Case: Hall v Poolman [2007] NSWSC 1330 ; (2007) 65 ACSR 123
Outcome: followed
cashflow test enables there to be taken into account in determining solvency or insolvency assets which are available to the Company which can be realised in order to answer indebtedness. However, there is a temporal limit upon this recourse. As Palmer J said in Hall v Poolman [2007] NSWSC 1330 ; (2007) 65 ACSR 123 at 163: "[187] An asset cannot be taken into account in assessing solvency at a particular time without reference to the time it would realistically take to effect realisation and produce cash. It is no indication of solvency indeed, it is the opposite to point to property as available to meet debts falling due next month when, even with the utmost expedition, that property cannot be turned into cash for 6 months. Realisable property can only be taken into account in assessing solvency "if that property is in such a position as to title and otherwise that it could be realised in time to meet the indebtedness as the claims mature": Bank of Australasia v Hall [1907] HCA 78 ; (1907) 4 CLR 1514 at [1907] HCA 78 ; 1543; 14 ALR 51 at 80; see, for example, Crema (Vic) Pty Ltd v Land Mark Property Developments (Vic) Pty Ltd (2006) 58 ACSR 631 ; [2006] VSC 338 at [141] - [144] per Dodds-Streeton J and Noxequin Pty Ltd v DCT [2007] NSWSC 87 at [14] and [15] per Barrett J. ... [265] The liquidators have focused on what they say is a critical gap in the elements of Mr Irving's defence. In order for the defence to succeed, there must be an expectation, held on reasonable grounds, that recourse to assets will enable debts to be paid, not at some indefinite time in the future, but so as to keep the companies solvent according to the definition in s 95A of the CA, namely, as the debts fall due to payment. It is not appropriate to base an expectation of solvency ( Sheahan v Hertz Australia Pty Ltd (1995) 16 ACSR 765 at 769): ... upon the prospect that [the company] might trade profitably in the future thereby restoring its financial position ... The question is whether the company at the relevant time is able to pay its debts as they become due not whether it might be able to do so in the future if given time to trade profitably ... [266] The law recognises that there is sometimes no clear dividing line between solvency and insolvency from the perspective of the directors of a trading company which is in difficulties. There is a difference between temporary illiquidity and "an endemic shortage of working capital whereby liquidity can only restored [sic] by a successful outcome of business ventures in which the existing working capital has been deployed": Hymix Concrete Pty Ltd v Garritty (1977) 13 ALR 321 at 328; 2 ACLR 559 at 566; Re Newark Pty Ltd (in liq); Taylor v Carroll [1993] 1 Qd R 409 ; (1991) 6 ACSR 255. The first is an embarrassment, the second is a disaster. It is easy enough to tell the difference in hindsight, when the company has either weathered the storm or foundered with all hands; sometimes it is not so easy when the company is still contending with the waves. Lack of liquidity is not conclusive of insolvency, neither is availability of assets conclusive of solvency: Expo International Pty Ltd (in liq) v Chant [1979] 2 NSWLR 820 at 837; 4 ACLR 679 at 718. [267] Where a company has assets which, if realised, will pay outstanding debts and will enable debts incurred during the period of realisation to be paid as they fall due, the critical question for solvency is: how soon will the proceeds of realisation be available: see the authorities cited at [187] above. Bearing in mind the commercial reality that creditors will usually prefer to wait a reasonable time to have their debts paid in full rather than insist on putting the company into insolvency if it fails to pay strictly on time, I think it can be said, as a very broad general rule, that a director would be justified in "expecting solvency" if an asset could be realised to pay accrued and future creditors in full within about 90 days." Having regard to the authorities and principles to which I have referred, I am satisfied that as at 31 December 2005 and thereafter throughout the whole of the relevant period up to 10 May 2006 the Company was insolvent. I have reached this conclusion by approaching the matter from a number of different directions. Mr Carroll acknowledged that he knew that he had a cashflow shortage after 31 December 2005. He also acknowledged that during the period from 31 December 2005 to 10 May 2006 the cashflow was tight in some months. He said that "some months the cashflow was very tight". In answer to the question whether the cashflow did not permit payment of superannuation contributions, he answered "yes". The significance of the time within which an asset can be realised in order to meet the liabilities of the Company was again emphasised in Hall v Poolman (supra) at par [187]: see par [107] above. The existence or availability of assets is not an answer to a claim of insolvency in the absence of any indication as to when, and to what extent, those assets can be pledged or realised. In order to have assets taken into account in determining the issue of solvency on a cashflow basis, it is necessary to establish that those assets are readily realisable in a short space of time: Hall v Poolman (supra) at par [267]. In the passage extracted at par [107] above, it is important to note that Palmer J referred to the realisation of an asset in "about 90 days" in order to pay not only accrued but also future creditors in full. Mr Carroll relied principally on the Company's inventory of stock to demonstrate the availability of a source from which cash could be obtained to pay existing debts. He submitted that in determining whether the Company was solvent at relevant times it was appropriate to take into account, and the Court was entitled to take into account, that at all relevant times it had timber stock on hand in excess in value of $1 million. Mr Carroll submitted that immediately prior to the commencement of the administration on 10 May 2006 the value of the stock had increased to in excess of $1.4 million. Mr Carroll relied upon Mr Bright's evidence, which he submitted was uncontested, that the timber stock could be realised by the Company as a going concern within two months. He submitted this was within the three month period referred to in Hall v Poolman (supra) at par [267] as the broadly acceptable timeframe for realisation of assets to meet debts. The value of the stock was contentious between the parties and Mr Bright's evidence must be treated with caution. Mr Bright did not undertake a stocktake valuation of the stock himself. He said that he was required "to allocate a value" to the existing stock on hand and he did so on the basis of an inspection. He did not attempt to confirm or ascertain the value of the stock otherwise than by what he called "a cursory look". I do not consider that I should take into account the total "value" of the stock as set out in either of the balance sheets or the stocktake figures referred to by Mr Carroll in determining whether on the dates of the balance sheets and stocktakes the Company was able to pay all its debts as and when they fell due. I also adopt, with respect, the observation of Palmer J in Hall v Poolman (supra) at 165: "[203] Solvency is a question of fact and in finding whether or not a company was solvent at a particular point of time in the past the court does not proceed upon possibility or speculation as to what might have happened when it has clear evidence as to what did, in fact, happen. ..." There was no other source available to the Company as at 31 December 2005 and throughout the relevant period which could have assisted the cashflow position of the Company to enable it to pay its debts as and when they fell due at that time. Plant and equipment as at 31 December 2005 had a value in the balance sheet of $1,447,972.76 and that value as at 9 May 2006 was not much different. Mr Carroll said that the value of the plant and equipment in the Company's accounts was arrived at by Mr Bright but Mr Bright did not give any evidence to that effect. Mr Carroll gave evidence that around April 2006 he had discussions regarding the obtaining of finance over equipment but these discussions did not proceed anywhere. There was no evidence before the Court that finance on the security of any of the plant and equipment of the Company was available. The next issue to determine is whether at the time the Company was insolvent there were reasonable grounds for suspecting that the Company was insolvent or would so become insolvent as the case may be: s 588G(1)(c). The test prescribed by s 588G(1)(c) is an objective test: Powell v Fryer [2001] SASC 59 ; (2001) 159 FLR 433 , Hall v Poolman (supra) at 174. The concept of "suspecting" or "suspicion" involves having a state of mind which falls between having a firm belief or a significant degree of satisfaction that insolvency exists on the one hand and wondering whether it exists on the other. The concept of having a "suspicion" requires an affirmative feeling: Hall v Poolman (supra) at 174. The distinction was explained succinctly in Tourprint International Pty Ltd v Bott (1999) 32 ACSR 201 at 215: "[67] "Expectation", as required by s 588H(2), means a higher degree of certainty than "mere hope or possibility" or "suspecting": 3M Australia Pty Ltd v Kemish (1986) 10 ACLR 371 at 378; Dunn v Shapowloff [1978] 2 NSWLR 235 at 249; (1978) 3 ACLR 775. The defence requires an actual expectation that the company was and would continue to be solvent, and that the grounds for so expecting are reasonable. A director cannot rely on a complete ignorance of or neglect of duty ( Metal Manufacturers Ltd v Lewis (1986) 11 ACLR 122 at 129) and cannot hide behind ignorance of the company's affairs which is of their own making or, if not entirely of their own making, has been contributed to by their own failure to make further necessary inquiries: Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405 ; Morley v Statewide Tobacco Services Ltd [1993] 1 VR 423 ; (1992) 8 ACSR 305. " This passage was approved by Palmer J in Hall v Poolman (supra) at 180. However, as I have noted earlier (par [107] above), whether a realisation of the stock or other assets can be taken into account has a temporal aspect or limitation to it. I adopt the observation of Palmer J in Hall v Poolman (supra) at par [187] (see par [107] above). Whether Mr Carroll had the relevant expectation depends upon the facts and circumstances known to him at the time, or throughout the period, he had that expectation. Whether Mr Carroll had reasonable grounds to expect, and did expect, that the Company was solvent throughout the relevant period and would remain solvent even if it incurred the debts during that period requires a staged inquiry. It was explained by Palmer J in Hall v Poolman (supra) at 182: "[269] There comes a point where the reasonable director must inform himself or herself as fully as possible of all relevant facts and then ask himself or herself and the other directors: "How sure are we that this asset can be turned into cash to pay all our debts, present and to be incurred, within 3 months? Is that outcome certain, probable, more likely than not, possible, possible with a bit of luck, possible with a lot of luck, remote, or is there is no real way of knowing?' [270] If the honest and reasonable answer is "certain" or "probable", the director can have a reasonable expectation of solvency. [271] If the honest and reasonable answer is anywhere from "possible" to "no way of knowing", the director can have no reasonable expectation of solvency. [272] If the honest and reasonable answer is "more likely than not", the director runs the risk that a court will hold to the contrary in an insolvent trading claim. [273] If the honest and reasonable answer is "no way of knowing yet, we need more information", the director must then ask: How long before we have the information so that we can give a final answer?" [274] If the honest and reasonable answer to that question is: "By a definite date which will not extend the realisation period (if there is to be one) beyond 3 months", the director may reasonably say: "Let's wait until then before deciding". [275] If the honest and reasonable answer is "there is no way of knowing yet when we will have the information to make a decision", the director must say: "Then there is no way that we can now have a reasonable expectation of solvency and there is no way we can reasonably justify continuing to trade without knowing when we will know whether the company is insolvent. Call the administrators". By this series of questions and answers I do not mean to lay down some pro forma test of directors' liability for insolvent trading. Each case depends on its particular facts. These questions and answers merely serve to illustrate that when a company is struggling to pay its debts, the directors must face up to the issue of insolvent trading directly and with brutal honesty: they must not shirk from asking themselves the hard questions and from acting resolutely in accordance with the honest answers to those questions." Mr Carroll advanced a number of grounds which he submitted were reasonable and which founded his expectation of solvency. Those grounds must be considered against the background that Mr Carroll knew throughout the relevant period that the Company was not in fact paying its debts as and when they fell due. I consider that whether Mr Carroll had reasonable grounds to expect that the Company was solvent during the relevant period depends substantially upon his reliance on the Company's inventory of stock and his reliance on communications with Mr Bright. Sections 1317S and 1318 are applicable to an insolvent trading claim such as has been brought in the present proceeding: Hall v Poolman (supra) at 191. Although there has been a debate as to whether s 1318 applies to an insolvent trading case in addition to s 1317S, it does not matter whether one or other or both sections apply as the Court is required to have regard to the same considerations in each section. I am satisfied that throughout the whole of the relevant period and, indeed, at all material times prior to 31 December 2005 Mr Carroll acted honestly. The plaintiffs did not submit to the contrary. In reaching this conclusion I have adopted the criteria for determining such honesty set out by Palmer J in Hall v Poolman (supra) at 193-194 in the following terms: "[325] In my view, when considering whether a person has acted honestly for the purposes of a defence under ss 1317S(2)(b)(i) or 1318 of the CA, the court should be concerned only with the question whether the person has acted honestly in the ordinary meaning of that term, that is, whether the person has acted without deceit or conscious impropriety, without intent to gain improper benefit or advantage for himself, herself or for another, and without carelessness or imprudence to such a degree as to demonstrate that no genuine attempt at all has been to carry out the duties and obligations of his or her office imposed by the Corporations Act or the general law. A failure to consider the interests of the company as a whole, or more particularly the interests of creditors, may be of such a high degree as to demonstrate failure to act honestly in this sense. However, if failure to consider the interests of the company as a whole, including the interests of its creditors, does not rise to such a high degree but is the result of error of judgment, no finding of failure to act honestly should be made, but the failure must be taken into account as one of the circumstances of the case to which the court must have regard under ss 1317S(2)(b)(ii) and 1318 of the CA." Having regard to all the circumstances of the case ought Mr Carroll fairly to be excused? Mr Carroll submitted that he should be excused in circumstances where he continued to take advice from Mr Bright and acted upon it. It was submitted that his approach to the Company's problems up to 10 May 2006 was that to be expected of a reasonable, commercially experienced director dealing with ongoing issues in a company which was suffering cashflow problems by reason of one of the Company's two businesses experiencing "cash burn". It was submitted that he sought and obtained advice from Mr Bright, an expert accountant experienced in the timber industry and that he did not ignore or downplay that advice, but acted upon it appropriately. The difficulty with this submission is that from September 2004 until 10 May 2006 the Company continued to have problems with the drying of the timber and the use of the kilns which it could not resolve. This had the consequence of creating what Mr Carroll called the "cash burn", which continued until 10 May 2006. It is not in doubt that throughout the relevant period Mr Carroll was faced with difficult decisions. To adopt and adapt the words of Hamlet "to trade or not to trade, that is the question". As I noted in par [148] above, Mr Carroll regularly during the relevant period asked the question whether the Company was insolvent or close to the line of being insolvent and on a number of occasions Mr Bright answered the question in the negative. That dilemma facing Mr Carroll brings to mind the observation of Palmer J in Hall v Poolman (supra) at 194: "[329] As I have discussed above at [266] and following, it is sometimes a difficult decision for a director of a trading corporation suffering from liquidity problems to decide whether, and when, to abandon hope of a change in the company's fortunes and to summon the administrators. There are often pressing interests involved in the decision: the jobs of employees will be lost, the investment of shareholders will evaporate, and a promising venture in which a great deal of personal effort may have been expended will end in failure. On the other hand, the livelihood of creditors whose businesses depend on reasonably prompt payment may also be ruined if a company continues to trade while insolvent. When confronted with the necessity of making a decision involving these factors, a director cannot afford to procrastinate or to avoid confronting realities. He or she must ask and honestly answer the hard questions: see [269] and following above". When finally confronted with the ultimatum from the Australian Taxation Office on 3 May 2006 Mr Carroll did not procrastinate. On the next day he spoke to Mr Bright who put him in contact with Mr McLellan and Mr Carroll met Mr McLellan three days later. The plaintiffs submitted that the fact that Mr Carroll persisted with the kiln drying business which involved cash burn and thereby permitted the Company to incur debts knowing that it could not meet those debts out of cashflow ought to preclude relief under ss 1317S or 1318 as he had been aware, for no less than eighteen months previously, of compelling factors pointing to the Company's insolvency. I have taken that submission into account and weighed it in the balance in having regard to all the circumstances of the case. However it is an exaggeration to say that there were compelling factors pointing to the Company's insolvency for no less than eighteen months prior to 10 May 2006. The potential insolvency facing the Company in June 2005 had been arrested in July 2005 by the capital contributions made by Mr Carroll and Mr Cameron. The spectre of insolvency did not re-emerge until the end of 2005, less than five months before 10 May 2006. There is no doubt that Mr Carroll permitted the Company to incur debts in circumstances giving rise to a contravention of s 588G of the Act. However, he did so against the background of all the circumstances to which I have referred in pars [193] [200] above. Mr Carroll did not profit personally from permitting the Company to trade in this way throughout the relevant period. He was not disregarding advice and, indeed, obtained advice from Mr Bright and others throughout the relevant period.