The insolvent trading provisions of the Corporations Law provide a number of defences to directors who may be sued by a liquidator on behalf of the company if the company engages in insolvent trading. One of the defences that are available to the directors is that there are reasonable grounds for suspecting that the company was not insolvent. That is an issue that has not been addressed directly in any reported section 588G or 588H case (these are the provisions which operate in relation to the insolvent trading provisions). However, the Full Court of the Supreme Court of Western Australia has recently delivered an important judgement in Levi v Gurlini ((1997) 24 ACSR 159) which provides some interesting observations on the question of what is meant by the phrase "reasonable expectation that a person is insolvent or not".
This is a case that dealt with preferences – the ability of a liquidator to recover money that had been paid to a creditor by an insolvent company on the basis that the particular creditor was being favoured by the insolvent company as against other creditors. For creditors, who received payment when insolvency looms for the debtor, to retain the money, they must be able to show (among other things) that when they received the money they did not appreciate that the particular company was insolvent. Did they have reasonable grounds for assuming that the payment was received in the normal course of business or that there was no insolvency involved? The court examined the question of what was reasonable in the context of the operation of the Corporations Law. The facts that concerned this particular transaction were these.
The relevant company (Benjamin Furniture Pty Ltd (Benjamin)) had entered into a series of deferred payment arrangements with various creditors including Timber Traders. The relevant payments under challenge were made pursuant to these arrangements. Timber Traders had indicated at about the time the deferred payment arrangements were entered into in September 1993 that it would only be prepared to continue to trade with Benjamin on COD terms. In fact that was the way in which trade had occurred from February of 1993. Previously Timber Traders had provided materials to Benjamin under a 30 day credit agreement.
The court looked at a number of facts including the history of the company's financial position over the previous few years and then had to examine whether Timber Traders was in fact acting reasonably. The relevant debt that had been paid to Timber Traders was $29,416.37. From the facts the court ruled that the amount had been outstanding for at least eight months.
Malcolm CJ on behalf of the Western Australian Full Supreme Court then went on to make these statements:
"It must have been apparent to [Timber Traders] that [Benjamin] was unable to pay its debts to Timber Traders as and when they fell due. [It was implicit from relevant documents that Benjamin] was borrowing money to repay its creditors, and had been unsuccessful in obtaining sufficient funds to make payment in full. ... The issue [before the court] was whether a reasonable person in the circumstances of Timber Traders would have had no reasonable grounds for suspecting that [Benjamin] was or would become insolvent at the time it became a party to [the relevant transaction]."
In the opinion of Malcolm JC the test that he should follow was the test adopted by Kitto J in Queensland Bacon Pty Ltd v Rees ((1966) 115 CLR 266 at 303):
"A suspicion that something exists is more than a mere idle wondering whether it exists or not; it is a positive feeling of actual apprehension or mistrust, amounting to 'a slight opinion but without sufficient evidence'. ... Consequently, a reason to suspect that a fact exists is more than a reason to consider or look into the possibility of its existence. The notion [which the words of the statute imply] is, I think, something which in all the circumstances would create in the mind of a reasonable person in the position of the payee an actual apprehension or fear that the situation of the payer is in actual fact that which the subsection describes – a mistrust of the payer's ability to pay his debts as they become due and of the effect which acceptance of the payment would have between the payee and the other creditors."
In the opinion of Malcolm CJ, the court at first instance in this case had been wrong to hold that Timber Traders did not have a suspicion. In his opinion:
"The inference is obvious that the change [from allowing payment on credit to payment on COD terms] reflected [Benjamin's] inability to carry out its obligations under [the arrangements]. ...
"In all of the circumstances, I have concluded that a reasonable person would have had reasonable grounds for suspecting that Benjamin was insolvent not only at the time when the agreement of the 1st of September 1993 was entered into but also at the time when each of the [relevant payments] was made."
In all of these circumstances Timber Traders was not able to keep the benefit of the payment which was set aside as a preference.
One suspects that a similar approach would be adopted in assessing the ability of a director to escape liability if he or she argues that he or she had reason to believe that the company was not insolvent and was able to pay its debts.
The issue was whether a reasonable person in the circumstances of Timber Traders would have had no reasonable grounds for suspecting that Benjamin was or would become insolvent...
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