (Cth) Insurance Contracts Act 1984 (Cth) Law Reform (Miscellaneous Provisions) Act 1946 (NSW) CATEGORY : Principal judgment Almario v Allianz Australia Workers Compensation (NSW) Insurance Ltd (2005) 62 NSWLR 148 Australian Securities and Investments Commission v Plymin and Others (2003) 46 ACSR 126 Ayoub v Lombard Insurance Co (Aust) Pty Ltd (1989) 97 FLR 284; (1989) 5 ANZ Ins Cases 60-933 Bailey v New South Wales Medical Defence Union Ltd (1995) 184 CLR 399 Barclay Holdings (Australia) Pty Ltd v British National Insurance Co Ltd and Another (1987) 8 NSWLR 514 Blair & Perpetual Trustees Co Ltd v Curran (Adams' Will) (1939) 62 CLR 464 CGU Insurance Limited v Porthouse [2008] HCA 30 Chamberlain v Deputy Commissioner of Taxation (ACT) (1988) 164 CLR 502 Commercial Union Assurance Co of Australia Ltd v Beard (1999) 47 NSWLR 735 Commonwealth Bank of Australia v Friedrich (Friedrich/National Safety Council case) (1991) 5 ACSR 115 GIO General Ltd v Wallace (2001) 11 ANZ Ins Cas 61-506 CASES CITED : Guthrie House Ltd v Cornhill Insurance Co Ltd (1982) 2 ANZ Ins Cas 60-466 Kinzett v McCourt (1999) 46 NSWLR 32 Macquarie Bank Ltd v National Mutual Life Association of Australia Ltd and Others (1996) 40 NSWLR 543 Mayne Nickless Ltd v Pegler [1974] 1 NSWLR 228 Permanent Trustee Australia Ltd v FAI General Insurance Co Ltd& Anor (1998) 153 ALR 529 Permanent Trustee Australia Co Ltd v FAI General Insurance Co Ltd & Anor [2001] 50 NSWLR 679 Permanent Trustee Australia Limited v FAI General Insurance Company Limited (in liquidation) (2003) 214 CLR 514 Port of Melbourne Authority v Anshun Pty Ltd (1981) 147 CLR 589 Ratcliffe v VS & B Border Homes Ltd (1987) 9 NSWLR 390 Tate & Sons v Hyslop (1885) 15 QBD 368 Toikan International Insurance Broking Pty Ltd v Plasteel Windows Australia Pty Limited (1989) 15 NSWLR 641 Twenty-First Maylux Pty Ltd v Mercantile Mutual Insurance (Australia) Ltd [1990] VR 919 VACC Insurance Co Ltd v BP Australia Ltd (1999) 47 NSWLR 716 TEXTS CITED : Ford, Principles of Corporations Law, 13th ed (2007) PARTIES : Martin John Green in his capacity as liquidator of Arimco Mining Pty Limited (in liquidation) (Plaintiff) CGU Insurance Limited (First Defendant) FILE NUMBER(S) : SC 50177/04 COUNSEL : Mr D Davies SC, Mr MS White (Plaintiff) Mr R Macfarlan QC, Ms C Needham SC, Mr S Goodman (First Defendant) SOLICITORS : Henry Davis York (Plaintiff) Kennedys (First Defendant) IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION COMMERCIAL LIST Einstein J Monday 18 August 2008 50177/04 Martin John Green in his capacity as liquidator of Armico Mining Pty Limited v CGU Insurance Limited & Ors JUDGMENT The proceedings 1 These proceedings concern a claim against CGU Insurance Limited Insurance as the Directors and Officers insurer of Arimco Mining Pty Limited (in liquidation) (Arimco) and its directors and officers. CGU issued a Directors and Officers Policy [No. 02DO 0265146] to Arimco and its directors, such Policy incepting on 31 December 1998 and continuing up to 31 December 1999. The policy also provided D&O Insurance to the directors and officers of the ARL Group. 2 The ARL group, through Arimco, mined gold and copper, at its Mt McClure, Mt Selwyn and Gidgee mines. 3 The proceedings are brought by virtue of leave having been obtained under section 6(4) of the Law Reform (Miscellaneous Provisions) Act 1946. The plaintiff is Mr Martin John Green in his capacity as liquidator of Arimco who seeks an order, pursuant to section 588M of the Corporations Act, that the directors pay to the liquidator an amount alleged to be equal to the loss or damage suffered by creditors in relation to debts incurred by Arimco at a time when he alleges that it was insolvent. 4 As originally constituted, the proceedings were brought also against the relevant directors and officers (being Roy Swan, John Roberts, Colin Smith and Donna Stubbs), and against the administrator of the estate of the late Philip Pearce (his wife Carol Pearce) and against CGU Insurance in relation to Mr Pearce by virtue of section 51 Insurance Contracts Act. 5 A settlement was effected between the plaintiff and the parties other than CGU on 7 July 2006 whereby the directors (who are taken to include Ms Stubbs) and Mrs Pearce as executor agreed to a judgment being entered against each of them for $15 million but with certain terms concerning payments to satisfy those judgments. Although CGU was a party to the mediation which resulted in that settlement, CGU declined to participate in the settlement. 6 The claim is an insolvent trading claim under section 588M of the Corporations Act. The allegation is that Arimco was insolvent from 1 February 1999. 7 On 14 March 1999 Mr Green was appointed Voluntary Administrator of Arimco and, on 7 May 1999, the creditors of Arimco voted to wind up the company and appointed him as liquidator. On 15 November 2004, the court ordered that Arimco be wound up and that Mr Green be appointed liquidator. 8 The claim is in respect of debts said to total $21,217,765.47 and to have been incurred between 1 February and 14 March 1999. The essential issues 9 CGU relies upon the following defences: i. First, CGU claims that by operation of a Terms of Settlement entered into on or around 5 July 2006 (the Terms) agreed between the liquidator and the directors, CGU's liability is capped at the amount which the directors are liable to pay, namely $320,000. Alternatively CGU claims that its liability is capped at $15,000,000 (see Amended Defence to Second Further Amended Summons (Defence), par. 20); ii. Secondly, CGU claims that it is entitled to reduce its liability under the policy to nil because of non-disclosure and misrepresentation by the company and its directors. Alternatively, CGU's pleaded case had claimed that an exclusion clause raising cognate issues was applicable; The defendant contends that the directors failed to disclose a range of matters including the following: (i) Changes to the financial position of ARL in November and December 1998. (ii) Changes which occurred at the mines in the second half of 1998. (iii) The fact that Rothschild, the financier of the ARL Group, had investigated the financial position of the mines and expressed concerns about their value. (iv) The fact that Rothschild was intending to undertake a review of the business, and that, if that review was unfavourable, ARL would be required to make payments in 1999 and 2000 which it would be unlikely to be able to meet. (v) The fact that ARL had been notified that Leighton Contractors Pty Ltd ("Leighton") intended to commence legal proceedings for $15,000,000. (vi) The fact that ARL was using funds raised under a rights offer for a specific purpose [exploration] for an ulterior purpose [the payment of amounts due to creditors]; iii. Thirdly, CGU claims that the liquidator has not proven that debts were incurred in the amount pleaded, or that the creditors' loss and damage is represented by the amounts of the debts; iv. Fourthly, CGU claims that the insolvency of the company in the period alleged by the liquidator is in issue because the liquidator does not admit that ARL, in October to December 1998, was insolvent, close to insolvent or even in a precarious position. [CGUs proposition is that the two must go hand in hand because it contends that there were no events intervening between the end of December 1998 and the beginning of February 1999 of such a drastic character to cause a buoyant company to suddenly become insolvent] 10 The pleaded issues also embrace the following questions: i. whether CGU would have entered into the contract of insurance for the same premium and on the same terms and conditions in any event; ii. if CGU makes out its defence based on sections 21 and 28 ICA, to what is it entitled to reduce its liability under section 28(3); [CGU abandoned its pleaded claim that it was entitled to rely on exclusion 3.2] Questions of admissibility 11 During the hearing a question arose as to the admissibility for particular purposes, of materials which only became known after December 1998. Counsel agreed that the ultimate decision as to the admissibility of these materials would be handed down in the final judgment upon the basis that during final address submissions would be taken on the admissibility issues. The ruling became known as 'the three pronged ruling' to cover the questions to be reserved into the final judgment concerning the admissibility of materials: i. going to the directors knowledge of facts; ii. going to the directors knowledge of the relevance of the facts, [assuming the directors were found to have known them]; iii. going to the suspicion or reasonable suspicion of insolvency. 12 In the events which happened [notwithstanding the court during final address having reminded the counsel of their entitlement to address on the evidence which they wished to contend was or was not admissible] very little instant specific attention was given by either party seeking in final address to contend that particular evidence was or was not to be required to be rejected as inadmissible in terms of the non-disclosure and misrepresentation cases. Mr Macfarlan submitted that there was no profit to be had in trawling through the evidence and examining its admissibility. His proposition was that the Court should approach the matter by identifying what evidence the Court found as compelling in the case and when and if that evidence had a cloud over it in terms of relevance and admissibility, the court would have to deal with the matter in the reasons. Mr Davies agreed with that approach, making the point that the written submissions of the liquidator had sought to identify where post 1998 material had been taken into account in coming to a view about a particular factor or group of factors. 13 In those circumstances the Court has approached the questions of admissibility in the fashion suggested by both senior counsel. Hence it is unnecessary for the court to assay the task of laying down blanket rulings. In truth the question becomes one of relevance. 14 Clearly, however, where the question is whether Arimco was insolvent at particular date, the Court may utilise the benefit of hindsight [as for example being given the assistance of expert evidence] to work out just what it is that is shown to have been the position ante. The dangers posed by litigation proceeding through the prism of hindsight 15 The crucial issue in the proceedings raises questions which are not easy of resolution. In large measure this is because of the enormous difficulties where so much of the evidence is, in one way or another, affected by hindsight. The dangers for the Court in such a circumstance have been alluded to on a number of occasions: as for example in Rosenberg where the Chief Justice put the matter as follows: "As the evidence emerged it became clear there was a serious question whether, even if the contingency had been brought to the attention of the respondent, it might have been expected to make any difference to her decision. This question was then addressed by the respondent in evidence belatedly and in the opinion of the trial judge unconvincingly. There is an aspect of such a question which may form an important part of the context in which a trial judge considers the issue of causation. In the way in which litigation proceeds the conduct of the parties is seen through the prism of hindsight, because if a foreseeable risk has eventuated and harm has resulted, the particular risk becomes the focus of attention, but at the time of the allegedly tortious conduct there may have been no reason to single it out from a number of adverse contingencies or to attach to it the significance it later assumed. Recent judgments in this Court have drawn attention to the danger of the failure after the event to take account of the context before or at the time of the event in which a contingency was to be evaluated. This danger may be of particular significance where the alleged breach of a duty to care is failure to warn about the possible risks." [at 15] emphasis added. 16 The events with which the proceedings are concerned occurred approximately 10 years ago. The evidence called from the underwriters and the evidence called from the directors suffered from the problems of endeavouring to avoid reconstruction with the benefit of hindsight, in a circumstance in which that exercise was mostly impossible. Likewise a huge amount of the evidence called from the respective experts involved their having had access to documents and materials post-dating the end of December 1998 so that even where large sections of the reports were ultimately not read, it could not be said that the hindsight factor had not influenced many of the opinions expressed in these reports. Hence the Court has been astute to monitor the evidence so as, wherever possible, to take account of the context in which particular evidence came forward. Overview of the types of issue litigated 17 The matters which were litigated involved a close examination of the financial position of Arimco embracing the performance of the mines. Mr Green's affidavit of 8 March 2007 [on which he was not cross examined] provided a skeletal overview of particular matters. Sections of this affidavit are appropriate to be set out although the whole of the affidavit is before the Court. Some of the matters which are referred to in Mr Green's affidavit are referred to later in the reasons where considerable more detail becomes important. 18 Hence although Mr Green's affidavit was not challenged by CGU, in certain respects the matters which were litigated exposed some additional and some different conclusions to those to which Mr Green had deposed. The findings in relation to these matters are also set out in the reasons which follow. Summary of Arimco's mining operations 19 The ARL Group, through Arimco, operated the following mines: i. a gold mine site at Mt McClure in Western Australia; ii. a gold mine site at Gidgee in Western Australia; and iii. a gold and copper mine site at Selwyn in Queensland. The ARL Group's banking facilities with Rothschild 20 The ARL Group's primary bankers were Rothschild. Mr Pearce was a director of the holding company of Rothschild [Details of the changing multi-option facility agreement arrangements with Rothschild are set out in the reasons which follow]. Rights Issue 21 On 28 July 1998 the ARL Group lodged with ASIC a prospectus in relation to a rights issue in order to raise funds to expand its exploration drilling programs at Mt McClure and Selwyn, and also to satisfy the requirements of Rothschild to raise equity. 22 The Rights Issue raised approximately $11.226 million in gross proceeds and, on 23 September 1998, ARL allocated under the Rights Issue 56,129,525 ordinary shares. 23 The net cash proceeds from the Rights Issue were approximately $10.2 million [further parameters concerning the Right Issue are also examined in the reasons which follow]. The ARL Group's Annual Report for year ending 30 June 1998 24 The ARL Group published in the same Annual Report the audited accounts of: i. the listed entity, ARL; and ii. on a consolidated basis, ARL and its controlled entities, including Arimco which was described as the "economic entity". 25 On 3 September 1998 the Audit Committee considered the draft financial statements for the financial year ending 30 June 1998. The Audit Committee resolved to recommend to the board of directors that the financial statements be adopted. 26 On 24 September 1998 the ARL Group's auditors, KPMG, signed the audited financial accounts in the Annual Report for the financial year ending 30 June 1998 (Annual Report). The content of this report is described further below. 27 On the same day, at a meeting of the ARL board of directors, the directors considered the Annual Report and resolved to adopt it. 28 As at the end of September 1998, according to the ARL Group's management accounts for the month of September 1998, the ARL Group had a cash balance of $12.45 million, which funds included the $10.2 million received from the Rights Issue. 29 Arimco, which was not a reporting entity and which was operated by ARL, did not produce its own cashflows. The ARL cashflows, which are reflected in the management accounts are, however, indicative of Arimco's cashflow given that it was Arimco which was the operating entity of the ARL Group. October and November 1998 30 After the approval of the Annual Report at the meeting of the board of directors on 24 September 1998, the ARL board met on two further occasions in 1998, on 30 October 1998 and 26 November 1998 respectively. 31 At the ARL board meeting on 30 October 1998, the directors had available to them the financial and operational performance of the ARL Group for the month of September 1998, in particular the September 1998 Financial Overview. 32 At the ARL board meeting on 26 November 1998 the directors had available to them the financial and operational performance for the month of October 1998, in particular, the October 1998 Financial Overview. 33 According to the minutes of the ARL board meeting held on 26 November 1998: Mr P A Pearce noted that CIBC were in discussions with Rothschild regarding conversion of the convertible notes and a sell-out of the shares to "friendly hands". Mr P A Peace noted that his discussions with Mr G Hodgkinson [of Rothschild] indicated that the $4 million [that would be raised from the conversion] would still be considered part of our facility and would be positive for the longer-term arrangement. 34 Following the ARL board meeting on 26 November 1998, at which the financial results for October 1998 were discussed, the ARL board of directors did not meet again until 3 February 1999. 35 Based on Mr Green's review of the documents of the ARL Group, in addition to the October 1998 Internal Monthly Report that was made available to the directors at the board meeting on 26 November 1998 and the weekly production results that were made available to Mr Swan, the following documents in relation to production were made available to Messrs Pearce, Swan, Roberts and Smith in November 1998: i. on 13 November 1998, they were provided with the summary management reports for the weeks of 27 October 1998 and 3 November 1998, and minutes of a meeting to discuss administration and contracts which was conducted on 9 November 1998; ii. on 20 November 1998, they were provided with the summary management report for the week of 10 November 1998; iii. on 25 November 1998, they were provided with the summary management report for the week of 17 November 1998. 36 As regards the cash balance of the ARL Group: i. as at October 1998, according to the October 1998 monthly management accounts, the ARL Group had a cash balance of $10.08 million; ii. as at November 1998, according to the November 1998 monthly management accounts, the ARL Group had a cash balance of $8.30 million. December 1998 37 There was no ARL board meeting in December 1998. There were no ARL board meetings in the period 26 November 1998 to 3 February 1999. 38 Further, the chairman, Mr Pearce, was absent from the ARL Group during the period 16 December 1998 to 18 January 1999 following surgery. 39 Based on Mr Green's review of the documents of the ARL Group, in addition to the weekly production results which were available to Mr Swan, the following documents in relation to production were made available to Messrs Pearce, Swan, Roberts and Smith in December 1998: i. on 4 December 1998, they were provided with the summary management report for the period 1 to 24 November 1998; ii. on 14 December 1998, they were provided with the minutes of a meeting held on 7 December 1998 which recorded that Mr Swan, Mr Ryan, Ms Stubbs, Mr Goldner and Mr Ingham met and discussed the results for just the one day of 1 December 1998; iii. according to an undated memorandum from Ms Stubbs to the directors, on 11 December 1998 Mr Swan, Mr Ryan, Ms Stubbs, Mr Goldner and Mr Ingham met and discussed the results for the period 1 December 1998 to 8 December 1998; iv. on 24 December 1998, they were provided with the summary management report for the period 1 to 15 December 1998. 40 On a date between 11 and 15 December 1998, the ARL Group completed and submitted to Jardine Australia Insurance Brokers Pty Limited (Jardine), a proposal for directors and officers professional liability insurance. Subsequently, on 29 December 1998, Jardine informed the ARL Group that the directors and officers would commence a new period of directors and officers' professional liability insurance with the first defendant, CGU Insurance Limited (CGU) ("the Policy"). The term of the Policy, which was formally issued by CGU on 19 April 1999, was from 31 December 1998 to 31 December 1999. 41 On 21 December 1998, there was a meeting of the Audit Committee. 42 On 24 December 1998, ARL received a letter from Rothschild which indicated that it intended to review the ARL Group's banking facilities, including giving consideration to an extension of the amortisation and expiry dates of the Arimco facility and the Mt McClure acquisition facility. 43 In December 1998, Rothschild negotiated the purchase by Geographe Resources Limited (Geographe) of the Convertible Note. On 29 December 1998, Rothschild transferred to Geographe the 20,000,000 ARL convertible notes for consideration of $4.7 million and the notes were immediately converted to equity. 44 Following the transfer of the Convertible Note and its conversion, the ARL Group's exposure to Rothschild had reduced to $8.7 million, comprising: i. the Mt McClure facility of $5.2 million, the repayment date for which was 31 July 1999; and ii. the $3.5 million overdraft, the repayment of which was to occur by way of seven monthly instalments of $500,000 starting in July 1999. 45 As at 31 December 1998, according to the December 1998 management accounts which were finalised in late January 1999, the ARL Group had a cash balance of $11.02 million. January 1999 46 The ARL board of directors did not meet in January 1999. 47 Mr Green's affidavit had also dealt with the January 1999 profit and loss position treating also with the then budget position and also with falling copper price. That section of the affidavit is reproduced below but I note that the matters litigated travelled into this period of time in greater detail so that later in the judgment the courts findings as to the precise position are to be found. In any event Mr Green had deposed as follows: i. During January 1999, the ARL Group suffered significant operating losses which exceeded any losses made by the ARL Group in the preceding six months and which resulted in the dissipation of the cash available to the ARL Group to pay Arimco's creditors. ii. In particular, Arimco sustained in January 1999 a significant operating loss (before abnormal items and income tax) of $5.4 million. According to the management accounts for the period July 1998 to January 1999 (see MJG2 tabs 3 to 9), Arimco made losses in August ($1.2 million), September ($1.0 million) and November 1998 ($1.42 million). Arimco had, however, made profits in July ($1.2 million), October ($684,000) and December 1998 ($364,000). In the circumstances, the loss Arimco made in January 1999 of $5.4 million was a significant departure from the profits and losses that Arimco had sustained over the previous six months, being almost four times larger than the November 1998 loss which until then had been the largest loss for the 1998 to 1999 financial year. iii. Gidgee's gold production in January 1999 was 27% below budget. iv. Mt McClure's gold production in January 1999 was 37% below budget. v. In relation to the shortfalls in gold production, and production generally, for the month of January 1999 reference may be made to: a) the weekly production results for 1 to 19 January 1998 that were available to Mr Swan; b) the summary weekly management reports for: c) 1 to 5 January 1999, which was circulated to the directors by Ms Stubbs on 13 January 1999 and which showed, inter alia, that gold production was down 28% and 44% at Gidgee and Mt McClure respectively, and copper production was down 19% at Selwyn. [See the memorandum dated 13 January 1999 from Ms Stubbs to the directors]; d) 1 to 12 January 1999, which was circulated to the directors by Ms Stubbs on 20 January 1999 and which showed, inter alia, that gold production was down 22% and 38% at Gidgee and Mt McClure respectively, 21% at Selwyn, and copper production was down 31% at Selwyn. [See the memorandum dated 20 January 1999 from Ms Stubbs to the directors]; e) 1 to 19 January 1999, which was circulated to the directors by Ms Stubbs on 28 January 1999 and which showed, inter alia, that gold production was down 16% and 44% at Gidgee and Mt McClure respectively, and copper production was down 15% at Selwyn. [See the memorandum dated 28 January 1999 from Ms Stubbs to the directors] and f) 1 to 26 January 1999, which was circulated to the directors by Ms Stubbs on 5 February 1999 and which showed, inter alia, that gold production was down 22% and 41% at Gidgee and Mt McClure respectively. [See the memorandum dated 5 February 1999 from Ms Stubbs to the directors]; g) the January 1999 Internal Report circulated at the ARL board meeting on 3 to 4 February 1999 which showed, inter alia, that gold production was down 27% and 37% at Gidgee and Mt McClure respectively. vi. The falling copper price impacted on Arimco's revenue from copper concentrate, the sale of which was regulated by an agreement with Glencore International AG (Glencore) by which Arimco was entitled to invoice Glencore for an advance payment of up to 90% of the estimated value of copper concentrate prior to shipment, with the balance being invoiced, subject to adjustments, upon the arrival of the shipment some months later. As a result, when the copper price fell significantly in January 1999, when adjustments were made following the arrival of shipments of copper concentrate some months after the original estimation of its value, the adjustment was such that the actual value of the shipment was less than the estimated value. Accordingly, Arimco owed Glencore in relation to the adjustments. This reduced the cash inflow for Arimco. vii. In addition to sustaining the significant operating loss of $5.4 million: a) the ARL Group incurred its most significant cash outflow for the 1998 to 1999 financial year of $6.9 million, leaving it with just $4.10 million in cash available. b) on 4 January 1999, the sum of $2,355,037.37, which funds formed part of the proceeds of the Rights Issue, were withdrawn from their deposit with Colonial State Bank. These funds were never returned to deposit and were applied to pay Arimco's creditors. The application of these funds towards the payment of creditors, and the failure to re-deposit them, indicates that Arimco was not earning sufficient revenue from its operations to pay its creditors from January 1999. c) Arimco's net current assets were $18 million in deficit to its current liabilities. viii. In January 1999, in addition to the reduction in production which was evidenced in the weekly summary management reports circulated to the directors by Ms Stubbs, the following information and documents were available to one or more of Messrs Pearce, Swan, Roberts and Smith in relation to the financial performance of Arimco: a) on 4 January 1999, Ms Stubbs circulated to "the board of directors", a memorandum in which she stated: Given that there was no board meeting in December 1998, I have attached the reports that would have been tabled at such a meeting in order to keep you informed. The reports attached are as follows: · operations report - November 1998; · secretarial report; · treasury report; Sheryll Young has indicated that the Finance Report for November 1998 will be sent to you when available. I understand that Robert faxed the Managing Director's report to Directors prior to Christmas… (See memorandum dated 4 January 1999 from Ms Stubbs to the ARL board of directors, and the attachments which were located with the memorandum, at MJG1 tab 11 at pages 345 to 378). b) letter dated 6 January 1999 from Rothschild to Ms Stubbs at MJG1 tab 11 pages 379 to 380); c) memorandum dated 14 January 1999 from Mr Ryan to Mr Pearce at MJG1 tab 11 pages 381 to 385; and d) from 18 to 20 January 1999, Mr Swan and Ms Stubbs, together with certain other senior managers, visited both the Gidgee and Mt McClure mines." 1 February 1999 48 By 1 February 1999, all of the proceeds of the Rights Issue, save for the $5.2 million on deposit with Rothschild, had been withdrawn from deposit as follows: i. on 4 January 1999, the sum of $2,355,037.37; and ii. on 1 February 1999, the sum of $3,005,557.81. 49 From 1 February 1999 up to Mr Green's appointment as administrator on 14 March 1999, Arimco continued to trade. ARL board meeting on 3 and 4 February 1999 50 The ARL board of directors met at the Selwyn mine in Queensland on 3 and 4 February 1999. Present at the meeting were Mr Pearce, Mr Swan, Mr Roberts, Mr Smith, Ms Stubbs and Mr Ryan. 51 The board papers that were available to the directors for the purpose of that meeting included: i. the Financial Overview for: a) November 1998 (pages 220 to 227); and b) December 1998 (dated 2 February 1999) (pages 95 to 102 and a further copy at pages 210 to 219); ii. the Internal Monthly Report for December 1998 (pages 71 to 94); and iii. the managing director's report for December 1998 (pages 115 to 117). 52 According to the minutes, Ms Stubbs tabled the Financial Overview for December 1998 "and provided a summary of significant matters, including the cash position of the group". According to the Financial Overview for December 1998, which report was dated 2 February 1999, the ARL Group was having significant cash flow difficulties and, in January 1999, the proceeds of the rights issue had been "borrowed" to pay creditors. The Financial Overview for December 1998 stated; The seemingly healthier cash balance was short lived since the majority of creditor payments were made in January and the January gold shipments dropped off. Other than the $5.2m invested with Rothschild, the remainder of the share rights funds were temporarily "borrowed" to meet the major payments at the end of January. 53 The managing director's report for December 1998, a copy of which was tabled at the board meeting, provided a summary of operations for December 1998 and a forecast for January 1999. The report: i. identified decreased production caused by low grade ore and mill shutdowns in December 1998; and ii. forecasted that production in January would be further hampered by, inter alia, mill shutdowns and rain. 5 February to 1 March 1999 54 From early to mid February 1999, Mr Pearce, Mr Swan, Mr Roberts and Mr Smith were provided with the production results for late January 1999 and February 1999 as follows: i. on 5 February 1999, they were provided with the results for the period 1 to 26 January 1999 which showed, inter alia, that gold production was down 22% and 44% at Gidgee and Mt McClure respectively, and copper production was down 15% at Selwyn; ii. on 10 February 1999, they were provided with the results for the period 1 and 2 February 1999 which showed, inter alia, that gold production was down 22% at Selwyn and copper production was down 16% at Selwyn; iii. on 18 February 1999, they were provided with the results for the period 1 to 9 February 1999 which showed, inter alia, that gold production was down 24% at both Gidgee and Mt McClure, down 12% at Selwyn, and copper production was down 16% at Selwyn; iv. at a meeting on 19 February 1999, Mr Swan, Ms Stubbs , Mr Goldner and Mr Ingham met to discuss the results for the period 1 February 1999 to 16 February 1999. The minutes of that meeting showed that gold production was down 25% at Gidgee, 16% at Mt McClure and 17% at Selwyn, and copper production was down 7% at Selwyn; v. at a meeting on 26 February 1999, Mr Swan, Ms Stubbs , Mr Goldner and Mr Ingham met to discuss the results for the period 1 February 1999 to 23 February 1999. The minutes of that meeting showed that gold production was down 17% at Gidgee, 10% at Mt McClure and 14% at Selwyn, and copper production was down 7% at Selwyn. 55 In the period 15 to 19 February 1999, Mr Swan sold on the ASX 300,000 of his 350,923 shares in ARL. 56 On 12 February 1999, Mr Goldner wrote to Mr Ryan regarding the Gidgee mine in relation to which he considered that, without further exploration, the mine would no longer be profitable, particularly as a result of high costs and the limited cash flow it was generating. 57 On Friday, 19 February 1999: i. according to the minutes of the management committee meeting held on 19 February 1999 at which Mr Swan, Ms Stubbs, Mr Goldner and Mr Ingham were present, in addition to the discussion in relation to production referred to above, it was agreed that a presentation would be made to the ARL board of directors at the next board meeting which was scheduled for 2 March 1999; ii. Mr Ryan spent his last day at the ARL Group's head office. The following Tuesday, 23 February 1999, Mr Roberts confirmed to various managers that Mr Ryan would not be returning. iii. Mr Goldner again wrote to Mr Ryan regarding " alternatives for reductions in exploration expenditure at Selwyn ". 58 On 25 February 1999: i. Ms Stubbs, Mr Goldner and Mr Ingham attended a meeting where the financial position of the ARL Group was discussed and it was decided that Ms Stubbs, Mr Goldner and Mr Ingham would make a presentation to the board of directors on 2 March 1999 regarding the situation; ii. Mr Pearce, who had by then been diagnosed with a serious illness, requested his co-directors to grant him leave for the period 5 to 26 March 1999, and that Mr Roberts take over as chairman of the ARL Group in that period. 59 On 26 February 1999: i. the management committee met. Present were Mr Swan, Ms Stubbs, Mr Goldner and Mr Ingham. In addition to the discussion of production for the period 1 February 1999 to 23 February 1999 referred to above, the minutes confirmed the statement that had been made in the minutes of the management committee meeting that was held on 19 February 1999 that a presentation on the cash flow position would be made at the next meeting of the board of directors which was scheduled for 2 March 1999; ii. Mr Swan, Ms Stubbs, Mr Goldner, Mr Ingham and Ms Young (the ARL Group's finance manager), considered the amount of cash that was available to Arimco to pay creditors for the following week ($4.1 million), and the creditors that required urgent payment ($15.1 million), and selected those creditors that would be paid from the limited cash available. 60 By 28 February 1999: i. the ARL Group had $6.97 million in cash available, of which $5.2 million comprised the deposit held at Rothschild; ii. the amounts that were being withheld from creditors were escalating. ARL board meeting on 2 March 1999 61 The ARL board of directors met on 2 March 1999. Present at the meeting were Mr Pearce, Mr Swan, Mr Smith, Mr Roberts and Ms Stubbs. 62 The minutes of the 2 March 1999 ARL board meeting record: i. Ms Stubbs, together with Mr Goldner and Mr Ingham, gave the presentation to the board on the ARL Group's financial position and cashflow which they had prepared in late February 1999. The presentation recorded, inter alia, that: a) of the $10.5 million raised by the rights issue: (i) only the $5.2 million which was held on deposit at Rothschild remained; (ii) only $1.684 million had been spent on exploration across the three mining sites; and (iii) $3.62 million had been spent on non-exploration expenditure. b) the cash allocated for creditors for the preceding week was $4.1 million against $10.8 million; c) there was a concern that creditors may stop supply, thereby leading to the shutting down of ARL's operations; d) there were total creditors and liabilities of $38 million; e) Arimco's position would " raise alarm bells " with its secured creditor, Rothschild; and f) it was likely that cashflow would remain negative (assuming exploration continued, which exploration was required to increase the life of the mines). 63 The minutes recorded: Ms D M Anderson [Ms Stubbs] advised that the Company was in a very difficult cash position. A reconciliation of the rights issue monies left versus what had been spent on the projects identified in the prospectus was provided, which indicated that the rights issue monies had been accessed for working capital requirements. In order to illustrate the cashflow difficulties, Ms D M Anderson outlined the cash requested by the sites this week of $10.8 million versus what was available of $4.1 million. The ageing and a list of the major creditors included in the cash request was provided and discussed. 64 In relation to cash flow, the minutes recorded that: Mr P D Ingham presented on the cashflow forecast for the remaining 4 months to 30 June 1999, which indicated negative group cash flow (including exploration) for the 4 months. 65 The board of directors agreed to take the following steps: a) to send Mr Smith to the Gidgee mine site the following day to review operations; b) management to access the $5.2 million held with Rothschild, albeit it was acknowledged that even if the $5.2 million was made available to the ARL Group, it would not alleviate the cash flow problems later that month; c) that Rothschild's corporate finance division be used to obtain strategic advice for the future direction of the company after first undertaking studies in relation to the maintenance of the Selwyn mine site, the preparation of life of mine plans for each mine (and the cost to close each mine), a reduction of exploration expenditure and an attempt to reduce royalty and expenditure commitments on tenements. 66 According to the agenda to the 2 March 1999 board meeting, the Financial Overview for January 1999 was not available, but was to be made available on Friday of that week (5 March 1999). 67 On 2 March 1999 the audit committee also met. In attendance were Mr Roberts, Mr Smith, Mr Pearce and Ms Stubbs of the ARL Group. Also in attendance were Mr John Gulson and Mr P Zammitt of the ARL Group's auditors, KPMG, and Mr S Lemonis of the ARL Group's solicitors, Watson Mangioni. 3 March 1999 to Mr Green's appointment on 14 March 1999 68 Throughout early March 1999 up to Mr Green's appointment on 14 March 1999, Arimco continued to withhold payment of creditors. 69 On 3 March 1999: i. Ms Stubbs contacted Rothschild to arrange a meeting. A meeting was scheduled for 10 March 1999; ii. Ms Stubbs confirmed to the directors that the directors and officers insurance had been renewed for the 1999 calendar year and requested the directors and senior officers to pay their respective contributions to the premiums. 70 On 5 March 1999; i. Rothschild wrote to ARL and requested the provision of certain documents for the purpose of the meeting scheduled for 10 March 1999. On 7 March 1999, Ms Stubbs forwarded Rothschild's letter to Mr Roberts with her views on what documentation could be provided to Rothschild. Ms Stubbs also noted: "I point out in further support of the above that Rothschild can call an event of default if in the opinion of Rothschild there is any adverse change in the financial condition or operations of the Company. An event of default allows them to demand immediate repayment of facilities"; ii. the ARL Group released to the ASX its half yearly figures for the six months from 1 July 1998 to 31 December 1998; iii. Mr Swan, Ms Stubbs, Mr Goldner, Mr Ingham and Ms Young again met to consider the cash that was available to Arimco and the creditors that required urgent payment, for the purpose of selecting those creditors that would be paid from the limited cash available. 71 On 6 March 1999: i. Ms Young, forwarded a memorandum to Ms Stubbs, copied to, inter alia, Mr Swan, headed " Week's cash distribution "; ii. Mr Goldner and Mr Ingham forwarded a memorandum to Mr Swan regarding the $5.2 million on deposit at Rothschild in which, having received on 5 March 1999 a request by Rothschild to provide recent financial information, they recommended that the $5.2 million be withdrawn immediately to ensure that Rothschild did not prevent access to those funds. 72 On 7 March 1999, Mr Swan conveyed to Mr Smith the contents of the memorandum he received from Messrs Goldner and Ingham on 6 March 1999 (having noted that Mr Roberts had also received a copy of the memorandum). 73 On 10 March 1999, Mr Roberts, Mr Swan, Ms Stubbs, Mr Ingham and Mr Goldner met with representatives of Rothschild to discuss the ARL Group's financial position, including the status of the payment of creditors. 74 On 12 March 1999: i. Mr Swan and Ms Stubbs met with representatives of Rothschild (Mr Geoff Hodgekinson and Mr Bruce Spencer) and Mr Andrew Love of Ferrier Hodgson at ARL's Sydney head office. Mr Roberts participated in the meeting by telephone. According to Mr Swan's file note, at the meeting on 12 March 1999: a) Rothschild expressed their concern at the information received by Rothschild at the 10 March 1999 meeting regarding the "serious financial position" of the ARL Group; b) Rothschild had brought Mr Love to the meeting in order to protect Rothschild's exposure; c) in relation to the solvency of the ARL Group, Donna Anderson said: …it was obvious from the figures that ARL was unable to pay its creditors and the situation was getting worse because of operational problems at Gidgee and Mt McClure and a delayed shipment of copper concentrates from Townsville. This meant that our revenue from production recently was poor, but that it would improve in the near future. The immediate problem was to be able to satisfy the creditors, particularly those whose payments had extended out to 60 days and beyond. d) in relation to the $5.2 million held on deposit with Rothschild, Ms Stubbs requested: …it would be very helpful if RAL [Rothschild] released all or some of the $5.2 million which was in fact ARL's money, but was "locked up" by RAL in accordance with the agreement following the rights issue in October 1998. (e) to meet again on 15 March 1999. ii. Mr Swan, Ms Stubbs, Mr Goldner, Mr Ingham and Ms Young again met to consider the cash that was available to Arimco and the creditors that required urgent payment, for the purpose of selecting those creditors that would be paid from the limited cash available. 75 On 14 March 1999, and prior to any further meeting with Rothschild, a meeting of the ARL board of directors was held at the Sydney head office. Only Mr Roberts and Mr Swan were present. The minutes of the board meeting record that the resolutions that were passed at the meeting included the following: i. " That John Barry Roberts be elected to act as Chairperson of the meeting " (the meeting having been advised of the resignation of Mr Pearce as a director); ii. " That in the opinion of the directors, the Company is insolvent or is likely to become insolvent within the foreseeable future "; iii. "That the Company's affairs be put under control of an Administrator pursuant to Part 5.3A of the Corporations Law ; and iv. " That Martin John Green be appointed Administrator of the Company ". 76 On the same day, there was a meeting of the board of directors of Arimco, although again, only Mr Roberts and Mr Swan were present. The minutes of the board meeting record that the resolutions that were passed at the meeting included the following: i. " That John Barry Roberts be elected to act as Chairperson of the meeting " (the meeting having been advised of the resignation of Mr Pearce as a director); ii. " That in the opinion of the directors, the Company is insolvent or is likely to become insolvent within the foreseeable future "; iii. "That the Company's affairs be put under control of an Administrator pursuant to Part 5.3A of the Corporations Law" ; and iv. " That Martin John Green be appointed Administrator of the Company ". Appointment of receivers 77 The following day, on 15 March 1999, Rothschild appointed Andrew Love, Peter Geroff and John Trevor of Ferrier Hodgson as receivers and managers of Arimco. The receivers managed the charged assets of the company, and maintained possession of most of the ARL Group's books and records, up until their retirement on 19 December 2000. 78 On 6 February 2001 CGU informed the directors of ARL and Arimco that "CGU denies liability to provide any indemnity in respect of any such claim" under the D&O Policy by letters each dated 6 February 2001 to each of the directors. 79 On 7 July 2006, the proceedings pursued by Mr Green against the second to sixth defendants were settled for the sum of $15 million [the effect of the terms of settlement are dealt with in the reasons]. 80 Mr Green has not paid any dividends to the creditors of Arimco. The witnesses 81 A brief overview of witnesses called by the parties is appropriate. The approach taken is to introduce the witnesses in the order in which they were called and in some cases to note the executive summaries informing the extensive analyses provided in the voluminous reports [backed by extensive documentation]. Where appropriate some observations are made in the reasons concerning the reliability of particular witnesses. The Court does take into account the fact that where particular witnesses [whether as experts retained by a party or being persons such as the underwriters who were cross-examined], were instructed to make extensive assumptions as to particular matters, they would likely have been heavily influenced by the character of those assumptions in the giving of their opinions, even where large segments of their affidavits or reports were not read. As previously observed, the findings are based on the whole of the evidence and a commonsense approach to the acceptance or rejection of particular evidence is taken by the Court in terms of its evidentiary weight. The plaintiff's case in chief 82 The plaintiff in aid of its case in chief called: i. Mr Gibbons, a partner of Ernst and Young, who had specialised in the Corporate Recovery, Restructuring and Reorganisation area for over 30 years focusing upon insolvency matters. Mr Gibbons had been directed on behalf of the liquidator to prepare an independent expert's report to be used as evidence in these proceedings and specifically to prepare a report as to whether, at any time or times during the relevant period [1 January 1999 and 14 March 1999], Arimco was insolvent, and if so, when it was insolvent for the said period(s). In his executive summary he expressed the view that Arimco was unable to pay its debts as and when they fell due by 31 January 1999 and remained insolvent at all times after that date. That view was based on the following suggested objective criteria said to have existed at 31 January 1999: · Arimco was balance sheet insolvent; · Current liabilities exceeded current assets even allowing for potential cash advances of funds held by ARL; · Arimco had incurred a substantial loss in January 1999 [taking into account as facts assumed by the witness that this loss resulted from the effect of significant production problems at the mines caused by inclement weather and maintenance issues]; · Cash flow from operations turned negative, reflecting the poor trading month and pressure from creditors. Also in January 1999 Arimco was withholding payments due to creditors. While in November and December Arimco temporarily utilised funds raised by the rights issue, these funds were repaid. In January 1999 further rights issue funds were utilised again and they were unable to be repaid; · Arimco had no ability to raise funds in the short term either from its existing facilities or other sources. ii. Mr Goldner, a former exploration manager of the ARL Group from 1992 to 1999. He was initially employed as chief geologist of the group and from April 1997 onwards, he was employed by Arimco as exploration manager-East. His focus as exploration manager for the group was to identify and assess the viability of acquiring and mining sites in Australia and he was responsible for advising the group in relation to the mineral deposits at the Selwyn mine. He was also involved, usually as part of the team, in numerous assessments of potential exploration and mining project acquisition opportunities for Arimco. He regularly travelled to see the Selwyn mine in Queensland and on an as required basis, to various other locations to assess various acquisition opportunities. He also visited Western Australia five or six times a year where he attended upon Arimco's Western Australian mines and also visited other potential acquisition and exploration sites. He had a regular involvement and interaction with ARL Group's board of directors as a result of his employment being based at the Group's head office in Sydney. The defendant's case 83 The defendants called: i. Mr Dorfan, currently director, 'Corporate Finance-Valuations', of Deloitte Touche Tohmatsu. His experience had principally been gained in the areas of forensic accounting and in valuations. He had undertaken numerous assignments where he had been required to analyse accounting records and establish trends for the purpose of preparing and assessing insurance claims and quantifying damages and loss of profits claims in commercial litigation matters, including breach of contract, patent infringement, passing off of goods and defamation cases. He had been instructed to answer a number of questions under particular headings as follows: · Establish the financial position, capital structure and operations of the ARL Group as disclosed in the Annual Report as at 30 June 1998, which is dated 24 September 1998, and compare that to the financial position, capital structure and operations of the ARL Group as at: (a) 26 November 1998, during the date of the last minuted directors meeting of Arimco and (b) 31 December 1998, being the inception date of the Directors and Officer's Insurance Policy issued by CGU. · Whether there was subsequent information of a material nature (and the nature of that information) not disclosed in the Annual Report "that could affect the financial position, capital structure or operations" of ARL and Arimco as at 26 November 1998 or 31 December 1998; · Were the directors aware of that information in that it was contained in, or apparent from, facts or documents made available to: Executive Director level Board Level · If the directors were not aware of the information, was the information such that they should have been aware of it. His executive summary included the following : 3.2 The Annual Report setting out the financial position at 30 June 1998 accompanied the Proposal. 3.3 As at 26 November 1998, the Group had no reliable forecasts. It had made a loss of $707,000 between 1 July 1998 and 31 October 1998 against a budgeted profit of $551,000. The copper price had fallen to 12 year lows and the Group's copper hedging contracts had become inoperative. Excluding the proceeds from a rights issue totalling $11.226 million received on 23 September 1998 (Rights Issue Proceeds), the Group's cash resources had reduced by $3.034 million and the Group's net current assets had fallen to a negative $2.169 million, whereas they were positive at 30 June 1998. There was the potential for the Group to breach certain of its covenants with its financiers, Rothschild Australia (Rothschild). 3.4 The Group had been given further notice of a claim by Leighton Contractors Pty Ltd (Leighton) of overt $15 million. Leighton had contracted with ARL for a number of years to mine ore and waste at Mt McClure. 3.5 The copper price had fallen further in December 1998. The November financial result (reported in December 1998) was a loss of $1.037 million as against a budgeted profit of $1.014 million. Selwyn was losing about $500,000 a month and the carrying value of the Selwyn mine required reassessment in light of the falling copper price. The liquidity position of the Group deteriorated during December 1998. 3.6 The Group had forecast a profit of $1 million (at the earnings before interest and tax level) for the two month period of January and February 1999. On the basis of my analysis, the Group was likely to lose $3.2 million over this period. I have recast the January and February 1999 forecast to allow for the following: (i) An assumed reduction in the gold head grade at the Gidgee mine; and (ii) The Group's US dollar hedging position, which was relevant to copper production from the Selwyn mine. 3.7 Rothschild was in the process of reviewing the Group's facilities during October, November and December 1998. These facilities included an "overdraft facility" of $3.5 million, the Mt McClure facility of $5.2 million (which was secured by way of a deposit from the Rights Issue Proceeds of an equal amount) and a guarantee facility. Rothschild had also advanced the Group an amount of $4 million by way of convertible notes. The Rothschild Multi-Option Facility Agreement dated 24 April 1998 (MOFA) (refer paragraph 8.31), which governed the aforementioned advances set out certain covenants, which required a working capital ratio of a least 1:1, tangible net worth of $100 million, a Project Life Ratio (PLR) of more than 1.8 and a Loan Life Ratio (LLR) of more than 1.5. 3.8 With the fall in the copper price, the Group was faced with the possibility that it might be in breach of the above covenants. By the end of December 1998 the Group's current ratio had reduced below 1:1. The carrying value of Selwyn was reduced by $25 million in the Half Yearly Report to 31 December 1998 (Half Yearly Report). 3.9 Rothschild's view of the Group's mining operations is set out in its two faxes dated 9 November 1998 and 8 December 1998. The initial indications from the faxes were that the Rothschild review might be unfavourable. 3.10 In the fax of 9 November 1998, Mr Spencer of Rothschild raises a number of "technical issues" regarding the Group's mining operations. The fax states that Selwyn is possibly cash flow negative and would have little value in a conventional banking model. Mr Spencer concludes that "Australian Resources is a high cost producer with relatively short mine lives based on current reserves." 3.11 In the fax of 8 December 1998, Mr Spencer calculates a notional negative cash flow of $2,367,974 for Selwyn for the four months ended 31 October 1998, at the December 1998 copper price. The Group had limited alternatives available to it. If it sought to place Selwyn on 'care and maintenance', this would crystallise significant liabilities for the Group, including redundancy payments, foreign exchange hedging losses and the Glencore loan. 3.12 By the end of February 1999, the Rothschild review had not been completed because the Group had not provided the information that Rothschild required for the review, including the information relating to the underground mine at Cockburn Deeps (the Group had ceased mining operations at the Cockburn Underground in December 1998). The value of the McClure mine would be affected if it was no longer viable to mine the Cockburn Deeps. 3.13 In my opinion, there were no material sources of funding available to the Group that would have enabled it to obtain relief in the short to medium term from its impending liquidity crisis. Based on the faxes of 9 November 1998 and 8 December 1998, it appeared unlikely that Rothschild would have been willing to advance funds to the Group. The Group had limited other possibilities available to it to extract itself from its financial difficulties. 3.14 To summarise, in my opinion, by the end of December 1998, the financial position of the Group had deteriorated as a result of the following: (i) The copper price had fallen from the levels achieved in the 1998 financial year and this was affecting the viability of the Selwyn mine. The Group's copper hedges had become inoperative. (ii) The Group had incurred operating losses in the five months from July to November 1998. (iii) The carrying value of the mines required reassessment. It was likely that there would be a substantial write down required of the Selwyn mine. 3.15 In addition, I note the following other factors with regard to the Group's financial position, capital structure and operations: (i) The Group had no reliable forecasts available to it as there had been significant changes at each of the mines. (ii) The Group was experiencing liquidity problems and had been required to access the Rights Issue Proceeds (which had been raised for exploration purposes) to pay trade creditors. (iii) ARL's financiers were reviewing the Group's facilities and if the review was unfavourable, the Group would be required to begin repaying those facilities, which would place further pressure on liquidity. (iv) ARL had been given additional notice of a claim of over $15 million by Leighton, which constituted a material contingent liability. 3.16 In my opinion the factors outlined above were of a material nature, had not been disclosed in the Annual Report and could affect the financial position, capital structure or operations of the Group. ii. Mr Robinson, who is an engineering company director and whose specialisation is in engineering in the mining industry. He had been asked to express his opinion whether significant events occurred before 31 December 1998 which were not disclosed in the ARL Annual Report attached to the insurance proposal form, which could have affected the "financial position or operation" of the ARL Group. In particular, he had been asked whether the significant events fall within the wording of Question 10 of the insurance proposal form which asks whether there was " information of a material nature that could affect the financial position, capital structure or operations" of the ARL Group. His report addresses the changes in the financial position and mining operations of ARL and the information that was made available to the Directors in the time period July to December 1998, relevant to these changes. The overview of his executive summary included the following : a) Several statements and some of the information the ARL Annual Report for year ended June 1998 [ Ref: Ernst & Young Report by Mr Gibbons dated February 2007 (Gibbons tab 1) ] had by 31 December 1998 ceased to be a fair and accurate description of ARL's financial position or plans. These statements described: a. The financial position of ARL; b. The operations at and plans for the mines and exploration Projects; c. The reserves and longevity of the mines; d. That there were grounds to believe the ARL Group would continue to trade profitably. b) By November 1998 there had been significant changes in the prospects, plans, areas mined, profitability and reserves estimations at each of the mines, which impacted negatively on ARL's financial position, profitability and mine longevity position, such that the position by November, and even more so by December, had deteriorated considerably compared to the picture presented by the ARL 1998 Annual Report ('Annual Report'). c) The ARL Board was aware in November 1998 of significant adverse changes in the mining operation, significant falls in the copper price, the unreliability of the ARL financial forecast, and the need for revised site forecasts to incorporate the effect of the changed nature of the operations and future plans for each of the mines. Future plans for the Mt McClure Gold Mine ('McClure'), ARL's largest mine, were uncertain and unsupported by a feasibility study. … g) ARL's major financier, RL Rothschild Australia Pty Ltd ('Rothschild'), was conducting an annual review of ARL's mines and the indications were that the outcome would be negative. ARL did not have available, and was unable to prepare, life of mine plans which reflected the changed nature of the operations and future planning. These plans had been requested by Rothschild in order to finalise its review. Other technical information requested by Rothschild was unable to be provided. Rothschild had conducted a detailed analysis showing that the life of the mines was short and that the Selwyn Mine ('Selwyn ' ) was incurring substantial losses each month due to the fall in the copper price. h) ARL was not generating cashflow for necessary exploration to extend the life of the mines or to pay its trade creditors. i) Reported results had led to significant downward revisions of reserves at McClure and at Selwyn, ARL's two largest mines. These affected the two underground mining operations that were specifically mentioned in the Annual Report as having high grade gold ore and potential for development/expansion respectively. iii. Mrs Cuthbert was, in November and December 1998, the Directors and Officers Insurance Manager for New South Wales for the company which became CGU. She was the underwriter who considered the proposal for renewal which she discussed with the National Directors and Officers Underwriting Manager, Mr Acance, to seek his approval to quote the renewal. She had reported to Mr Acance on underwriting matters. iv. Mr Acance, who was in 1998 the National Underwriting Manager-Directors and Officers, and also the Southern Region Manager, in the Professional Risks Insurance division of the company which became CGU. He was a fellow of the Australian Insurance Institute who had in 1998 joined American Home Insurance, working in professional indemnity insurance in Australia as an underwriter. Since that time he had worked in Australia in the professional indemnity insurance market. In April 1989 he commenced employment as an underwriter in the areas of professional indemnity and directors and officers liability with Pacific Indemnity Underwriting Agency a joint venture of QBE insurance Australia and Commercial Union Assurance. In July 1996 he became the National Underwriting Manager-Directors and officers, and concurrently Southern Region Manager in the Professional Risks Insurance Division of Commercial Union Assurance. In February 2000 he became the manager of CGU's Professional Risks Division and remained the National Underwriting Manager-Directors and Officers, until November 2001. The plaintiff's case in reply 84 The plaintiff called the following witnesses in its case in reply: i. Mr Roberts, who had joined the ARL group as chairman in July 1993 and who had remained a director after Mr Pearce took over as chairman of ARL in 1997. Mr Roberts became a director of Arimco on 4 March 1999. He had attended board meetings of AOL and was also a member of the ARL audit committee; ii. Mr Ryan, who had joined the ARL group in late 1992 and in January 1997 was appointed managing director of ARL, holding that position until he left the group in February 1999. He was director of Arimco during the same period. From late December 1998 he was advised that he was to be replaced as managing director of ARL and his services were to be terminated. Hence all decisions of any significance after late December were made by Mr Pearce, the chairman; iii. Mr Swan, who from 1991 to 1999 was employed as the chief mining engineer for Arimco and was responsible from the operations and production at Arimco's mines. He became a director of Arimco in September 1991 and a director of the ultimate holding company, ARL, in June 1993. 85 In passing I note that it has not been necessary formally to list the affidavit evidence of witnesses not required for cross examination. Naturally all of the evidence is taken into account in the reasons which follow. Dealing with the disclosure and misrepresentation issue The material provisions of the Insurance Contracts Act 86 The non-disclosure and misrepresentation issue accounted for the vast bulk of the factual evidence mobilised by both parties. 87 It seems convenient at this early stage in these reasons to make some reference to the relevant provisions of the Insurance Contracts Act which inform the non-disclosure/misrepresentation cases. Section 21 88 By section 21 of the Insurance Contracts Act, the directors were obliged to disclose to CGU: 1. …"every matter that is known to (the directors), being a matter that: (a) (the directors know) to be a matter relevant to the decision of the insurer whether to accept the risk and, if so, on what terms; or (b) a reasonable person in the circumstances could be expected to know to be a matter so relevant." 89 Section 21(2) provides that the directors were not required to disclose matters: (a) that diminish the risk; (b) which are common knowledge; (c) which are known to the insurer in the ordinary course of business, or which the insurer ought to know; or (d) as to which the insurer has waived the duty of disclosure. Section 28 90 To the extent that the directors failed to comply with the above-described obligation, or misrepresentations were made to CGU before the contract of insurance was entered into, section 28 operates to reduce the liability of CGU to the amount that would place it in the position that it would have been in had the directors complied with their obligations of disclosure, or the representations not been made. The multi-stage process 91 It is of assistance to thumbnail sketch the multi-stage process in terms of the questions to be asked in respect of the factors of significance identified by CGU as having had to be disclosed. The questions which arise in relation to each of those factors may be put as follows: (a) did the directors know of the matter? (b) if so, did the directors know that the issue was a matter relevant to the decision of the insurer whether to accept the risk and if so on what terms? (c) if they did not, would a reasonable person in these circumstances be expected to know the issue was so relevant? (d) if either (b) or (c) apply, was the company excused from the need to disclose on the basis of the matters in section 21(2)? (e) even if the matters ought to have been disclosed or there had been a misrepresentation, would the insurer have issued the policy in the way it did in any event? (f) if it would not, what is the liability of the insurer under section 28(3)? An analysis of the legislative history and judicial application of ss 21 and 28 92 Sections 21 and 28 of the Act were enacted following an Australian Law Reform Commission, Report No. 20, 1982 on Insurance Contracts. 93 A convenient summary of the legislative history is contained in the judgment of McHugh, Kirby and Callinan JJ in Permanent Trustee Australia Limited v FAI General Insurance Company Limited (in liquidation) (2003) 214 CLR 514 at 527-529: The applicable provisions of the Insurance Contracts Act : [23] The Act was enacted as ameliorative legislation following a report on insurance contracts by the Australian Law Reform Commission in 1982 in which the Commission said: "The duty should itself extend to facts which the insured knew, or which a reasonable person in the insured's circumstances would have known, to be relevant to the insured's assessment of the risk. " [24] The Second Reading Speech of the Insurance Contracts Bill contained this : "At common law an insurer may avoid a contract whenever the insured fails to disclose, whether innocently or fraudulently, a fact which is material to assessing the risk and which is known to the insured ... Clause 21 both clarifies and ameliorates the existing law. It clearly states that the insured's duty is only to disclose those facts which he knew, or which a reasonable person in the circumstances could be expected to have known, to be relevant to the insurer's assessment of the risk." [25] And pars 59-62 (Pt IV — Disclosures and Misrepresentations) of the Explanatory Memorandum to the Insurance Contracts Bill were as follows : "59. Present Law — An insured is required to disclose to the insurer all material facts relating to the insurance he proposes to effect and which are material to the insurer's assessment of the risk he is incurring or as to the premium he should charge. At common law, some lines of authority support the proposition that the insured's obligation is to disclose every material fact known to him and which a reasonable man would realise to be material. Other authorities, and particularly more recent Australian cases have rejected this approach in favour of the `prudent insurer' test i.e. a fact is material if it would have reasonably affected the mind of a prudent insurer in determining whether it will accept the insurance, and if so, at what premium and on what conditions. 60. The duty exists before the contract is entered into and continues until the contract is concluded. If an insured fails to do so, the insurer may, on discovering the full facts, elect to avoid the contract of insurance ab initio and he may do so whether or not any loss has occurred. An insured need not disclose facts: (1) which are known, or presumed to be known, to the insurer; (2) which are of common knowledge; (3) which tend to diminish the risk; (4) which are covered by or dispensed with by a warranty or condition; or (5) as to which the insurer has waived the requirement. 61. Proposed Law — An insured will have, before the contract is entered into, a duty to disclose to the insurer all material facts of which he is aware. His duty will be to disclose those facts which he knows or which a reasonable person in the circumstances could be expected to know would be relevant to the insurer in his decision to accept the risk and, if so, on what terms (clause 21(1)). The insured is not required to disclose matter (1) that diminishes the risk; (2) of common knowledge; (3) that the insurer knows or in the ordinary course of his business as an insurer ought to know; or (4) as to which compliance with the duty of disclosure is waived by the insurer. An insurer will be deemed to have waived compliance if, in response to a question in a proposal form, the insured failed to answer the question or gave an obviously incomplete or irrelevant answer to it. (clauses 21(2) and 21(3)) 62. Rationale — Clause 21 clarifies the existing law by specifying the test of materiality. It also ameliorates the existing law, particularly in so far as the `prudent insurer' test has been applied, for this test takes no account of the insured's circumstances or the circumstances in which the contract of insurance is negotiated. Clause 21 mitigates the application of the duty by providing that the insured's duty is only to disclose those facts which he knew or a reasonable person in the circumstances would have known to be relevant to the insurer's assessment of the risk. As an examination of what a reasonable man would know cannot take place in a vacuum, a court would not be precluded from considering an insured's position and circumstances in applying the test. Clause 21 also clarifies the circumstances in which an insurer will be deemed to have waived compliance with the duty." (Emphasis in original.) 94 Prior to the enactment of the Insurance Contracts Act, the common law test was that of the "prudent insurer". That approach is exemplified in cases such as Mayne Nickless Ltd v Pegler [1974] 1 NSWLR 228. 95 In the years following the enactment of the Insurance Contracts Act there was some uncertainty as to whether the "prudent insurer" test was to be incorporated into section 21: see Toikan International Insurance Broking Pty Ltd v Plasteel Windows Australia Pty Ltd (1989) 15 NSWLR 641 at 649; Ayoub v Lombard Insurance Co (Aust) Pty Ltd (1989) 5 ANZ Ins Cases 60-933; Twenty-First Maylux Pty Ltd v Mercantile Mutual Insurance (Australia) Ltd [1990] VR 919 at 923.35-50. 96 The position was clarified by the New South Wales Court of Appeal in Permanent Trustee Australia Co Ltd v FAI General Insurance Co Ltd [2001] 50 NSWLR 679. The leading judgment was delivered by Handley JA (with whom Meagher and Powell JJA agreed). 97 At 686-687 his Honour stated: "31 A further consideration which makes the previous law irrelevant for present purposes is that s 21(1) (a) refers to "the insurer". The test of materiality under the previous law was whether the fact would reasonably have affected the mind of a prudent insurer: see Barclay Holdings (Australia) Pty Ltd v British National Insurance Co Ltd (1987) 8 NSWLR 514 at 516, 522, 526 which approved that test as formulated by Samuels J in Mayne Nickless Ltd v Pegler [1974] 1 NSWLR 228 at 239. 32 Section 21(1) (a) substituted a test of relevance, contains no express requirement of reasonableness, and refers to "the insurer", not "a prudent insurer". 33 The construction of the section is not free from authority. In Toikan International Insurance Broking Pty Ltd v Plasteel Windows Australia Pty Limited (1989) 15 NSWLR 641 at 649, Samuels JA, in a statement that was not necessary for the decision, said that the test of "materiality" (sic) was still that of "a prudent insurer" as formulated in Mayne Nickless Ltd v Pegler . 34 In Ayoub v Lombard Insurance Co (Aust) Pty Ltd (1989) 97 FLR 284 at 296 , Rogers CJ Comm D followed this dictum although it had been questioned by commentators and the defendant had submitted it was incorrect. 35 In Twenty-First Maylux Pty Ltd v Mercantile Mutual Insurance (Australia) Ltd [1990] VR 919 at 923, Brooking J referred to Ayoub but concluded that the hypothetical prudent insurer had been banished by s 21(1) which confined attention to the particular insurer concerned. In Macquarie Bank Ltd v National Mutual Life Association of Australia Ltd (1996) 40 NSWLR 543 at 612-614, Powell JA, who wrote for the Court on this question, endorsed the view of Brooking J, and this Court reaffirmed that view in Commercial Union Assurance Co of Australia Ltd v Beard (1999) 47 NSWLR 735 at 745-746. 36 In my judgment s 21(1) (a) leaves no room for the continued operation of the previous test of materiality. The changes are too many and too substantial to allow this, and they must have been deliberate. The section appears in a code and it is not possible to construe it as codifying the previous law. It follows, in my judgment, that the appellants' submission that the relevant matter did not have to be disclosed fails." 98 Although the decision of the New South Wales Court of Appeal was overturned by the High Court in Permanent Trustee supra, the approach set out above in the judgment of Handley JA was not overturned. Although the majority of the High Court (McHugh, Kirby and Callinan JJ) did not in express terms adopt what was said by Handley JA as set out above, it was nevertheless implicit in their judgment that it is the decision of the particular insurer that is relevant (see e.g. pars. [23]- [25] [extracted above]). That circumstance has now been affirmed by the recent decision of the High Court in CGU Insurance Limited v Porthouse ([2008] HCA 30, 30 July 2008), which is referred to below. 99 Returning to Permanent Trustee, the majority [McHugh, Kirby and Callinan JJ] said [at 30-33]: [30] The first matter to notice about s 21(1)(a) is that "every matter that is known to the insured" is qualified by the expression "being a matter that the insured knows …". The word "knows" is a strong word. It means considerably more than "believes" or "suspects" or even "strongly suspects" . And the matter, to answer the description that para (a) of the subsection states, must be a matter that is not only "relevant to the decision of the insurer whether to accept the risk, and if so, on what terms", but also one that the insured knows to be such a matter . The alternative for which para (b) of the subsection provides, is also important: if the insured does not "know", the question becomes, whether a "reasonable person in the circumstances" would "know [the matter] to be a matter so relevant" . It is also noteworthy, particularly if it should become necessary to deal with the other grounds of appeal, that the knowledge of which the subsection speaks, either actual or constructive, is the knowledge of the insured, and not of any insurance intermediary, a term defined by the Act and clearly embracing an agent of the kind that Sedgwick was. This is at least to suggest that the reference to the insured is intended to be a reference to the insured personally and not to its agent or broker. However, it is not essential to our reasons to determine this point… [32] It is right in our opinion to concentrate on the language of the Act and to derive its intended meaning and operation from that language. Approaching the issue for decision in that way, it is significant that the Act uses the words "accept the risk" in s 21(1)(a) and not a phrase such as "to enter into the contract of insurance" or, "to renew a contract of insurance" the former of which is in substance used in the introductory words to the section. The words, "accept the risk" are key words. The second reading speech and the explanatory memorandum make it clear that they were deliberately chosen. The words may have a long settled meaning at common law. That does not however mean that the Act was an enactment of it. The common law was generally concerned with materiality. This Act is concerned with relevance. Another indication that the decision, whether the matter should be disclosed, is a decision about the relevant risk, rather than, for convenience, what we will call the "commerciality" of the contract of insurance, is given by the reference in s 21(2) of the Act to the "disclosure … that diminishes the risk". The focus of attention is upon the risk , ie the particular insurance hazard . It is not, as such, upon the much broader question of the commercial willingness of the insurer to accept the risk, still less emotional or individual reactions to that question. Assessment of the risk , ie the insurance hazard, is susceptible to objective ascertainment. Assessment of other considerations including commercial and emotional responses, would ordinarily be much less readily ascertained on retrospective assessment. We do not consider that there is any particular difficulty in keeping these concepts separate as the language of the Act requires. The Act focuses on the particular risk of the insurance propounded. The alternative hypothesis opens a Pandora's box involving a large range of other considerations, such as are illustrated by the facts of the present case. 100 The section 21 test for disclosure was described by the High Court in CGU Insurance Limited v Porthouse [supra] in the following terms: "[52] The statutory test for disclosure now to be found in s 21 of the Insurance Contracts Act focuses on the "reasonable insured", not the "prudent insurer", and operates, first, by reference to the actual knowledge of the insured (s 21(1)(a)), and secondly, by reference to what "a reasonable person in the circumstances could be expected to know" (s 21(1)(b)). That latter statutory phrase has been interpreted as meaning that one should take into account only factors which are "extrinsic" to the insured, such as the circumstances in which the policy was entered into, rather than "intrinsic" factors such as the individual idiosyncrasies of the insured[27]. Whilst it is possible to take into account the circumstances of the insured, the ultimate question under s 21(1)(b) turns on consideration of a reasonable person's state of mind, not the insured's state of mind[28]. [53] A test of disclosure, which operates by reference to both the insured's actual knowledge and the knowledge of a reasonable person in the same circumstances, is calculated to balance the insured's duty to disclose and the insurer's right to information. The insurer is protected against claims where the insured's disclosure is inadequate because the insured is unreasonable, idiosyncratic or obtuse and the insured is protected from exclusion from cover, provided he or she does not fall below the standard of a reasonable person in the same position." 101 Thus, in applying sections 21 and 28, the focus is upon the particular insurer, not the "prudent insurer", and it is the decision making process of the particular underwriters which is under consideration. 102 Returning to parameters of section 21, notably Hodgson J [then CJ Equity Div] in Permanent Trustee Australia Ltd v FAI General Insurance Co Ltd (1998) 153 ALR 529 had observed inter alia as follows: i. that 'known' in section 21 (1) of the Act means more than suspected or believed : what is required is that the matter should be the subject of a true belief, held with sufficient assurance to justify the term "known"; ii. that a belief may, however, sometimes itself be a matter relevant to the decision of an insurer as an insured may know that it has a particular belief, and know that it's having that belief is relevant to the decision of an insurer, in which case that belief itself is a matter which must be disclosed: [at 582-583]; iii. that section 21 (1) required disclosure of every matter known to the insured [or to a reasonable person] 'to be a matter relevant' to the insurer's decision but did not require disclosure of every matter which, if volunteered, would be known to be relevant to the insurer's decision : Tate & Sons v Hyslop (1885) 15 QBD 368; cf Guthrie House Ltd v Cornhill Insurance Co Ltd (1982) 2 ANZ Ins Cas 60-466; iv. that the 'insurer' in section 21 meant the particular insurer; which insurer may have idiosyncrasies, and may be different in various ways from the hypothetical reasonable insurer : but the possibility of an untoward effect from these considerations was to some extent avoided by the requirement that either the insured know that the matter was relevant , or that a reasonable person in the circumstances could be expected to know that it was relevant : [at 584]. [This formulation was approved both on appeal by the New South Wales Court of Appeal in FAI and again in GIO General Ltd v Wallace (2001) 11 ANZ Ins Cas 61-506 In Wallace , Heydon JA [with whose reasons Priestley JA agreed] cited with approval [at 15] the following passage from the decision of Hodgson CJ in FAI General Insurance : "Known" in section 21 (1) means more than suspected or believed. What is required is that the matter should be the subject of a true belief, held with sufficient assurance to justify the term "known". When the trial judge contrasted "actual knowledge" with "suspicion or belief", he was doing no more than applying the test which was correctly formulated by Hodgson CJ in Eq and which was approved by this Court on appeal: Permanent Trustee v FAI (supra)] Summary of findings 103 Before commencing a detailed analysis of the evidence, it is useful to set out an overview of the respective submissions, and a summary of the findings made by the Court on these issues. A thumbnail sketch of the alternative approaches taken by the parties 104 A thumbnail sketch of the alternative approaches taken by the parties could be put as follows: i. CGU has carefully and exhaustively subjected the affairs of Arimco over a somewhat extended period [but especially the period from the middle of 1998 to the end of December 1998] to a microscopic examination in the attempt to establish that by the date when the proposal was put forward, the situation faced by Arimco was so far different from that reflected in the 1998 accounts that a number of significant matters, clearly requiring to be disclosed to CGU, were not disclosed; ii. The liquidator has contended that Arimco had been in operation successfully for an extended period and had suffered from ups and downs on a number of occasions, so that there was no particular reason why any of the problems which it faced between the middle of 1998 and the end of December 1998 would have raised any form of alarm bells in the minds of the directors [or to be more precise, constituted matters known to the directors, being matters that either: a) the directors knew to be matters relevant to the decision of the insurer whether to accept the risk and, if so, on what terms; or b) a reasonable person in the circumstances could be expected to know to be matters so relevant.] Hence the liquidator's proposition that neither limb of the section 21 test was breached. The findings which are to follow in these reasons 105 For all the elaborate detail which the four-week hearing covered, the central finding is that the insured represented to CGU in December 1998 that the description of the company's position at 30 June 1998, to be found in the Annual Report, fairly reflected its position in December 1998. This representation was made in the following ways: i. by the provision of the Annual Report with the proposal without making any further disclosures; and ii. by the negative answer to question 10 which involved an enquiry as to whether there was any subsequent matter affecting the financial position or operation of the company which needed to be disclosed. 106 The finding is that the Annual Report did not reflect the company's position in December 1998 as: i. there had been significant adverse changes to each of the operations with respect to the three mines which comprised the only business operations of the company; ii. these changes had been reflected in the company's overall position and performance and in particular by the incurring of losses on income account, by the negative cash flow that had been incurred and by the position as revealed in the balance sheet. 107 Additionally another major difference between the position disclosed in the Annual Report and the actual position in December 1998 involved the position which had been taken by Rothschild and which is closely examined in the reasons below: in essence and as put by Mr McFarlane QC appearing for CGU: "[T]here was a sword of Damacles in effect hanging over the company's head in that it had $8.2 million in debt which was due to be paid to its banker, Rothschild, in the next calendar year. ARL couldn't pay that debt and still operate in the same fashion it had been operating. An extension was in the complete discretion of Rothschild but Rothschild was conducting a detailed review and had already expressed strongly negative views about the company's operations and assets". 108 In short, the findings in relation to the above matters reflected in the reasons which follow mandate CGU's entitlement to reduce its liability under the policy to nil: it has proven its case of non-disclosure and misrepresentation by the company and its directors. The finding is that, had a proper disclosure been made to CGU, it would have written a policy but included the insolvency exclusion, which in the circumstances of these proceedings would have absolved it from any liability under the policy. 109 This result flows inexorably from a comparison between: i. on the one hand, the information furnished to CGU in terms of the 1998 Annual Report for the ARL/ Arimco group; and ii. on the other hand, the different position which was faced by the ARL Group/ Arimco by the time the application for renewal of insurance was made in mid December 1998. 110 As the reasons which follow make clear, certainly the insured failed to disclose to the insurer matters required to be disclosed in terms of the section 21 (1) (b) test: i.e. matters known to the directors which a reasonable person in the circumstances would have known to be matters relevant to the decision of the insurer whether to accept the risk and if so on what terms. 111 In my view the evidence also mandates a finding that the insured breached the section 21 (1) (a) test: by failing to disclose every matter known to the insured being a matter that the insured knew to be a matter relevant to the decision of the insurer whether to accept the risk, and if so, on what terms. 112 It is pertinent to note that CGU also heavily relied upon a suggested additional sword of Damacles said to have been hanging over the company in terms of the $15,000,000 claim from Leighton. Arimco contends that had this issue been disclosed CGU would simply have included its standard specific exclusion. CGU contends that the insolvency exclusion would have been included. That matter receives attention in the reasons which follow. 113 Naturally the reasons which follow will treat in some detail with the evolution of the changed position in terms of the several problem areas which had arisen. Centrally there were a variety of matters known to the directors during the last few months of the calendar year 1998 which satisfied the description "matters which the directors knew to be matters relevant to the decision of the insurer whether to accept the risk and, if so, on what terms". So much already appears from the executive summaries of those of the reports earlier set out. What was disclosed to CGU? 114 An unsigned proposal was provided to CGU on or about 14 November 1998, accompanied by a copy of ARL's Annual Report for the year ended 30 June 1998. A signed proposal form was provided on or about 15 December 1998. 115 The Annual Report supplied to CGU had been adopted by the ARL board of directors on 24 September 1998. It contained inter alia the following information: i. it declared that the ARL Group achieved an operating profit after tax and abnormals of $3.59 million (compared to a loss of $19.55 million for the previous year) from operating revenue of $152 million (compared to $152.7 million for the previous year); ii. it foreshadowed growth in the coming year; iii. it contained a "Statement by Directors" which was signed by Mr Pearce and Mr Ryan and which said, inter alia: 1. In the opinion of the Directors of Australian Resources Limited: … (c) at the date of this statement [24 September 1998], there are reasonable grounds to believe that the Company will be able to pay its debts as and when they fall due; iv. under the heading " Post Balance Date Events ", it stated that, according to the auditors: There have been no matters or circumstances that have arisen since the end of the financial year that have significantly affected or may affect the operations of the economic entity, the results of those operations or the state of affairs of the economic entity in subsequent financial years, other than: a) the Rights Issue, which raised $11.226 million; and b) the commencement of the Company Law Review Act 1998 as a result of which ARL's share premium reserve of $37.340 million was transferred to ARL's share capital account, thereby increasing the share capital to $82.244 million. 116 Question 10 of the insurance proposal form provided: "Q. Is there any subsequent information of a material nature not disclosed in the attached financial statements…that could affect the financial position, capital structure or operation of the Corporation?" 117 It was answered: "A. No." What additional matters were known to the directors in December 1998? 118 As noted above, it is the knowledge of the directors, and not their suspicion or belief, which is significant [except in so far as the directors may know that they have a particular suspicion or belief, which in itself may be a matter needing to be disclosed]. The facts which are relevant are those facts which were known to the particular directors at the material time. It is not necessary to consider matters which the directors were unaware of at the time, but which can now, with the benefit of hindsight or more detailed analysis, be seen to have affected the company in the months prior to December 1998. The means by which the directors became aware of financial and operational matters 119 Because of the significance of determining what precisely was known to the directors in December 1998, considerable time was spent on identifying the documents which were available to the directors, and the various meetings which took place prior to this date. These details are set out as follows: i. Each of the Mt McClure, Gidgee and Selwyn mines produced weekly reports of their respective operations and production. The reports were usually produced by the mine managers of the respective mines and forwarded to the Sydney head office on a Friday. The production data in those three reports was consolidated into a one page report (weekly production results) which was generally made available the following Monday at weekly meetings attended from time to time by Mr Swan, Mr Ryan, Ms Stubbs and several senior officers, including Mr Peter Goldner (Manager Exploration (East)), Mr David Otterman (Manager Exploration (West)) and Mr Peter Ingham (Manager Engineering). From those meetings, either a document described as a "summary management report", or minutes of the meeting [similar in form and content to the summary management reports], would be created and circulated to the directors approximately one week after the meeting. These reports contained a summary of production of gold and copper and exploration at the mines, in addition to comments on cash flow and borrowings. ii. The persons who attended the weekly management meetings also produced the Internal Monthly Reports which were made available to the directors at their board meetings. iii. In addition, the persons who attended the weekly management meetings also prepared the Quarterly Reports, which reports were issued to the ASX some three to five weeks after the end of the quarter. Management Accounts, sales and cash flow iv. Management accounts and cash flow forecasts were prepared by the ARL Group's finance and accounts team in Sydney of which Ms Stubbs was the CFO and Ms Sheryll Young was the ARL Group Finance Manager. v. Each of the mines were required to report to head office regarding their accounts payable and cash was allocated to the mines by the head office to pay creditors. In addition, the mines would provide monthly draft trial balances which were used, together with sales information, in the preparation of the monthly management accounts. The management accounts were prepared on a consolidated basis, but also identified the financial position of each company, including Arimco. vi. In addition to having access to the reports and attending meetings as discussed above, there was also evidence that the directors regularly communicated with each other outside board meetings. Findings as to the knowledge of the directors 120 In final submissions, the liquidator made various admissions regarding matters which were known to the directors in December 1998. In other areas, the knowledge of the directors was contested. Taking the totality of the evidence into account, the finding is that the directors were aware, in December 1998, of the great majority of the matters finally alleged by CGU. Given the, at times, infelicitous drafting and degree of overlap and repetition contained within the various alleged 'matters', it is inconvenient to deal with each of the various allegations in detail, however the finding is that at least the following key matters were known to the directors in December 1998: i. There had been 'significant changes' at a number of the mines, including: a) The Cockburn Deeps project at Mt McClure mine, which had been highlighted in the Annual Report, had been suspended. b) The main alternative being considered, Cockburn Open Pit Cutback Stage 3, would be likely to produce lower grade ore, and would not come into significant production until about July 1999, causing production at Mt McClure prior to July 1999 to drop significantly. c) Reserves at Mt McClure had fallen by over 50% from the figure quoted in the Annual Report to the figure available to the directors in November. d) Grades at the 276 mine at Selwyn mine had been falling since October and were well below budget. e) As a result of the performance of the 276 mine, there would have to be a significant reduction in the ore reserves of the 276 mine in future [cf: Roberts T605.37]. f) By the end of October 1998, Selwyn mine was in a significant loss making and negative cash flow position, with losses having most likely increased in November and December due to the falling copper price. g) The head grade being achieved at Gidgee mine was significantly below budget and the mine was below forecast. h) Gidgee mine would be exhausted by about mid-1999 and would need to be closed at substantial cost. ii. As a result of these changes, the financial forecasts available to the directors were no longer accurate and required revision. iii. The changes to the Group's financial position included: a) Cash resources reduced by $3.034 million between 1 July 1998 and 31 October 1998 (excluding the rights issue funds); b) Net current assets (excluding the rights issue proceeds) had fallen from a positive at 30 June 1998 to negative $2.169 million; c) The Group's operations were behind budget and had gone from profit to loss making. Specifically, they made a cumulative loss of $707,000 between 1 July 1998 and 31 October 1998 against a budgeted profit of $551,000, and a loss of $1.037 million in November 1998 against a budgeted profit of $1.014 million; d) The Group was facing severe liquidity problems towards the end of 1998; e) At 30 June 1998, there had been a positive working capital (surplus of current assets over current liabilities) of $3.865 million. The 31 October 1998 balance sheet in the November Board papers showed a much-reduced working capital of $125,000. This included the rights issue funds, which were devoted to the specific exploration drilling projects identified in the prospectus, and not available as general working capital. Mr Ryan accepted that there was in these circumstances effectively a negative working capital of at least $7 million. f) ARL was beyond extended payment terms for some of its creditors and was holding back cheques each month. g) ARL's copper hedging contracts had become inoperative because of a substantial fall in copper prices. iv. Mr Roberts, at least, was aware in November and December 1998 that, to his mind, it was inevitable that the rights issue funds would have to be used, at least to some extent, to pay creditors. [I note that the evidence showed that rights issue funds had, in fact, already been used to pay general creditors prior to the end of December 1998, however it was not established that the directors had knowledge of this fact before February 1999] v. The Group had been given notice of a claim in the region of $13 million to $15 million by Leighton. vi. The Group's financier, Rothschild, was in the process of conducting a thorough review of the mines, and was under no obligation to extend the facilities, which included debts of some $8.2 million, which were due in the following financial year. Were these matters known to the directors, or a reasonable person in the circumstances, to be relevant to CGU's decision to accept the risk, and if so, on what terms? 121 As CGU contended, the financial soundness of the subject company and its ability to continue to operate satisfactorily during at least the period of insurance was a matter of fundamental importance to the grant of insurance. This is a matter of commonsense and is confirmed by the evidence: i. The evidence of Mr Acance and Mrs Cuthbert demonstrates this, as do the blackboard notes which Mrs Cuthbert brought into existence in December 1998 and the Underwriting Manual of CGU at CB1/23 especially at 37-40. ii. Question 10 and the final page of the Proposal Form requiring the provision of financial accounts and disclosure of any subsequent matter affecting the financial position or "operation" of the company are to the same effect. iii. Each of the director witnesses similarly recognised this to be the case: · Roberts at T567.16-568.6; · Ryan at T670.7-22; 732.47-733.17; · Swan at T752.6-31; 752.51-753.1; 808.8-49. The relevant of the 'significant changes' at the 3 mines 122 Of course ARL Group's only business operations comprised its operations at the three mines. Hence a proper understanding of the position of the three mining operations at the time of inception of the insurance was fundamental to the Insurer's understanding of the position of ARL. 123 That the 'significant changes' to the mines were relevant to CGU's decision is demonstrated by the following: The suspension of the Cockburn Deeps Project i. Mt McClure had for some years been ARL's largest producer. The Cockburn Deeps project, together with an identified one at Gidgee, had been the most highlighted project in the Annual Report. The Report stated that production from this project was anticipated to commence early in 1999. It was budgeted to be far and away the biggest contributor to production at Mt McClure in the first half of 1999 and was to produce more than half of the total production for Mt McClure for that period. ii. A possible replacement (Stage 3 of the Cockburn Open Pit Mine) was under consideration in December 1998 but only recently it had been assessed by ARL as uneconomic at current gold prices and examination of it was incomplete. Even if shown to be economic, the project would have required a capital investment of $5m. Further, the project would not become cashflow positive for a year after its commencement. The declining circumstances at Selwyn mine i. By the end of October 1998, Selwyn was in a significant loss making and negative cash flow position, with losses likely to increase as the copper price fell, as it did, after the end of October. ii. The falling copper price had impacted adversely on Selwyn's copper operations as ARL's copper price hedges had become inoperative and it was locked into an unfavourable US$ exchange rate. iii. The Selwyn gold production operations were also in difficulty because the Starra 276 mine, which was budgeted to produce about 50% of Selwyn's gold production and about 25% of its copper production for 1998-9, had continuing problems. The poor gold grades which gave rise to the concern led to the downgrading of Starra 276 reserves by about 50% as at 31 December 1998. While the directors could not have known about this revision at the relevant time, they expected in December that it would have to occur. Problems at Gidgee mine i. Similarly, Gidgee's operations were in trouble, with the Omega mine having had to close early and severe grade problems being experienced. Mr Swan acknowledged that in November and December 1998 he was very concerned about the performance of Gidgee. Based on current reserves, Gidgee had a mine life of only 12 months or less as at early November 1998. 124 In the result, the evidence established that the position of the mines in November and December 1998 stood in marked contrast to the robust picture of them presented in the Annual Report. As the effective operation of the mines was key to the financial soundness of the company and its capacity to continue operating through the term of the insurance, the finding is that the matters relating to the mine were matters which a reasonable person in the circumstances could have been expected to know to be relevant to the insurer's decision to accept the risk. The financial situation 125 Unsurprisingly these adverse positions at the mines were reflected in the overall financial position of ARL. 126 The liquidator's case is that there was nothing particular about the events of July to December 1998 that put the company into any different position financially from the one it had been in at other times during its history. There was therefore, on his case, nothing to put the directors on notice of any material matter that might affect the profitability of the company, and therefore require to be disclosed to the insurer. 127 As noted by CGU, there is a fundamental tension between this claim and the liquidator's proposition that by 1 February 1999, only one month after the insurance came into effect, the company was insolvent. 128 The liquidator sought to resolve this tension by contending that: i. there was an unprecedented loss in January 1999 in the order of $5.4 million; ii. the causes of that loss were unexpected events constituted by rain and mechanical and other operational issues at each of the three mines and falls in the copper price. 129 In fact, as demonstrated by the evidence below, there was no 'unprecedented loss' in January 1999 in the order of $5.4 million: i. Documents contemporaneous with the appointment of the Administrator record the view held by ARL's auditors and by ARL staff in March 1999 that the January loss was in the order of $2.5 million. ii. The figure of $5.4 million was derived from management accounts. Mr Gibbons did not seek to verify the accuracy of the management accounts and was unable to reconcile the loss shown there to the figure of $2.5 million. iii. A large contributor to the loss of $5.4m can be seen to be $3.353m in respect of "change in inventory-bullion". Even after being given overnight to investigate the question, Mr Gibbons was unable to explain this adjustment in stock which had the effect of substantially increasing the January loss and was contrary to the direction in which he would have expected the stock of ARL to have moved in January. Mr Gibbons agreed that, on examination, it transpired that this stock adjustment was the reason why, to use the words in his report, "the cost of sales blew out significantly" in January. 130 The upshot is that the loss in January 1999 cannot be regarded as having been established to be anywhere near $5.4 million. Rather, it would appear to have been $2.5 million or less, being at a level that reflected a continuing downward trend rather than any set of dramatic unexpected events in January. 131 The large cash outflow in January 1999 of ($6.9 million) was mainly due to the payment in January 1999 of creditors outstanding in December 1998. Again, this did not reflect the occurrence of any dramatic, unexpected events in January 1999. Rain, mechanical and operational issues and falls in the copper price 132 Similarly, the evidence failed to establish that there had been any unusual events in January, in the realm of mechanical failures or other operational issues, which would have lead to a sudden and surprising change in Arimco's financial situation. 133 The cross examination of Mr Goldner, who was the witness most likely to have detailed knowledge of what occurred at the mines in January 1999, but who had not refreshed his memory from the detailed mine and Internal Monthly Reports before swearing his affidavit, shows that what occurred in January 1999 was neither dramatically different from what had occurred before, nor unexpected. In the cross examination, Mr Goldner was taken to detailed documentary records of what occurred which contradicted the liquidator's case on this issue. 134 Mr Goldner, Mr Ryan and Mr Swan acknowledged that the contemporaneous documents provided the best indication of what happened in January 1999. These documents establish that: i. At Selwyn mine, the January 1999 Internal Monthly Report records that "January was a good month with copper and production on budget." Thus, although the mine may have been affected by rain and some mechanical difficulties, these issues did not prevent production from being on budget. ii. At Mt McClure, The Internal Monthly Report for January 1999 notes that ""January was a poor month with gold production well below budget". However, the report identifies that the causes of the shortfall in production were: a) as to 50%, Cockburn Deeps not being pursued; b) as to 20%, poor ore definition; c) as to 30%, the factors identified at CB2167, including ore issues, mill shutdowns and metallurgical complications. iii. Cockburn Deeps had been suspended in December, and problems with the competency of the ore resembled those noted in the December Internal Monthly Report. Thus the vast majority of the shortfall at Mt McClure was not caused by new or unexpected issues, but by the continuation of matters known to the directors in December 1998. iv. At Gidgee mine, the Internal Monthly Report for January 1999 records that gold production was 27% below budget. The main shortfall was the head grade, which was 29% below budget. Problems with the head grade at Gidgee were simply a continuation of problems which had occurred prior to 31 December 1998. The relevance of the changes to the financial position 135 Ultimately however, the question of whether there were any dramatic changes to Arimco's financial position in January leading to the company's insolvency is only indirectly relevant to whether there were any matters that should have been disclosed to the insurer. The key issue remains whether any of the financial indicators known to the directors in December 1998 were such that a reasonable person would have known that they were relevant to the insurer's decision. For this, it is necessary to examine the financial position of ARL with very special care. 136 The financial matters of which the directors were aware in December 1998 are set out above. They include a decline in cash resources, current assets and working capital, as well as the fact that the company was facing liquidity problems, making significant losses and withholding payments to creditors. 137 The finding is that these matters paint a very different picture of the company to that which was disclosed in the Annual Report submitted to the insurer. 138 The 1998 Annual Report which accompanied the proposal presented the ARL group as being in robust financial condition as at 30 June 1998. For example: a) there was a profit before tax and abnormal items of $9.159m; b) the current ratio (current assets/current liabilities) was a healthy 1.12:1; c) net current assets were $3.865; d) there was cash on hand of $2.57m ;and e) each of the mines was forecast to prosper. 139 In contrast to this positive report, the impact of the events at the 3 mines subsequent to 30 June 1998 was so dramatic during October and November 1998 that, as Mr Gibbons agreed, a number of the indicators pointed towards the insolvency of ARL. According to Mr Gibbon's evidence, during December 1998, ARL "was on the downhill slide towards the insolvency that occurred in January" and it was "close to (or) on the brink of insolvency". Some of the indicators of severe financial stress identified by Mr Gibbons and known to the directors at the relevant time included: i. a history of monthly losses; ii. the withholding of cheques due to creditors; and iii. the use of rights issue funds to pay creditors [Noting that, although the directors did not know that this was occurring in December 1998, they were aware that this would become inevitable in the following year]. 140 The fact that the directors recognised that significant financial changes had occurred is born out by the fact that they requested a revised budget be prepared in November 1998. The November board Financial Overview described reporting of the group's projected results as having been "postponed until the more realistic site re-forecasts are completed". 141 The fact that there were temporarily no financial forecasts available to the board while revisions were made is not in itself something that a reasonable person would know to be relevant to an insurer's decision. As Ms Cuthbert conceded, the mere fact that revised forecasts were needed does not reflect poorly on the board absent some unreasonable delay in preparing the revised forecasts. Nonetheless, the matters which lead the directors to call for the revised forecasts were each significant departures from the financial situation of the company as disclosed in the 1998 Annual Report. As such, the finding is that a reasonable person would have known that these were matters relevant to the insurer's decision, and which they had a duty to disclose. The rights issue moneys 142 Another matter which, in the circumstances, should undoubtedly have been notified to the insurer, is the directors' knowledge, in December 1998, that the rights issue moneys would need to be utilised in order to pay creditors in January. It is clear that such a matter would have been known by a reasonable person in the circumstances to be relevant to the insurer's decision whether to accept the risk and if so on what terms. 143 This conclusion is supported by the evidence of Mr Gibbons, who, under cross examination, gave evidence that in normal circumstances a financier would be concerned that use of funds such as the rights issue funds for other than their specific purpose would raise questions as to the potential liability of directors for misuse of funds. It would also have been an indicator that the company was under severe financial stress. 144 There is also evidence that the directors themselves were aware of the serious implications of the use of the rights issue funds. None of the director witnesses asserted that the rights issue proceeds were available, without restriction, for payment of creditors, and several directors expressed the view that their understanding was that the rights issue funds were not available for the payment of general creditors: i. Mr Roberts gave evidence that it was his view that the rights issue funds should be put into separate accounts to be used only in extreme circumstances. ii. Mr Swan gave evidence that if the rights issue funds were going to be used to pay creditors, or might be so used, that was something which are he would expect a person outside Arimco intent upon assessing the financial position to want to know about. iii. Mr Swan also gave evidence that: a) he had the view in the latter part of 1998 that the rights issue funds were, when received, earmarked for the specific intended uses identified in the prospectus; b) that their use should only confined to those purposes; c) that they were not available for general working capital purposes. iv. Mr Ryan gave evidence that that his view in November 1998 was that the rights issue funds were not available for payment of general creditors. 145 The conclusion on the evidence is therefore that the directors knew, in December 1998, that the rights issue funds were not available for general use, except perhaps in 'extreme circumstances'. When this is combined with Mr Robert's admission that he was aware, as of December 1998, that it was inevitable that rights issue funds would have to be used in the immediate future to pay creditors, it leads to the conclusion that the directors must have been aware that this impending use of rights issue funds was an indication that the company was under extreme financial stress, and was therefore a matter highly relevant to the insurer's decision. The situation with Rothschild 146 Compounding these problems for ARL was the fact that some $8.2 million in debt was repayable to Rothschild, its sole financier, during the forthcoming calendar year: i. Mr Roberts acknowledged that a need to make this repayment would have created a "very critical" situation. Reference to the balance sheet at 31 October 1998 shows that this was an understatement. ii. Rothschild was conducting a review which was intended to be completed in January 1999. ARL had no right to extension of the facilities. Any extension was completely at Rothschild's discretion. iii. Detailed analyses had been undertaken in November and December 1998 by Rothschild and communicated to ARL (facsimiles of 9 November and 8 December 1998 at CB 4/1168 and 1453). The outcome of the analyses was very negative so far as ARL's position was concerned and there were no countervailing indications from Rothschild suggesting that the outcome of the review in January might nevertheless be favourable to ARL. 147 Rothschild is a specialist financier in the mining industry and experienced in the resources sector. It is one of the world's leading resource bankers with exposure to the mining industry by way of general financing. It had been the sole banker to ARL for a number of years. ARL provided Rothschild with information on a regular basis concerning the operation of its mines, including monthly performance reports and projections. 148 The description which follows of the dealings between Rothschild and ARL in the period November 1997 to December 1998 demonstrates that Rothschild carefully and closely monitored ARL, was concerned about ARL's ability to produce cashflow and its mining operations and was prepared to advance or extend facilities only when Rothschild's position was fully protected. There is nothing surprising about an experienced financier taking this position but it confirms that ARL could not expect any indulgence from Rothschild if, as reasonable people in the position of the directors of ARL would have anticipated as likely, Rothschild's review in January 1999 did not have a favourable outcome. History of the relationship between ARL and Rothschild 149 Late in 1997 ARL requested that Rothschild allow it to defer repayment of a facility that ARL had with Rothschild. 150 On 10 November 1997, Mr Ryan met with Mr Spencer and Mr Murray of Rothschild. Mr Spencer was ARL's account manager and a mining engineer or analyst who had performed annual reviews of ARL's mining operations over the previous years, including visits to various mines. Mr Ryan perceived Mr Spencer to have expertise in mining matters and to have knowledge of ARL's mining operations. Mr Murray was the relationship manager. 151 Rothschild had called the meeting to discuss operations, finances, corporate activities and an annual review. During that meeting Rothschild advised that deferral of the ARL facility repayment at that time was difficult due to the performance of Rothschild's operations over the last few months and the repeated non-delivery of "next month" style improvements. Mr Ryan agreed that Rothschild's position was difficult but advised that insistence on repayments from the start of January 1998 would make cashflow very tight. 152 Arising from this discussion Rothschild was to be provided with weekly production reports and other internal cashflow projections that would allow it to determine the cash state of the company. Mr Ryan was also to provide a weekly comment to Rothschild. 153 During that meeting there was also discussion as to how ARL was going to fund the "cash drain" particularly as the existing Arimco $7 m facility was fully drawn. Mr Ryan indicated that closing Gidgee was "on the table" if the situation did not improve. Closure costs for Gidgee were estimated at about $5 m. 154 Mr Ryan asked whether Rothschild would consider converting part of its debt into equity. Mr Murray said that Rothschild could purchase equity on market and that the situation had changed considerably from when it had asked for equity options in August 1997. Mr Murray said that Rothschild was not so much uncomfortable with the debt position as uncomfortable with the cashflow. The debt was covered by $28 million of ITM hedging and the projects, but the ability of the company to generate surplus cash in the short term was a concern. 155 Mr Murray's note of the meeting, concluded: "Things at Australian Resources are going to be very tight over the next few months and a lot is going to (and has to), change in the operations. RAL is attempting to build up its knowledge to ascertain the best form of attack/involvement from here and is going to have to monitor the position very closely." 156 From late 1997 ARL provided Rothschild with weekly production reports and internal cashflow projections. 157 A further meeting occurred on 20 January 1998 involving Mr Spencer, Mr Pearce, Ms Anderson and others. Discussion included the performance of, future prospects and cashflow forecasts for each of the mines and it was decided that ARL would prepare an 18 month corporate cash forecast for presentation to Rothschild on 22 January 1998. That presentation occurred on 23 January 1998. 158 On 31 March 1998, Rothschild wrote to ARL and Arimco offering variations to three current facilities provided by Rothschild to those companies, and two new facilities. These facilities are discussed in greater detail in 11.4 to 11.25 of Mr Dorfan's report. 159 The first facility was a facility between Rothschild and Arimco, referred to as the Arimco Facility. It was originally dated 26 June 1995 and had been varied several times thereafter. Rothschild proposed to vary the Arimco Facility to reduce the limit from $9 million to $5 million. Further the amount of $5 million outstanding was to be repaid by 10 monthly repayments of $500,000 from 30 April 1998 to 31 January 1999. This was subject to conditions precedent including the repayment of $4 million on the existing Arimco facility. 160 The second facility was a Guarantee Facility between Rothschild and ARL originally dated 13 December 1994 and which had been varied subsequently. The proposed variations involved a reduction in the guarantee limit from $2.5 million to $1 million with amounts outstanding under the facility to be cash collateralised as to 25% by 31 December 1998, 50% by 31 March 1999 and 75% by 30 September 1999. 161 The third facility was a hedging facility between Rothschild and Arimco, originally dated 25 August 1992 and varied several times subsequently. The proposed variations included a reduction in the net risk position limit from $35 million to $20 million. 162 The fourth facility was a new facility offered by Rothschild to ARL, and known as the Convertible Note Facility. Pursuant to the Convertible Note Facility, Rothschild was to purchase notes convertible into ordinary shares of ARL for a total face value of not more than $4 million. The purpose of the convertible note facility was to repay $4 million of the Arimco facility (thus satisfying the condition precedent for the Arimco Facility discussed above). 163 The fifth facility was also a new facility, the Mt McClure Acquisition Facility, pursuant to which Arimco would borrow up to $5.2m for the purpose of acquiring the remaining 36.65% interest in Mt McClure. Fees were payable according to a schedule set out at CB1/335. The amount of the fees was a function of the amount drawn under the facility. The fees were onerous. The $5.2m was to be repaid in full by 31 March 1999. 164 The offer contained in the 31 March 1998 Rothschild letter was accepted by ARL and Arimco on 31 March 1998. 165 On 16 April 1998, Mr Spencer provided to ARL a copy of Rothschild's cashflow model used to calculate project and loan life ratios. This model shows a detailed understanding of ARL's mining activities and includes a sensitivity analysis, which showed that the facility ratios were sensitive to changes in the gold and copper price and ore grades. Ms Anderson, a de facto director, was to review the model. 166 According to the minutes of ARL's Due Diligence Committee, in late May 1998, Rothschild agreed to extend the repayment date on the Mt McClure facility from 31 March 1999 to 31 July 1999 on the condition that ARL maintained a "blocked" cash deposit account equal to the amount owing. This is further evidence of the cautious approach taken by Rothschild. 167 On 3 June 1998, Rothschild wrote to Arimco and ARL offering variations to the Mt McClure facility. In particular, the expiry date was extended from 31 March 1999 to 31 July 1999. However, it was subject to a condition that ARL raise no less than $10 million net through the sale of equity by 31 August 1998, otherwise the expiry date would revert to 31 March 1999. The fee schedule was to be varied to reflect the extended expiry date. 168 This offer was accepted by Arimco and ARL on 5 June 1998. 169 On 28 July 1998, Rothschild wrote to Arimco and ARL concerning further variations to the Arimco facility. 170 The variations included a further reduction in the amount of that facility, from $5 million to $3.5 million, and an extension of the repayment date from 31 January 1999 to 31 July 1999. Further, the amount of $3.5 million was to be repaid by 7 monthly repayments of $500,000 each, commencing on the last business day of January 1999 and ending on the last business day of July 1999. 171 In the same letter, Rothschild agreed to vary the 3 June 1998 offer letter concerning the Mt McClure Facility by extending the date by which $10 million had to be raised through the sale of equity from 31 August 1998 to 31 December 1998. 172 These proposals were accepted by Arimco and ARL on 31 July 1998. 173 On 10 September 1998, Rothschild wrote to ARL offering to permit the seven monthly repayment of the Arimco facility to commence at the end of July 1999. Rothschild expressly retained an absolute discretion to give notice cancelling the extended repayment date, such that repayments would commence at the end of January 1999. 174 On 18 September 1998, Rothschild wrote to ARL foreshadowing a review of the Rothschild facilities and expressing an interest in receiving a feasibility study for Cockburn Deeps. The review was to start with a thorough review of each of the three mines and would involve visits to each of the mines. The review would be a detailed review including each of the matters listed at page CB2/817 including life of mine projections. 175 On 29 September 1998, Rothschild confirmed that Arimco had placed $5.2 million on deposit with Rothschild on 25 September 1998. The deposit represented part of the funds received by ARL from its recently completed equity raising. Rothschild confirmed that the special conditions under the offer letters had been met and that the Mt McClure Facility expiry date was unconditionally extended to 31 July 1999. 176 On 12 and 13 October 1998, Mr Spencer and Mr Ward of Rothschild visited Selwyn and/or a mining analyst. Mr Ward had a financial background. 177 On 2 and 3 November 1998, Mr Spencer, together with a geologist, Mr Rosenstreich visited Gidgee and Mt McClure. 178 On 9 November 1998, Rothschild wrote to ARL. The Rothschild facsimile sets out in detail a series of matters that had arisen as a result of the site visits undertaken by Rothschild to the mines. The numbers used by Rothschild in that facsimile came from information provided by ARL. 179 The facsimile expressed negative views with respect to each of the mines. Mt McClure and Gidgee were said to have a mine life of approximately 12 months. Selwyn was said to have a mine life of approximately 17 months, with the 276 mine making a negative contribution to cashflow. Gidgee was also said to have little (if any) value in a conventional banking model. 180 The facsimile concluded with some general remarks in which Rothschild suggested that there be further discussions. Rothschild stated: "The next logical step is for Australian Resources to present us with life of mine budgets based on current reserves and sensible inclusion of delineated resources which you can justify as being convertible into reserves. It may be worthwhile for Mike Rosenstreich to review geological sections with John Roberts next time John is in Perth. I would like to meet and discuss the best way for Rothschild to continue its review process." 181 The Rothschild 9 November 1998 facsimile identified issues important to ARL's financial position and ongoing operations. It was a matter of significance to Mr Roberts and the other directors because Rothschild was ARL's only banker and a substantial amount of money owed to it was due in the following year, in circumstances where ARL was dependent on the favourable exercise of discretion by Rothschild as to whether any extension would be granted. 182 The receipt of this facsimile was matter of "grave concern" to Mr Roberts and the other directors of ARL. Mr Swan's evidence was that the reaction of the directors was one of concern that the facsimile "came through so negative" and that he said to Mr Roberts that it was a worry that Rothschild had sent the facsimile. It was the subject of discussion among the directors and managers and in the case of the directors both prior to and at the November board meeting. The board minutes record, under "Visits to mine site" that Mr Ryan provided an update on Rothschild's comments after the visits to the mine sites. 183 Mr Robinson, the mining expert called by CGU, agreed with the Rothschild analysis, and Mr Roberts conceded that Rothschild's approach of confining its interest only to minerals which could be shown to be capable of economic extraction from the ground was a perfectly reasonable approach for a banker to take. 184 The resolution of the 26 November 1998 board meeting to revise the budgets, including as a prerequisite, the forecasts for each mine effectively meant that from 26 November 1998 the existing cashflow and production projections were to be disregarded. Indeed after the November board meeting no forecasts were prepared or included in the financial overviews. The passage of time without those revisions occurring, in circumstances where the Rothschild facsimile required an urgent response indicated that what Rothschild had sought could not be provided. As Mr Swan conceded the Life of Mine plans sought by Rothschild in order to complete its review weren't provided prior to 31 December ("they take a long time to generate"). There were many reasons why ARL was not in a position to reforecast Selwyn. The reworking of the budgets was not completed prior to Administration. 185 On 8 December 1998, Rothschild sent a further facsimile to ARL. 186 That facsimile dealt solely with the effect of the current copper price on Selwyn. It attached a cashflow analysis showing that a current metal prices Selwyn was losing cash at the rate of approximately $500,000/month. 187 This was a matter of concern to the directors. 188 On 23 December 1998, Mr Ryan and Ms Anderson met with representatives of Rothschild. Mr Ryan's note of the meeting indicates that at that meeting: i. Rothschild indicated that it had negotiated with Geographe Resources to sell the convertible note to Geographe Resources for $4.8m; ii. Mr Ryan provided a brief update on the life of mine plans and it was agreed that these would be reviewed in mid-January 1999; iii. Mr Ryan asked Mr Hodgkinson of Rothschild to seek leave from his Credit Committee to provide ARL with a letter prior to 31 December 1998 stating that Rothschild was reviewing its banking facilities and that subject to review approvals in January 1999 the debt would be "termed out" at least past 31 December 1999; and iv. Ms Anderson requested that Rothschild review the requirement under the guarantee facility to cash collateralise the facility by $250,000 each quarter for the next 3 quarters. 189 On 24 December 1998, Rothschild wrote to ARL confirming that Rothschild: "…is currently in the process of reviewing Australian Resources' loan and guarantee facilities. We expect to complete this review in January providing sufficient information is available during that period…in regard to the Guarantee Facility, we have received local shareholders' approval to defer the $250,000 cash collateralisation due on 31 December 1998 to 31 March 1999. We are currently awaiting approval from our shareholders in London before we are able to provide a formal offer to amend the facility. In the interim, Rothschild will temporarily waive the requirement for Australian Resources to place an additional $250,000 on deposit in a blocked account before 31 December 1998. We will inform you once we have received a decision from our shareholders." 190 The Rothschild response can be seen to be very guarded. 191 As at December 1998 the following repayments would, unless there were a favourable exercise of discretion by Rothschild, fall due during the term of the insurance policy: i. the $5.2 million Mt McClure facility, on 31 July 1999; ii. the $3.5 million Arimco facility at $500,000 per month from 31 July 1999, or if, the review outcome was unfavourable and (as would seem likely in these circumstances) Rothschild cancelled the extended expiry date, from the end of January 1999: see Dorfan at 11.4. 192 ARL would not have been able to make these repayments. If repayment was required by Rothschild, ARL would have had little choice but to enter into liquidation. 193 The Rothschild review was to have been completed by 31 December 1998 but was dependent upon provision of requested information by ARL including "more detailed information on the proposed underground mine at Cockburn Deeps" and a completed feasibility study for Cockburn Deeps. As at 31 December 1998 the Rothschild review was incomplete. ARL had not provided the life of mine budgets requested in the 9 November 1998 facsimile or completed a feasibility study and Rothschild had not made any decision save for a temporary deferment of the requirement to collateralise the Guarantee Facility to the extent of $250,000 by 31 December 1998. 194 Rothschild had an unfettered discretion whether or not to extend the facilities. ARL's ability to continue as a going concern was largely dependent on Rothschild extending the facilities. ARL had no legal or moral right to an extension. 195 Rothschild had repeatedly stated that the life of mines was a major matter of concern to it. This was a key focus of the review and had been queried by Rothschild in the past. Rothschild said, and did, nothing to resile from this position, or to indicate that the outcome of the review would be favourable. As Mr Swan conceded, ARL had received from Rothschild two communications (the facsimiles of 9 November and 8 December 1998) which were negative so far as ARL's position was concerned and ARL had not received any countervailing indications from Rothschild. 196 ARL was not able to prepare life of mine budgets which could reasonably be expected to satisfy Rothschild because it did not have the reserves or the resources readily convertible to reserves with which to do that. As to the former, Rothschild's facsimile of 9 November 1998 showed its dissatisfaction with the level of existing reserves at all the mines. 197 Nor was ARL in a position to provide a completed feasibility study for Cockburn Deeps which would satisfy Rothschild, as further work was required as stated in the draft feasibility study, and the project had been recognised to be uneconomic, and suspended. 198 The proposed alternative of a Stage 3 cutback to the Cockburn pit was unlikely to satisfy Rothschild on the review, given the technical difficulties identified by Rothschild in its 9 November 1998 facsimile and its "low confidence" in a further cutback. 199 ARL was not in a position to increase its reserves by "proving up" resources to reserves. To do so would require demonstration that there were "resources" which could be economically extracted, and to do so significant upfront expenditure was required (see earlier as to Cockburn Deeps and Cockburn Pit Stage 3) which ARL was not in a position to fund. 200 The evidence of the asserted "historical conversion rate" of resources to reserves put forward in the affidavits of Messrs Roberts and Swan as the basis on which they wished to "set [Rothschild] straight" was shown in cross examination of them and Mr Goldner to be founded on false bases. 201 All of this put ARL in a very precarious position, a position directly relevant to its financial position and operations during the period of the proposed policy. 202 The directors' evidence called by the liquidator demonstrates that the directors were aware of all these matters. 203 Given the negative views expressed by Rothschild to ARL during its review and the lack of any basis for a rebuttal by ARL, the probability was that the review would have an unfavourable outcome, with the attendant catastrophic consequences for ARL. 204 At the very least, it is common ground that Rothschild and ARL were in disagreement about fundamental matters concerning ARL's mines, future planning (notably the Stage 3 cutback) and life of mines, including the significance of resources to the evaluation of the life of the mines. They disagreed at a time when a favourable exercise of Rothschild's discretion was critical to the survival of ARL over the next 6-12 months. 205 The fact that ARL was talking to Rothschild about whether Rothschild would, in its discretion, extend the term of the debts was a material consideration for someone assessing the financial position of ARL. 206 It is fair to observe that in final address Mr Davies spent considerable time in seeking to make good the proposition that the directors had every reason to be optimistic and confident that they would satisfactorily resolve any issues which they apparently had with Rothschild as a result of the November and December facsimiles. He took the Court through many documents emanating as far back as September 1997, showing a Rothschilds Credit Committee proposal inter alia including the following: "Reserves with the large amount of resources at Gidgee and underground resources at Selwyn ensuring that production should continue for all mines well in excess of four and a half years. Mt McClure can operate for about seven years based on current reserves. ARL closely monitors all three operations, recently visited the projects, detailed reviews are currently being drafted. ARL concludes all three mines are well managed and should meet or exceed budget expectations." 207 In like fashion he took the Court to other documents which across particular periods of time appeared to show that Rothschild had not ignored the resource position and had had reason to be satisfied that particular resources could be converted to reserves and could be mined. 208 Mr Davies' proposition was that there were a number of indications, for example as at late March 1998, when Rothschilds had remained undaunted, notwithstanding what he described as short-term cash flow problems. In particular a further Rothschild Credit Committee paper had made the following observation: "Australian Resources reported an operating loss for the six month period" - that is to December 97 - "of $0.68 million, $12.2 million for the full year 97, and a net loss after tax of $2.4 million, including the $9.6 million writedown. Revenue of $62.5 million for the six months was down significantly from previous years. All covenant ratios other than the current ratio are currently being met. These financials reflect the short-term cash flow problems that Australian Resources is currently facing and underlines the need for Australian Resources to renegotiate the terms of ARL's facilities." 209 Mr Davies' proposition was that, although ARL had gone through a very difficult period at the end of 1997, Rothschild was fully cognizant of the then situation and nonetheless prepared to back ARL again. 210 Mr Davies essential contention was that CGU's case in these proceedings simply failed to do justice to the very firm historical support given by Rothschilds to the ARL group. 211 The problem for the liquidator's case in this regard inheres in the context: leaving aside the problems of comparison as between particular chronological periods of difficulties which the group may have had [and in respect of which it may one way or another have been able to successfully reach an appropriate accommodation with Rothschild], the focus of the Court's investigation presently is as to what was and was not at the material time, a material consideration for an insurer assessing the financial position of ARL. The evidence establishes that late December 1998 represented a period of time when the Group's very survival was clearly something which could not be taken for granted. These were plainly matters known to the directors which a reasonable person in the circumstances would have known to be matters relevant to the decision of the insurer whether to accept the risk and if so on what terms. Not even the historically demonstrated anterior support given to the Group by Rothschilds could gainsay this proposition. The Leighton claim 212 Finally the directors were aware in December 1998 that there was also outstanding a claim for $15 million. 213 The liquidator sought to argue that this claim was not seen as a matter of high significance by the directors, as it was perceived as an ambit claim. Nonetheless, the evidence established that ARL was taking the claim seriously, and that: i. At the end of December ARL was not in a position to reliably assess the validity of the claim, or at least most of it, because Leighton hadn't provided adequate information. ARL's rejection of most of the claim had led to Leighton stating on 23 December 1998 that it had instructed solicitors and intended to commence proceedings. ii. As is apparent from the balance sheet as at 31 October 1998, ARL would not have been able to pay the claim if it were successful, and continue its operations in their existing form. 214 Whilst it is very difficult to determine what the net result of such a very large claim might be after strongly contested litigation, the simple fact was that the claim could not be overlooked in terms of its potential to adversely affect the group's already fragile financial position. 215 The finding is therefore that a reasonable person in the position of the directors would have been aware that this was a matter relevant to the insurer's assessment of the risk involved in issuing the insurance, and therefore a matter which they were obliged to disclose. A challenge is made to the admissions elicited from the directors 216 Mr Davies submitted that many of the so-called admissions elicited from the directors under cross examination should be heavily discounted for a few reasons: i. the extensive passage of time since the material events; ii. the manner in which the cross examiner tended to take the witness to documents with which the witness may not have been familiar or may not have been able to recall, which a forensic practice was said to unfairly call for the witness to reconstruct that which was not possible to be reconstructed without the benefit of hindsight; iii. some occasion where the witness is said to have been misled by the complex financial records put to the witness themselves being incorrect for one reason or another. 217 In answering these submissions, Mr McFarlane correctly observed that in both the cross examination of directors and in CGU's submissions the defendant had been particularly careful to focus upon what it was that was the knowledge of the directors prior to 31 December so as not to confuse the knowledge which was thereafter acquired. As I see it both sets of parties simply had to cope with a forensic environment in play and if either party formed the view that certain questions and cross examination required clarification, the proper course was to in the usual way seek to re-examine. Standing back from all of the detail in the sundry accounting documents, cash flows, projections and other materials upon which the witnesses were cross-examined, it seemed to me that there was nothing particularly extraordinary about the way in which witnesses were cross examined regardless of the undoubted fact that from time to time either cross examiner might have made mistakes in drawing the witnesses being cross examined attention to particular line entries. And certainly in the course of the extensive final addresses, both parties were in a position to draw the courts attention to any suggested mistakes in the interpretation of formal documents and indeed did so. 218 Taking one only example of a matter which had been overlooked by CGU in the course of its cross examination, the manner runs as follows. 219 Mr Davies took the court to Exhibit D11 [formerly MFI 6]. The submission was that the relevant document was put to the directors as if the material contained in it was correct and then concessions were extracted from them. This was said to unfairly represent the position. 220 The submission was as follows: i. exhibit D11, was said to contain figures that were obtained from CB 5732; ii. take January: under Lotus South it says 3649. If one goes to page 5732 the 3649 figure appears as the last line under Lotus South but no account is taken if one goes up four lines further of the figure of 15,578, which is also grams of gold; iii. similarly, all of the figures along Lotus South in exhibit D11 ignore that further line; iv. Mr Davies then contended that this made a significant difference to the totals in exhibit D11 and a significant difference to the percentages that are calculated for Cockburn Deeps. 221 In final address Mr Macfarlan dealt with this issue making clear that there had been two purposes in terms of his cross examination concerning Exhibit D11. The first was to show that the two mines that had brought about the significant and 'record' gold production in the latter part of 1998 were going to run out in early 1999. They were the Cockburn pit total figure, the first one, and then also the later stage 2. They were petering out in February, March. That point was unaffected by Mr Davies submission. 222 The other point of the document was to demonstrate that the Cockburn Deeps project, which was abandoned or at least suspended, was a very significant budgeted contributor. Mr Davies was correct in that Mr Macfarlan did miss a line out when dealing with Lotus South laterite. 223 Mr Macfarlan submitted that this had not made a significant difference because otherwise Mr Davies would have clarified the position apropos the particular line entry. 224 Mr Macfarlan then furnished the court with a document in which CGU had redone the calculation taking into account the matter raised by Mr Davies. This document entitled "Revised Exhibit D 11 McClure budgeted production became MFI D13. 225 As is apparent what has changed is the line relating to Lotus South laterite where CGU had amended the figures to take into account the additional figures that Mr Macfarlan had overlooked in preparing that calculation. What was important was that the bottom line [the percentage of Cockburn Deeps] did not change in a relatively significant fashion. What is still shown is that, going into the third quarter of the financial year, the Cockburn Deeps project was to be well over 50 per cent, and for the whole of the half-year it was to be close to or approaching 45 percent. Hence it did not indicate that the Cockburn Deeps project, which was abandoned or at least suspended, had been otherwise than a very significant budgeted contributor. Section 28 Would CGU have acted differently if the matters had been disclosed? 226 To the extent that the directors failed to comply with their obligation to disclose matters which they or a reasonable person knew to be relevant,, section 28 of the Insurance Contracts Act operates to reduce the liability of CGU so as to put it in the position which it would have been in had the directors complied with their obligations of disclosure. 227 Section 28 provides that: (1) This section applies where the person who became the insured under a contract of general insurance upon the contract being entered into: (a) failed to comply with the duty of disclosure; or (b) made a misrepresentation to the insurer before the contract was entered into; but does not apply where the insurer would have entered into the contract, for the same premium and on the same terms and conditions, even if the insured had not failed to comply with the duty of disclosure or had not made the misrepresentation before the contract was entered into. 228 Section 28 provides for two possible remedies. If the failure to disclose or misrepresentation was made fraudulently, then the insurer is entitled to avoid the contract (s 28(2)). This does not need to be considered, as no allegations of fraud were made on the pleadings. Alternatively, section 28(3) provides that, where the alleged failure to disclose or misrepresentation is not fraudulent, the insurer's liability "is reduced to the amount that would place the insurer in a position in which the insurer would have been if the failure had not occurred or the misrepresentation had not been made". 229 Having found that the directors failed to comply with their duty of disclosure, it is now necessary to establish what position CGU would have been in had one or all of these matters been disclosed: i. the significant changes at the mines; ii. the significant change in the financial position of the company; iii. the fact that the directors were aware that rights issue funds would inevitably need to be used to pay creditors. iii. the intention of the Group's financier, Rothschild, to conduct a thorough review of the facilities; and/or iv. the fact of the Leighton claim. 230 CGU contended that if any of the above factors had been fully disclosed, the insurance policy would only have been issued with an insolvency exclusion in standard terms. This exclusion would have protected CGU from any liability for insolvent trading, and therefore would reduce its liability under the present suit to zero. In contrast, the liquidator contended that CGU would not have imposed an insolvency exclusion. At worst, the liquidator contends that CGU would have imposed a specific exclusion excluding liability for damage arising out of the Leighton claim. This kind of exclusion would have no impact on CGU's present liability, as none of the damages claimed by the liquidator arise out of the Leighton proceedings. 231 As already indicated, the evidence marshalled by CGU on this point consisted primarily of the evidence Ms Cuthbert and Mr Acance, who were the underwriters involved in the Arimco application for renewal. 232 Ms Cuthbert was the underwriter who performed the initial assessment of the Arimco application. It is common ground that Ms Cuthbert, as a junior employee, did not have authority to underwrite the policy with which these proceedings concerned [her underwriting authority at the material time was $10,000,000]. For that reason she consulted with Mr Acance, a more senior officer, who determined to commit CGU to renew the policy. 233 Both Ms Cuthbert and Mr Acance were closely questioned about the steps they took in reviewing the Arimco application for renewal. Of course, the application in question was one renewal amongst many, and was dealt with almost 10 years ago. In Mr Acance's case, he was unable to recall almost any specific events surrounding this particular application, and was only able to give evidence as to the general approach which he believes he would have taken to an application of this type. Similarly, the Court takes into account the difficulty involved in giving evidence as to what one hypothetically would have done if certain information had been disclosed at a particular point in time. It will always be difficult for a witness to ignore those facts which are known through the benefit of hindsight. In the current case, it was undoubtedly difficult for the witness to put out of his or her mind the knowledge that the company the subject of the renewal application was insolvent mere months after the application was made. 234 Because of the key nature of the evidence of each of these two witnesses, and the need to approach such evidence with special care, the affidavit and oral evidence of Ms Cuthbert and Mr Acance is explored in some detail below. Evidence given by Mrs Cuthbert 235 The evidence given by Mrs Cuthbert was that at CGU it was her practice, when she had concerns about a company's financial position, to either decline to quote or to quote with an insolvency exclusion clause. 236 Mrs Cuthbert gave detailed evidence as to the materials which she had been given at the time and as to the manner in which she interpreted those materials. She gave evidence that, in assessing the proposal, she would have relied upon the information contained within the proposal form (including the negative answer to question 10) and would have carefully studied the attached Annual Report. 237 Having read the Annual Report, Ms Cuthbert made a note of some of the significant information using a computer program described as 'Insure 90' [also referred to by the parties as 'the blackboard']. While the actual underwriting file could apparently not now be located despite various extensive searches and inquiries, this computer datasheet, which was accessed by both Ms Cuthbert and Mr Acance, was annexed to the affidavits. This spreadsheet automatically generated certain totals and ratios and was one of the tools that the underwriter would use to assess the risk. 238 The spreadsheet shows that Ms Cuthbert made a note of various financial data obtained from the Annual Report, such as the current ratio, liquidity ratio, liability to net worth ratio and borrowings to net worth ratio. She concluded on the basis of the information available to her that "(t)he ratios and other figures looked much the same as the previous year and the profitability had improved." Overall she concluded that "it all looked positive." 239 As evidenced from the spreadsheet, it appears that Ms Cuthbert made an error in explaining that a reduction in the liquidity ratio was due to a change in accounting practices. In fact, the change in accounting did not explain the fall in the liquidity ratio, which was due instead to a fall in cash and receivables. Ms Cuthbert was unable to say whether, if she had realised her error in December 1998, she would have been prompted to investigate further the company's financial situation. Mr Acance's evidence on this issue was that, if he had been aware of the mistake, it would not have made any difference to the way he dealt with the underwriting of the risk. 240 The liquidator also highlighted various other information contained within the Annual Report which he claimed refuted Ms Cuthbert's conclusion that 'it all looked positive'. These factors, which were not noted on the blackboard, included the following: i. the cash flow from operating activities had declined in the previous two years from $53.256 million to $34.152 million (page 3) and the average cash costs per $/oz had risen from 267 to 373 over the same period; ii. average cash costs $/oz had risen from 242 to 373 over the 5 year period and from 335 to 373 over the previous year; iii. the cash costs per $/oz for gold at Selwyn had risen from 49 to 193 over the same two year period; iv. the cash cost per $/oz for gold at Mt McClure had risen in the previous two years from $341 to $414 and in the previous 12 months from $397 to $414; v. the available cash had declined from June 1996 from $14.686 million to $9.217 million at June 1997 and again to $2.568 million at June 1998. Mr Acance's evidence is that if he had known this he would in any event have issued the policy without an insolvency exclusion; [The defendant's explanation for this reduction in the cash position was that between 1997 and 1998 Arimco spent $5 million purchasing the remaining joint venture interests in the Mt McClure mine, thus it is not a fair or relevant comparison between the two years. Cf: transcript 863] vi. the net cash provided by operating activities had declined from $36.767 million in June 1997 to $34.152 million in June 1998. Mr Acance could not remember discussing this nor was he concerned about it; vii. the current assets only remained approximately equal to those at June 1997 by reason of the inclusion of stockpiles in the inventories amounting to some $13.3 million. This came about as a result of a change in accounting policy. The effect of that was that the net worth was increased only as a result of the inclusion of the stockpiles; viii. although the receivables were approximately halved, and those receivables were very largely a reduction in trade debtors, there should have been a corresponding increase in the cash position but the reverse was the case with the cash being reduced from $9.2 million to $2.5 million. 241 Essentially, this evidence suggests the possibility that further information disclosed by the directors may also have been overlooked (in the same way) by the insurer. Given the number and significance of the matters which the Court has found the directors had a duty to disclose, this argument is rejected. Evidence given by Mr Acance 242 The evidence of Mr Acance was very significant to the cases of both parties. He gave evidence regarding the information which he was given by Ms Cuthbert, his own approach to dealing with the proposed renewal, the significance which he attached to various items of information which had been imparted to him, what he would have done had various other items of information been imparted to him and similar. It is no exaggeration to say that he was exhaustively tested on his affidavits and on virtually every one of the areas in relation to which he gave evidence. The enquiry covered the whole of his approach to underwriting risks and closely examined virtually every one of the factors which he contended would have been relevant to his assessment of Arimco's proposal. 243 Mr Acance admitted that he did not recall the specific events surrounding this particular application, however he was able to give evidence of his usual practice in assessing an application of this type, and his recollection that there was nothing unusual about the Arimco application to take it outside of this parameter. 244 Mr Acance believes that he would not have viewed the insurance application itself, or the 1998 Annual Report for the ARL Group. He believes that he would have relied on Ms Cuthbert to inform him of the significant information they contained. 245 He gave evidence that he had seen and assessed hundreds of mining risks. When assessing a mining industry risk there were critical items like costs of extraction of minerals, selling costs and reserves of the mine in addition to the general financial position of the company and the structure of the balance sheet. 246 Mrs Cuthbert would have called him on the phone and advised him that she had received a renewal submission for a $30 million limit from Jardine in relation to the ARL Group, and asked him "Can you have a look at this and tell me if you agree?'. 247 Mr Acance was aware that the ARL Group had insured with CGU previously. He would have opened the Insure 90 screen on his computer so that they were both looking at the underwriting screen. He would have asked Mrs Cuthbert a few questions including questions such as: (a) Production costs for the mineral; (b) Selling costs; (c) Production output estimates; (d) General financial overview; (e) Her views on the company's gearing; (f) Comparison of last year's results; (g) They may also have discussed any possible Mergers & Acquisitions with interested parties like the Gutnick (Great Central Mining) Group. 248 Mrs Cuthbert's notes on the spreadsheet say: "Gold production for year was 207,241 ounces. Gold production for 98-99 is projected to rise to 250,000 ounces". This told him that gold production would be increased by about 20% with a healthy margin between production costs and the forward sale prices. 249 The spreadsheet showed the net profit after tax ('NP. a/tx') of $3.585 million. This told him that there had been an improvement in profitability and the Group was trading profitably. Profitability was an important factor when he assessed an insurance risk. 250 The spreadsheet showed net worth of $159.537 million which told him the Group's assets exceeded its current liabilities by a comfortable margin. The current ratio ('Curnt') on the underwriting screen was 1.12 which was acceptable to him. 251 Another item that he considered most important was exploration expenditure and exploration success, because this was needed to extend the life of a mine and generate more revenue in the future. 252 He assumed that he had found out from his discussions with Mrs Cuthbert that Arimco had raised some $11.2 million gross/$10.2 million net, for a rights issue after 30 June 1998. The likelihood that he had asked a question in relation to that matter or that Mrs Cuthbert had offered that information was high even though the information did not appear on the blackboard. He regarded the fact that the company had raised that money as very significant information for considering whether to underwrite the risk [transcript 352]. 253 Mr Acance's evidence was that there was nothing on the spreadsheet or in what Mrs Cuthbert told him to raise any question or doubt about the ARL Group's ongoing viability or insolvency. Had there been anything of concern he would have called for the underwriting file and looked at the proposal and the Annual Report in detail himself. Had there been any indication that ARL might have financial difficulties or become insolvent during the period of insurance, he would definitely not have approved the renewal on the same terms. He would have offered a renewal with a reduced limit, say $1.0 million, and with an insolvency exclusion in CGU's standard wording in 1998. Assessment of risk 254 Mr Acance gave evidence that: If Question 10 of CGU's proposal form had been answered "Yes" on this renewal submission, I would have called for full particulars of the matters disclosed in answer to Question 10 and personally looked at the file and read the Annual Report in detail. If the answer impacted on life of mine or production costs, for example, I would have called for detailed up to date information on all those things up to the time of the submission of the renewal proposal form. Depending on the further information I might then offer terms with an insolvency exclusion and with a lower level of cover. 255 Mr Acance was shown the mining and financial factors listed in the appendix to these reasons, and asked to assume for the purposes of his affidavit that each of these facts was true in November and December 1998. He gave evidence that if he had been aware of the information in any one of the items listed under "Major Factors", prior to approving the insurance application, he would have offered renewal terms with an insolvency exclusion and a lower limit of liability. 256 His evidence was that had he been aware of the information listed under 'Other Relevant Information', he may have offered renewal terms with an insolvency exclusion and a lower limit of liability for some of those items in combination with some of the other items. 257 He was also shown a list "List of Financial Information" [also for convenient set out in the appendix at the end of these reasons] and then asked to assume that the statements on that list were true in November and December 1998. On that assumption he had been asked to say which of those statements would have been relevant to his assessment of the ARL proposal and what his decision would have been on the renewal submission, had he been informed of each of those matters. 258 His response was put in the following terms: If I had been aware that the Board of ARL had no financial forecast or prediction for the next 6 or 12 months, I would have assessed them as being unable to provide any accurate answer to Question 10 of the submission and I would not have offered renewal on the same terms as were given. If I had been aware of the information listed under "Major Factors" as items 1-2 and 4-5A, I would have offered renewal terms with an insolvency exclusion and a lower limit of liability. Also if I had known the information in both items 3 and 4. Under 'Other Relevant Information' on that list, if I had known the information in items 6-10 inclusive, taken together that information would have been a major factor in my assessment of the risk, and I would have offered renewal terms with the insolvency exclusion and a lower limit of liability. Under 'Other Relevant Information', if I had known the information in items 23 and 24, together that information would have been a major factor in my assessment of the risk taken in the context of a negative cashflow, because my thinking would have been that if Rothschild did not extend or renew ARL's facilities, ARL would need to source additional funding to repay Rothschild within the next 12 months and also find another financier to provide facilities for ARL's business operations. In the economic climate in 1998, and with the low mineral prices, this would not have been easy, so I would have regarded those two items in combination as a major consideration and I would have offered renewal terms with the insolvency exclusion and a lower limit of liability. In combination, items 25, 26 and 27 would be a major factor and if I had known all of that information I would have offered renewal terms with an insolvency exclusion and a lower limit of liability. 259 It was put to him that, in the ordinary course of underwriting a risk, if there had been an answer "yes" to question 10 he would not have descended to the level of detail contained in the lists of information annexed. His answer was: Yes but it depends also on the financial structure in the information provided. If the information provided in the financials [in] such [a] case [is] that it is unacceptable or there's some question of acceptability or the notes are not positive I would have requested the files or I would have requested some parts of the files or asked additional questions. [transcript 356] 260 Under cross examination he was challenged in relation to the evidence that he had given that had there been any indication that Arimco might have financial difficulties or become insolvent during the period of the insurance, he definitely would not have approved the renewal of the same terms but would have offered the insolvency exclusion. It was put to him that he would not have offered the insolvency exclusion merely if he had perceived that Arimco might have financial difficulties in the Policy year. His answer was that this was incorrect [transcript 358]. The mining factors 261 Ms Cuthbert's evidence was that she would have tried to assess what impact the various mining factors would have had on the company economically, and then referred it to Mr Acance. 262 It was put to Mr Acance that many of the matters were operational issues which would have concerned him as an underwriter. He replied that: I am not really concerned on operational matters. What I am concerned about are the numbers, whether the numbers are big enough that will become a problem for them on their sustainability. 263 The finding on the evidence is that CGU would not have been concerned with the details of the mining operations, but would have paid close attention to any factor which had the potential to impact upon the company's bottom line and capacity to continue trading. The financial situation 264 Ms Cuthbert gave evidence that: Had I been aware of any downward trends in profitability or cashflow, or value of the assets, or seen any indication that the Group might not be able to continue as a going concern, I would have raised the matter with Mr Acance and I would also have recommended to him that we offer a reduced limit of indemnity, on unfavourable terms and with an insolvency exclusion in CGU's standard form. 265 Taking some specific examples, Ms Cuthbert said that if she had been aware of the following financial matter, she would have raised it with Mr Acance and recommended imposing an insolvency exclusion: ARL's cash resources (excluding the rights issue proceeds) had fallen to a negative $2.169 million, whereas they were positive at 30 June 1998 266 Had this issue been raised, Mr Acance's affidavit evidence was that he would have offered the renewal only with an insolvency exclusion and a lower limit of liability. 267 Under cross examination Mr Acance gave evidence as follows: Q. Would you have a look at item 3. Do you see you were asked there to assume in combination with item 4 that the net current assets excluding the rights proceeds had fallen to a negative $2.169 million? A. Yes. Q. Do you know when it was that they had fallen to $2.169 million negative? A. No. Q. If the directors had told you when they applied to renew the policy that the company's net asset position remained constant or relatively constant to the end of November 1998, which was the last accounts they then had available, would that have satisfied you? A. Yes. Q. Even if it was without the rights issue would that have satisfied you? A. Yes. [This cross examination refers to the fact that, while the group's current net assets had changed significantly, the group's net assets had not. This is due to the fact that the change in current net assets was contributed to significantly by the fact that, in July 1998, the debt to Rothschild became a current liability, while previously it had been a non-current liability.] 268 Mr Acance then qualified his position making clear that it was necessary to link item 3 with item 4 of the financial matters: There was potential for ARL to breach the covenants in its facilities with Rothschild and not be able to correct the breach (being the shareholders equity covenant and/or project life ratio covenant and/or loan life ratio covenant). 269 Thus the fact that the debts to Rothschild had become due within the next 12 months is clearly closely linked to the state of the relationship between ARL and its financier. 270 Ms Cuthbert's evidence is that had she known the following information, she would have raised it with Mr Acance: i. ARL's cash resources (excluding the rights issue proceeds) had reduced by $3.034 million between 1 July 1998 and 31 October 1998. ii. The Group had made a cumulative loss of $707,000 between 1 July 1998 and 31 October 1998, against a budgeted profit of $551,000. 271 Mr Acance's evidence was that if he had known the first of the matters above, he would have offered renewal with an insolvency exclusion [Mr Acance was not asked to assume the second matter above: this is one example of the many difficulties caused by the way in which matters where put to these two witnesses in similar but non-identical terms]. 272 Mr Acance was challenged as to whether he would have considered it appropriate to exclude the rights issue funds when examining ARL's cash resources in December 1998. His evidence was as follows: Q. But part of the group's operations was exploration, was it not? A. Yes. … Q. To find further resources that can be converted to reserves A. Yes. Q. So would you agree with me that it would be an unbalanced exercise just to look at the cash resources without those rights proceeds when you were considering what you would do about renewal? A. When you are underwriting a risk like this and you have a rights issue, the rights issue is for a specific purpose. You continue to look at the resources of the company. If the resources of the company is unfavourable you continue to ask what is the company doing about this for the future. The question I guess on this case is that the rights issue will be extinguished one day, they will be able to spend that money but the company should continue to be feasible to be profitable in the future. Q. Yes, but when you asked what is this company doing about its financial position, one very legitimate answer would be, I suggest to you, that it is expending funds that it has received from a rights issue on further exploration to improve profitability? A. I agree with that statement. The use of rights issue funds to pay general creditors 273 Ultimately, Mr Acance and Ms Cuthbert were asked to concede that it was relevant to take the rights issue proceeds into account when looking at the cash resources of the company, based on the fact that the company was in fact expending money on exploration, which was the purpose for which the money was raised [see the cross examination above]. Nonetheless, this approach obscures the central fact that the directors were aware, by December, that at least some significant portion of the rights issue funds would have to be expended on the payment of general creditors, a purpose which fell outside the prospectus. Neither Ms Cuthbert nor Mr Acance were shaken from their evidence that this was a matter which would have been significant to the insurer, and which would have lead to the imposition of an insolvency exclusion. 274 Ms Cuthbert's evidence was that the use of rights issue funds for any purpose outside the prospectus would be 'of concern' to the insurer (T328.25). 275 Mr Acance's evidence was that: [An] important factor in assessing any D&O insurance submission is the moral character of the Board. Because CGU is insuring the directors of the company, their integrity and character is an important consideration. I have been asked to assume that ARL's 'Financial Overview' for February 1999 states under the heading "Cash flow" that " Other than the $5.2 million invested with Rothschild, the remainder of the share rights funds were temporarily 'borrowed' to meet the major payments at the end of January" . I have been informed that the rights issue funds were raised following the issue of a Prospectus by ARL which stated that the funds to be raised would be used for exploration purposes. If the rights issue funds were used for other purposes, or there was a prospect that they would be used for other purposes, that would have been an important factor in my mind when considering this submission. In combination with other information, it would have made me offer renewal terms with an insolvency exclusion and a lower limit of cover. Rothschild review 276 Ms Cuthbert's evidence was that she would have recommended an insolvency exclusion based on the letter from Spencer of 9 November 1998 and also in respect of the Spencer letter of 8 December 1998. In her oral evidence she said that if she had seen the letter she would have needed to get assistance from Mr Acance as she did not have any understanding about what life of mines budgets were and did not understand what was meant by life of mines generally. She agreed that if she had been told that the company was in the process of preparing further line of mines budgets and that Rothschild was content with that she would have felt comfortable with it. 277 Ultimately, Ms Cuthbert agreed that if she had known that Rothschild had agreed in December 1998 to extend the time for payment of $250,000, and extend time to permit the Group to have into the New Year to prepare its further forecasts she would have had comfort that Rothschild was providing support for the company. 278 Mr Acance regarded the relationship between a company and its financiers as highly relevant when assessing risk. Had he been aware that ARL was in disagreement with Rothschild on matters that had the potential to affect its future financing arrangements, he would have seen that as a major risk and would certainly have offered renewal only with an insolvency exclusion. 279 Mr Acance was closely questioned on this issue, and a number of matters were put to him which he admitted would have provided 'some comfort' in relation to the relationship between ARL and Rothschild [for example the sale of the Convertible Notes]. Nonetheless, he ultimately did not resile from his position that, had full disclosure been made regarding the Rothschild situation, he would not have renewed the policy without an insolvency exclusion. An assessment of the evidence 280 On this issue, the Court is required to perform the difficult task of assessing on the balance of probabilities what is really a hypothetical question: What would CGU have done had the various relevant matters been disclosed? This involves effectively making a decision as to which were or were not factors which would have caused CGU to take a particular approach. 281 In almost whatever way one approaches the matter there are difficulties posed for the Court by the way in which the parties elected, for forensic reasons, to present their cases. These difficulties concern the evidence given by Mr Acance in particular, but also the evidence given by Ms Cuthbert. Both parties were from time to time able to draw comfort from particular answers given by these two witnesses. There was certainly a plethora of material to permit either senior counsel to move around between the sundry factors which had been put to these witnesses as assumptions, and sometimes, as assumptions to be made in conjunction with the making of other assumptions. The Court's task is made more difficult by the way in which each witness was asked to comment on a large number of overlapping but at times divergent assumptions, not all of which were ultimately central to the defendant's case. 282 Ultimately the case put by the liquidator was that the evidence of both Mr Acance and Mrs Cuthbert should not be accepted to the extent that their evidence was that if they had known all or some of the factors put to them as assumptions, they would only have issued a renewal of the policy with the insolvency exclusion. The liquidator's case took into account particular approaches shown to have been taken in a number of underwriting files where no insolvency exclusion had been insisted upon. Further the liquidator's case heavily rested upon the proposition that it was not possible for Mr Acance nor Mrs Cuthbert to put out of their minds the matters which they came to know subsequently and could not have known at the time. The liquidator's case was that the matters which had been identified by Mr Acance and Mrs Cuthbert as 'concerns about Arimco', were in fact not matters with which they were at all concerned based upon the approach they took to the material that was supplied to them in December 1998. 283 It has to be said that whilst Mr Acance was not always consistent in the answers which he gave under cross examination, and although he had to correct himself on occasion, by and large he presented as an extremely competent witness with sufficient experience in the discipline which constitutes his expertise to have been able to explain his position quite comfortably throughout the cross examination. Bearing in mind the proper approach to the difficult task of making every effort to avoid reconstruction by use of the benefit of hindsight, and taking into account the many matters which Mr Acance was asked to assume and on which he was asked to base a deal of his evidence, yet still the balance of probabilities favours accepting his evidence as reliable. 284 The Court accepts that certain of the answers given in cross examination of Mr Acance favoured the liquidator's case. But the cross examiner's questions in relation to those answers were extremely carefully elicited, again with an eye to quarantining one or other particular area for close consideration. Nonetheless, the difficulty for the liquidator is that there remained many significant areas where Mr Acance could not be shaken from his evidence that, had particular matters been disclosed, he would not have issued the policy without an insolvency exclusion. These areas include the Rothschild review and the use of rights issue funds to pay general creditors. 285 Under cross examination Mr Acance was challenged in relation to the evidence that he had given that had there been any indication that Arimco might have financial difficulties or become insolvent during the period of the insurance, he definitely would not have approved the renewal on the same terms but would have offered the insolvency exclusion. It was put to him that he would not have offered the insolvency exclusion merely if he had perceived that Arimco might have financial difficulties in the Policy year. His answer was that this was incorrect [transcript 358]. 286 Although Ms Cuthbert obviously had problems in recalling the detail of a number of the events of the time, I formed the view that she was careful in her endeavours to acknowledge where she was unsure and generally gave reliable evidence. 287 Even though one remains in the world of speculation and reconstruction, the balance of probabilities heavily favours the Court's finding that these answers are reliable. The real problem with the liquidator's case inheres in the strength of the evidence that material matters were not disclosed and [notwithstanding some success in cross examination, of Mr Acance in particular] its inability to successfully challenge his central tenet [stemming from his sharp eye for accurate answers to question 10 of the proposal] that he would have treated the application quite differently had a positive answer been given to this question. In short, the disclosure to him of the sundry indicators [set out in these reasons] that Arimco was in a precarious financial position, and might have financial difficulties or become insolvent during the period of the insurance would have resulted in his not having approved the renewal without an insolvency exclusion. The Leighton claim 288 The one exception to the general acceptance of Mr Acance's evidence is with respect to the Leighton claim. 289 Ms Cuthbert's evidence in respect to the Leighton claim was that, if she had been made aware of the claim she would have raised it with Mr Acance and asked for further information. When further details surrounding the claim were put to her on cross examination, she admitted that it was possible that the policy would have been issued with a specific exclusion for the Leighton claim, and without an insolvency exclusion. She maintained, however, that she would have raised the matter with Mr Acance and been guided by him. 290 Mr Acance gave evidence that if he had been aware of claim by Leighton against the company then [even if no other relevant matters had been disclosed] he would only have agreed to approve the renewal with an insolvency exclusion. His evidence was that he regarded this claim as a major risk, as he knew Leighton by reputation as a strong litigator that would not back away from litigation. 291 The finding is that, on this issue, Mr Acance's evidence was contradicted by relevant documentary evidence. Specifically, Mr Acance was taken on cross examination to a document described as 'Underwriting File 7'. This file concerned an application for insurance approved by Mr Acance in which the company seeking insurance had disclosed that they were facing a claim against them for NZ $60.5 million, which exceeded their shareholders equity of $47.4 million. The file demonstrates that in this case, Mr Acance expressly considered imposing an insolvency exclusion, but rejected this in favour of a specific exclusion of the claim. 292 Mr Acance's explanations for the approach in Underwriting File 7 was that the reason for this specific exclusion was that there would not be an aggregation of the claim from one year to the next, that the insured had $39 million sitting in the bank, and that if there was any insolvent trading claim it would only extend over a very short period on the basis that if they lost the claim they would have to pay the money immediately. 293 But the better evidence is the blackboard note made by the underwriter on the underwriting file after discussing the notified claim with Mr Acance – to the effect that the standard specific exclusion used by CGU would protect it in the circumstances. The terms of that standard exclusion were certainly wide enough to cover any indirect claims arising from the insolvency caused by the notified claim. Whether that was correct or not, the evidence is that that is what CGU believed was the case and that application of the specific exclusion was its practice as demonstrated by the evidence of the underwriting file. 294 Given the concerns expressed above about the reliability of witness testimony which has been degraded by time and affected by hindsight, and despite the finding that Mr Acance's evidence was honestly given and for the most part highly reliable, the documentary evidence with regards to this issue must be preferred. Conclusion as to CGU's position had the relevant matters been disclosed 295 The balance of probabilities is in favour of CGU [had it known all the material facts which should have been disclosed] not having renewed the policy without imposing the insolvency exclusion. 296 With respect to the Leighton claim, the finding is that had the Leighton claim alone been disclosed to CGU, the probabilities are that CGU would have issued the policy with a specific exclusion for the Leighton claim. The effect of sub-sec. 6(4) of the Law Reform (Miscellaneous Provisions) Act 297 By reason of the above findings it becomes strictly unnecessary for the Court to deal with the arguments put forward by CGU resting upon the basis of sub-section 6(4) of the Law Reform (Miscellaneous Provisions) Act 1946. 298 Nonetheless against the prospect that the matter may go forward on an appeal I propose to deal with at least certain of the contentions put by CGU. 299 Sub-section 6(4) provides: "(4) Every such charge as aforesaid shall be enforceable by way of an action against the insurer in the same way and in the same court as if the action were an action to recover damages or compensation from the insured; and in respect of any such action and of the judgment given therein the parties shall, to the extent of the charge, have the same rights and liabilities, and the court shall have the same powers, as if the action were against the insured . …" (emphasis added) 300 CGU has contended and I accept that: i. CGU has the same rights as the insureds, i.e. the same rights as the directors: this is a protection for the insurer built into sub-sec. 6(4): see Bailey v New South Wales Medical Defence Union Ltd (1995) 184 CLR 399 at 447.7 per McHugh and Gummow JJ; Brennan CJ, Deane and Dawson JJ agreeing at 415.9. ii. The purpose of the subsection is to assimilate proceedings against the insurer to those against the insured: Kinzett v McCourt (1999) 46 NSWLR 32 at 49 [89] per Spigelman CJ. iii. The insurer "is put into the shoes of its insured": Ratcliffe v VS & B Border Homes Ltd (1987) 9 NSWLR 390 at 397 (Hunt J); see also Almario v Allianz Australia Workers Compensation (NSW) Insurance Ltd (2005) 62 NSWLR 148 at 155 [38] (Ipp JA; Hodgson JA and Hunt A- JA agreeing) and the cases there cited. iv. For present purposes, those "shoes" are shaped by the Terms. 301 CGUs submits and I accept that the effect of the Terms is as follows: a) the directors agreed to the entry of judgment against each of them in the amount of $15,000,000 (clause 1(a)); b) the following amounts were to be paid to the liquidator within 7 days of the liquidator's confirmation of creditor approval under sec.477 of the Corporations Act : 1. $270,000 from Messrs Swan, Smith and Roberts; 2. $30,000 from Ms Stubbs; 3. $20,000 from Mrs Pearce, qua the executor of the estate of Mr Pearce (clause 2(a) (i)-(iii)); c) Messrs Swan, Smith and Roberts agreed to pay a further $180,000 within 28 days of the termination of the proceedings in favour of CGU (clause 2(a) (iv)). This payment will not be required if, and only if, the directors perform their obligations under the Agreement and the liquidator either obtains judgment against CGU or reaches a compromise with CGU (clause 3); d) the liquidator agreed (subject to clause 3, dealing with the $180,000) not to enforce the balance of the judgment against directors who performed all of their obligations under the agreement (clause 2(b)); e) the liquidator agreed to discharge the judgment if, and only if, the proceedings terminate in favour of the liquidator, the liquidator reaches a compromise of the proceedings against CGU or the proceedings terminate in favour of CGU (clause 4); f) the Agreement was conditional upon the liquidator obtaining the approval of creditors under s 477 of the Corporations Act (clause 6). 302 Apparently it is common ground that: i. the directors complied with their obligation under clause 2(a): see Notice to Admit Facts dated 18 June 2008 and response [CB 8/2669-71]. This means that the liquidator has received payments totalling $320,000 and that they were made within the required period after creditor approval; ii. On 7 July 2006, judgment was entered. Orders were made requiring the directors to pay the liquidator $15,000,000 [CB 8/2550]. Dealing with the first group of submissions 303 The first submission explains the effect of the terms and their subsequent performance as follows: a) First , the liquidator has received $320,000 pursuant to clause 2(a) (i)-(iii). b) Secondly, the liquidator would be entitled to a further $180,000 pursuant to clause 2(a) (iv) within 28 days of any termination of the proceedings in favour of CGU . c) Thirdly , whilst there is a judgment in the sum of $15,000,000 against each of the directors, the liquidator cannot enforce that Judgment. 304 There are then said to be are several reasons why the liquidator is unable to enforce the judgment: a) The first reason is that it is a condition precedent to the enforcement of the judgment that a party have failed to perform all of his or her obligations under the Terms (clause 2(b)). That condition has not been satisfied. The directors were obliged to consent to the entry of judgment and to pay the amounts prescribed in clause 2(a). As noted above, they have done so. It follows that the liquidator cannot enforce the judgment against the directors. b) The second reason is that the condition referred to above [dealing with the undertaking to pay a further $180,000 within 28 days of the termination of the proceedings in favour of CGU and the circumstances in which that payment would not be required] can only be not complied with if CGU is found to be not liable to the liquidator. Accordingly, on the assumption, upon which consideration of the effect of the Terms must logically be approached that CGU is otherwise liable to the liquidator, there is a now unconditional restriction upon the liquidator enforcing the $15m judgment. c) The third reason is that the liquidator has agreed to discharge the judgment. By clause 4 of the Terms, the liquidator agreed to discharge the judgment if one of the following events occurs: i) the proceedings terminate in favour of the liquidator; ii) the liquidator reaches a compromise of the proceedings against CGU; or iii) the proceedings terminate in favour of CGU. Decision 305 In my view the third of these reasons is of substance. Critically these three events cover the field of possible outcomes. It follows that the liquidator has agreed to discharge the judgment regardless of the outcome of the proceedings. 306 In the result liquidator is seen to have contracted for the entry of a judgment but has: i. relevantly agreed not to enforce the judgment and ii. agreed to discharge it in any event. The further alternative arguments put by CGU 307 To my mind it is unnecessary to determine either the substance of the contentions set out above as the 'first' and 'second' reasons why the judgment could not be enforced nor the further alternative arguments put by CGU. I propose however to shortly summarise those further arguments. 308 The second and alternative argument runs as follows: i. In the event that the above argument about the enforceability of the judgment was not accepted by the Court, CGU put the following submission: a) the liquidator has compromised the proceedings against the directors for $15,000,000; b) the cause of action has merged into the judgment, and no longer has an independent existence: Chamberlain v Deputy Commissioner of Taxation (1988) 164 CLR 502; Blair & Anor v Curran (1939) 62 CLR 464 at 532 (Dixon J), Port of Melbourne Authority v Anshun Pty Ltd (1981) 147 CLR 589 at 597, 611; c) CGU stands in the shoes of the directors and the liquidator cannot recover more than $15,000,000 from it; 309 The third argument is that the authorities support the proposition that it would not be conscionable to permit an insured or a third party [as plaintiff with leave to proceed under the Law reform miscellaneous provisions Act 1946, s 6] to allege against the insurer a matter which contradicts the basis upon which the plaintiff's entitlement to recover from the insurer was determined. In short the proposition was that a plaintiff was not permitted to approbate and reprobate. Particular reliance was placed upon VACC Insurance Co Ltd v BP Australia Ltd [1999] NSWCA 427: at 27-32. 310 CGU contended that the approach taken by the liquidator to this litigation indeed involved the taking of inconsistent stances where the liquidator was seen to have approbated and reprobated. The argument runs by commencing with the proposition that CGU is to be pictured in the shoes of the insured, namely the directors. The proposition is that the liquidator, as third party plaintiff, is seen to have reached an agreement with the insured to take a limited amount: albeit at the same time denying that agreement when it comes to sue the insurer. Dealing with the section 588G and 588M issues The principles 311 Pursuant to section 588G(2) of the Corporations Law the plaintiff must prove facts which gave a person seeking properly to perform the duties of a non-executive director of the company reasonable grounds to say: "I suspect that the company is insolvent": Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115 at 124 (with due modification to take account of the wording of the current section). In Australian Securities and Investments Commission v Plymin (2003) 46 ACSR 126, Mandie J said (at [423]: "Reasonable" in this context imports the standard of reasonableness appropriate to a director of reasonable competence and diligence, seeking properly to perform his duties as imposed by law (when viewed as a whole) and capable of reaching a reasonably informed opinion as to a company's financial capacity. In other words, facts and matters must be shown to exist which would give grounds for a director acting in accordance with that standard to suspect insolvency. 312 For the purposes of section 588G(2)(a) the plaintiff must prove that the directors were aware of certain matters and facts giving rise not to an actual suspicion of insolvency but which constituted reasonable grounds for such a suspicion: Plymin at [426]. Statements by the directors as to whether and when they actually formed a suspicion are therefore irrelevant. 313 For the purposes of section 588G(2)(b) it is sufficient that a reasonable person in a like position to the particular director in the company, in the company's circumstances, would be aware of the facts and matters constituting reasonable grounds for suspecting insolvency, and it does not matter that the director was not actually aware of the of those facts and matters. Sub-section 588(2)(b) applies to cases where the directors did not know of the relevant facts and matters because they had failed to ascertain them, but a reasonable person in a like position would or ought to have ascertained those facts and matters: Plymin at [426]. 314 Section 95A of the Corporations Law defines insolvency as inability to pay all the person's debts as and when they become due and payable. Suspicion of insolvency therefore depends on the view a reasonable director would take, not just of the balance sheet, but of the existing debts, the time when they are all due to be paid and the company's present and expected cash resources (see Ford, Principles of Corporations Law, 13th ed (2007) at [20.100]). 315 The type of suspicion required to be found for the purposes of section 588G(2) is more than a mere wondering as to insolvency; it requires a view or a mistrust of appearances as to ability to pay debts to be formed, even if the evidence is insufficient to warrant a positive belief: ASIC v Plymin at [427]. Belief in insolvency on the balance of probabilities is not the test. The preconditions for liability 316 The preconditions for liability set out in section 588G(1) were established by the evidence. The relevant defendant directors remained directors of Arimco throughout the period when the debts relied on by the plaintiff were incurred, save for Mr Ryan who resigned as a director on 4 March 1999 and Mr Roberts and Mr Smith who became directors of Arimco on that date. 317 CGU has admitted that Messrs Roberts and Smith, in their capacity as directors of ARL throughout the relevant period, acted as directors of Arimco as well due to the control ARL exercised over the management of Arimco. CGU has also admitted that Ms Anderson, though not an appointed director, was a "director" in the extended meaning of that term under the law. 318 The directors were aware of the following matters during January 1999 or at least by the time of the Board meeting held on 3 and 4 February 1999 or shortly thereafter: i. severe disruption of mine production due to: a) bad weather; b) machinery and equipment; c) low grade ores; d) a delay in shipment of copper concentrate (as reflected in the November Financial Overview at the 3 February 1999 Board meeting; the directors had been aware that a delay would occur since the 30 October 1998 Board meeting. ii. ARL/Arimco suffered a loss of $5.45 million in January 1999, was suffering cashflow difficulties and the rights issue funds, except for the $5.2 million on deposit with Rothschild, had been used to pay creditors (reported to the directors at the 3 February Board meeting); iii. ARL/Arimco was not paying creditors as and when debts fell due (cashflow document dated 23.12.98 at CB 13/4320 indicating the need to withhold funds from week to week up to 16/2/98 which a reasonable person in the directors' position would have been aware of during January 1999); iv. the continuing drop in the copper price and its effect on ARL/Arimco (this was also reported to the directors at the 3-4 February 1999 Board meeting); v. on 4 January 1999 Ms Anderson circulated to the directors a Treasury report for December 19998 which advised them that there was no hedging in place to provide any protection against the falling copper price. 319 ARL had withdrawn $2.36 million of the rights issue funds invested with Colonial State Bank as early as 4 January 1999, and a further $3 million invested with Colonial State Bank on 1 February 1999. These funds were used to pay creditors and were (for the first time) not reinstated, resulting in the net cash position of the group moving from $10.55 million as at 31/12/98 to $5.2 million as at the date of the February Board meeting. 320 The finding is that a reasonable person in the position of the directors would have known of these transactions during January 1999. 321 As stated above, the evidence of the directors as to whether they had actually formed a suspicion of insolvency is not relevant to the questions to be determined under section 588G(2). Under that section the question is whether the facts and matters either known or which would have been known formed reasonable grounds for such a suspicion. 322 The evidence establishes that at or shortly before the February Board meeting (the Board papers being circulated to the directors a few days before each such meeting), the directors were made aware that: i. the cash available to ARL had reduced from $11.017 million as at the end of December 1998 to $5.2 million held on deposit with Rothschild; ii. the main reason for the reduction in available cash was that most, but not all, creditors due to be paid in January had been paid from the cash on deposit largely related to the rights issue raising in September 1998, and those funds had not been repaid and there was no immediate cash to repay them; iii. as at the end of December 1998 there were current liabilities to creditors of $27,294,000 (not including the Rothschild facilities), and overall current liabilities of $43.05 million. Current assets included only $925,000 in receivables, and there was a deficit in working capital of $1.663 million. Receivables had markedly declined since the figure of $6.4 million in September 1998; iv. there was no operative hedging in place for gold or copper; v. the January gold shipments had 'dropped off'; vi. the failure of the copper ship to arrive in January, a matter known to the directors in January 1999 ; vii. the copper price had continued to fall during January; viii. in light of there being no current reliable budget projections, there was no immediate ability to easily raise borrowings. 323 The knowledge of these matters gives rise to a reasonable suspicion that Arimco was insolvent. 324 From 1 February 1999 the directors of Arimco were either aware of facts and matters giving rise to a reasonable suspicion of Arimco's insolvency (section 588G(2)(a)) or a reasonable person in their like position within ARL in its circumstances at the beginning of February 1999 would have been aware of facts and matters giving rise to a reasonable suspicion of insolvency (section 588G(2)(b)). 325 The finding is that Arimco was insolvent as at 1 February 1999 and remained so during the period. Short minutes of order 326 The parties are to bring in short minutes of order, on which occasion costs may be argued. Appendix Earlier in these reasons I indicated that an appendix at the end of the reasons would set out the sundry matters which Mr Acance had been asked to assume as correct as at November and December 1998. Those matters were as follows: MINING INFORMATION: MAJOR FACTORS Reserves and Resources 1. Since June 1998 there had been downward revisions of the Reserves and Resources estimates at ARL's two largest mines: (a) The estimation of probable reserves at Mt McClure Mine had been revised downwards by about 50% in December 1998; and (b) The estimation of reserves at the 276 mine at Selwyn had been revised downwards by about 50% in December 1998. Rothschild review 2. Rothschild was the ARL Group's financier. They were in the process of conducting 'a thorough review of the three mines'. By a letter dated 9 November 1998 Mr Bruce Spencer of Rothschild Australia had informed ARL that in his opinion the September 1998 results indicated future cashflow problems for the Selwyn Mine and in his opinion the mines had short lives of 12-17 months. 3. In combination with the letter of 9 November 1998, by a letter dated 8 December 1998 Mr Spencer had informed ARL that in his opinion based on the results for the 4 months to October 1998 Selwyn had notional negative cashflow of approximately half a million dollars per month and requested a meeting with ARL to discuss strategies. 4. ARL was not in a position to provide to Rothschild the life of mine budgets based on current reserves that Rothschild had requested in its letter dated 9 November 1998. Financial reporting 5. By 26 November 1998 there had been changes in the operations at and the future plans for each of the mines, such that the cashflow forecast did not accurately reflect all the actual areas being mined, or the future plans for Mt McClure or the reduced profitability at Selwyn due to the low copper price. 6. At the board meeting on 26 November 1998 the directors had called for a 'revised budget' or cashflow forecast to be prepared and financial forecasts were 'postponed until the more realistic site re-forecasts are completed'. Meantime the Board had no current financial forecast to 30 June 1999. Mt McClure 7. At Mt McClure it was planned or contemplated to proceed with a further open pit cutback. A further cutback would require substantial capital expenditure at the early stages including for waste stripping in the region of $5-10 million. Negative Cashflow 7A. The Group had a major cashflow deficit of over $8 million as at the end of November 1998. 8. - OTHER RELEVANT INFORMAITON General 9. By December 1998 there had been changes which adversely affected the operations of the mines and the profitability of the Group such that the position was not as optimistic as suggested by the ARL Annual Report 1998. 10. - 10A. The monthly cashflow from ARL's mines to November 1998 was (approximately) as shown on line 9 of Appendix 8 (Annexure D to this affidavit). Rothschild review 11. - 12. If the outcome of the Rothschild review was adverse, Rothschild would not be likely to extend the expiry of its facilities due in July 1999 and the McClure Facility repayments would commence in January 1999 at $500,000 per month. Selwyn Mine 13. Copper sales provided about 60% of Selwyn's revenue. By November/December the US$ copper price had fallen to approx 10% below forecast. ARL's FX hedging was not offsetting the price falls due to a raising A$. 14. US$ copper prices had been falling since July 1998 and by December 1998 the price of copper at about US$ 0.67 cents/lb was below US$1500 per tonne which was a 12 year low. 15. Selwyn profitability had been trending down since July 1998 with negative cashflow over the period October to December 1998, including a loss of $1.2 million in October 1998 against a forecast loss of $127,000. 16. The falling copper price was reducing the profitability of the Selwyn Mine which could be losing in the region of 500,000 per month. 17. At Selwyn gold accounted for the balance of about 40% revenue. The 276 deposit was one of Selwyn's major ore sources. It was budgeted to produce relatively high head grades. 276 grades had been falling since October and were well below budget. 18. The Annual Report had described 276 as having potential for expansion however it had not lived up to its promise. By December 1998 the 276 reserves had been downgraded by about 50% and these would likely be exhausted by about July 1999. 19. Selwyn Mine had become unprofitable and might need to be put on care and maintenance within the next 12 months if the copper price did not improve, or it continued to fall. C & M costs could be around $10 million. Mt McClure 20. The Annual Report had stated that 1999 production would come from the 'high-grade underground operation' at Cockburn Deeps and that 'work is well in hand to see this project in production by early 1999'. However the results were not achieved at the early development stage and in December the project had been abandoned. 21. Mt McClure reserves and resources schedule had been revised downwards in December 1998 with substantial downward revision of the Cockburn Underground resources. 22. Instead it had been decided to proceed with the Cockburn Open Pit Cutback stage 3. This was a complete change in direction of mining at Mt McClure, from an underground operation expected to produce high-grade ore to a further cutback of the pit which would produce lower grade ore. 23. The then current open pit operations (stage 2) were scheduled to complete in February or March 1999 and the stage 3 cutback was not expected to come into significant production until about July 1999. IN the meantime Mt McClure production would drop significantly. 24. Rothschild had expressed "low confidence' in the stage 3 cutback and the decision was likely to have an adverse impact on the annual review in progress by Rothschild. Gidgee 25. The Annual Report had stated that production would come from the high-grade underground operation at Swan Bitter Deeps however the reserves were only sufficient for about 6 months. 26. The Annual Report had stated that production would come from Mt Townsend however the grades were well below the 6.6 g/t budgeted and stated in the Annual Report. 27. Gidgee was below forecast and had exceeded its exploration budget by about $100,000. 28. Gidgee Mine would be exhausted by about mid 1999 and would need to be closed within the next 12 months. Closure costs would be substantial. His evidence was that had he been aware of the information listed under 'Other Relevant Information', he may have offered renewal terms with an insolvency exclusion and a lower limit of liability for some of those items in combination with some of the other items. FINANCIAL INFORMATION: MAJOR FACTORS 1. The ARL directors had recognised that the Group's financial forecast needed revision, and had called for a revised budget and re-forecasting from the mines. Until that was done, the Board had no accurate financial prediction for the next 6 – 12 months. 2. ARL Group's cash resources (excluding the rights issue proceeds) had reduced by $3.034 million between 1 July 1998 and 31 October 1998. 3. In combination with item 4 below, that Group net current assets (excluding the rights issue proceeds) had fallen to a negative $2.169 million, whereas they were positive at 30 June 1998. 4. There was potential for ARL to breach the covenants in its facilities with Rothschild and not be able to correct the breach (being the shareholders equity covenant and/or project life ratio covenant and/or loan life ratio covenant). 5. ARL had been given notice of a claim in the region of $13-$15 million by Leighton and the Group did not have the funds available to pay a claim of that magnitude. 5A. The Group had a major cashflow deficit of over $8 million at the end of November 1998. OTHER RELEVANT INFORMATION Selwyn 6. The copper price had fallen so low that it was adversely affecting Group profits and liquidity. 7. The Group's copper hedge contracts had become inoperative. 8. Selwyn profitability had been trending down for the last 4 months prior to November with an unbudgeted loss of about $1.2 million in October. 9. The fall in the copper price had potentially reduced the carrying value of the Selwyn Mine by about $43 million on a pre-tax basis. 10. The Selwyn mine was losing approximately $500,000 or $900,000 per month. If Selwyn were placed on care and maintenance, this would result in redundancy payments, crystallise the hedging losses which in March 1999 were around $6.4 million and require the repayment of the Glencore loan which in February 1998 was around $2.3. The Group was not able to make these payments. A sale of the Selwyn mine was seen as unlikely. Mt McClure 11. The Cockburn Deeps project, which has been reported as a major project in the Annual Report, was not proceedings. Gidgee 12. The head grade being achieved at Gidgee was significantly below budget. General 13. The Group's operations were behind budget. 14. There had been an overall deterioration in the financial position from a profitable company to a company that was making losses. 15. The Group made a low of $1.037 million in November 1998 against a budgeted profit of $1.014 million, a variance of over $2 million. 16. - 17. - 18. The Group was facing severe liquidity problems towards the end of a calendar year 1998, in combination with item 19. 19. ARL was beyond the extended payment terms for some of its creditors and was holding back cheques each month, in combination with item 18. 20. - 21. - 22. - Rothschild Review 23. Rothschild, who was the major source of debt funding to the Group, was in the process of reviewing ARL's facilities at the end of calendar year 1998. The initial indications, as evidenced by faxes of Mr Spencer dated 9 November 1998 were not favourable. 24. A negative review might bring about the following result: (a) the expire date for the McClure Facility of $5.2 million would be 31 July 1999 and little likelihood that the facility would be termed out. (b) the expire date for the $3.5 million Multi-Option Facility agreement (Overdraft Facility) would revert to 31 July 1999. (c) repayments of $500,000 per month would be due commencing January 1999, under the Multi-Option agreement. Decrease in value of mining assets 25. The copper price had fallen to a ten year low with a consequential reduction in the value of the Selwyn mine sufficient to affect the ratios in the Rothschild Facilities. 26. The half yearly report for the period ended 31 December 1998 recorded a reduction of $25 million ($16 million on an after tax basis) in the carrying value of Selwyn. This had the effect of reducing the net worth of the Group from $139.121 million to $123.121 million. 27. The Annual Report reflects the carrying values of the mines at $115.798 million. A valuation of $57 million would have necessitated a write down of $58 million, which would have reduced the net assets of the Group from $123.121 million to $65,121 million. Potential breach of the Rothschild covenants 28. The cashflow forecast considered by the Board at its meeting on 26 November 1998 predicted that the current ratio would fall below a ratio of 1, the ratio required by the Rothschild facility. 29. By 31 December 1998, the current ratio was 0.92, which was below the ratio of 1 required by the Rothschild facilities (a temporary waiver had been given by Rothschild). 30. Using the gold and copper prices at November, the value of Selwyn according to the Table was about $15 million (excluding exploration potential). At this value there would be a potential breach of the covenant in the Rothschild Multi-Option Facility concerning shareholders equity, which required the net worth of the Group must not fall below $100 million. 31. When ARL went into administration, Mr Roberts (director) provided valuations of the mines at Selwyn $20 million, McClure $30 million and Gidgee $7 million. On these valuations, the Group would be in breach of its net worth covenant with Rothschild. 32. A breach of the covenants might result in an unfavourable review and would also constitute an event of default. This could result in Rothschild demanding immediate repayment of the funds that it had advance to the Group. Limited sources of further funding 33. There was little chance that sufficient short-term funding was available to alleviate the Group's liquidity problems. 34. By November and December 1998, the Group had limited alternatives available to it to extricate itself from its financial difficulties. Exploration 35. The Group was dependent on continuing exploration because of "relatively short mine lives". Successful exploration was essential to prove up resources to reserves and extent mine life. 36. If the rights issue funds, which were earmarked for exploration were used to pay creditors, as occurred in about January 1999, ARL would be unable to delineate further reserves and this would have adverse consequences for the future operations of the Group. Contingent liability 37. The receipt of a $15 million claim from Leighton indicated a material contingent liability. The costs of defending the claim, which included the costs of hiring consultants to investigate the claim, would place further pressure on the Group's cashflow position.] ************* 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. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated.