Turkalert winding up companies by contingent creditors (wtm)

Pieter Oomens and William Marsh | November 2013 | Commercial Disputes and Transactions

Zomojo Pty Ltd Pty Ltd [2013]

v Zeptonics FCA 1131.

In a recent Federal Court case leave was granted to a contingent creditor to wind up several debtor companies. Affidavits relied on by the debtors in other proceedings were successfully used by the creditor to help prove their insolvency.

Moreover, the debts – while contingent – were to be taken into account when assessing insolvency.

Background Under the Corporations Act, winding up proceedings may be brought by a contingent creditor if that creditor obtains the leave of the Court: s 459P(1)(b). Leave will be granted if there is a prima facie case that the company is insolvent: s 459P(3).

A contingent creditor is someone who is owed an existing obligation that will or might produce a debt at a future date or if some event happens.

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Winding Up Companies By Contingent Creditors

The plaintiff was a contingent creditor arising from a judgment on liability but in respect of which damages had not yet been assessed and costs orders that had not yet been taxed. The judgment (the ‘Liability Judgment’) arose from breaches of fiduciary duty by a former employee of the plaintiff. The debtors were companies that were held to have been complicit in such breaches and thus accountable for any profits obtained by them as a result. The Court, in those earlier proceedings, directed the debtors to produce affidavits deposing to such profits. Affidavits were served but they contained denials that there had been any profits. Some affidavits deposed to the fact that some of the companies had never traded and that others had traded at a loss. It was said for all of the debtors that there was no foreseeable prospect of their receiving any sales revenue.

The evidence – if accepted – would render the Liability Judgment and costs orders entirely Pyrrhic. The problem for the debtors was that they were outflanked: the plaintiff sought to rely on the debtors’ affidavits which when coupled with the Liability Judgment, costs orders and some other facts that came to light, proved that the debtors were, in fact, insolvent.

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Insolvency Under the Corporations Act, the test for insolvency is whether the company can pay all its debts as and when they become due and payable: s 95A. It is a cash flow test. The nature of a company’s assets, and the company’s ability to convert those assets into cash within a relatively short time to meet debts as and when they fall due and payable, must be considered in determining solvency. Commercial realities are relevant in considering what resources are available to a company to provide an income source out of which to meet its liabilities.

The debtors’ own evidence showed that none of them had an income stream, or any foreseeable prospect of a future revenue stream and none had a source of credit available. Further, their claim of solvency did not make any allowance for the contingent debts arising from the Liability Judgment and costs orders. One company did have cash at bank but it also had two loans to related entities. These loans were said to be long-term and non-recourse. Those latter assertions were found to be just that, ‘assertions’.

They were in any case at variance with the fact that a substantial payment had been made to one of those related entities shortly before the winding up of the hearing; the Court finding that the explanation for such payment being anything other than partial repayment of the debt to the related party, ‘implausible’.

Factoring In Contingent Debts When Assessing Insolvency The debtors argued that the liabilities arising from the Liability Judgment and costs orders should not be taken into account because nothing was yet due and payable (quantum was the subject of challenge and they had not exhausted their appeal rights). It was held that the fact that the debts were contingent did not mean that they were excluded from consideration. Determining insolvency for the purposes of a winding up application involves an element of looking forward and it is material to consider not only the debtors’ capacity to pay debts currently payable, but also their capacity to pay debts that would

become due and payable. As to their right of appeal argument, they had already failed in an application for leave to appeal and had made no attempt to satisfy the Court hearing the winding up application that any appeal against the Liability Judgment would raise genuine and arguable grounds.

The debtors’ evidence demonstrated that they did not have a present ability to pay any amount to discharge their debts nor any expectation to be able to pay their debts as there was no prospect of any improvement in their financial position. The one debtor that had cash at bank had extant current and non-current liabilities (the so-called ‘long-term loans’) that exceeded that cash balance. There was no cogent evidence before the Court that the long-term loans would not ultimately have to be repaid and it was clear that the debtor could not repay the loans now or in the future.

Conclusion The most common means used by creditors to procure the winding up of a debtor company is reliance on a statutory demand under s 459E of the Corporations Act. This is a device which requires the subject debt to be due and payable.

By definition a contingent debt is not due and payable.

However, a contingent creditor can procure a winding up of a company which has a liability to it as this case demonstrates. Moreover, contingent debts are to be taken into account when assessing insolvency.

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Pieter Oomens and William Marsh | November 2013

For more information, please contact: Pieter Oomens Partner T: 02 8257 5709 M: 0417 268 334 pieter.oomens@turkslegal.com.au

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Pieter Oomens and William Marsh | November 2013

William Marsh Lawyer T: 02 8257 5745 M: 0415 504 486 william.marsh@turkslegal.com.au

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