The Supreme Court of New South Wales on Insolvency and Sexually Transmitted Debt

The Supreme Court of New South Wales on Insolvency and Sexually Transmitted Debt; Southern Cross Interiors Pty Ltd v Deputy Commissioner of Taxation [2001] NSWSC 621

Many company directors will be aware that the Corporations Act allows company directors to recover preferences from creditors (ie money paid to creditors when an insolvent company is in its death throes). It is perhaps ironic that businesses with efficient credit control systems will often be on the receiving end of such claims by liquidators, should one of their customers become insolvent.

It is less well known that when a liquidator makes a successful preference claim against the Commissioner of Taxation, the commissioner may claim an indemnity against the directors of the insolvent company. The test applied by the Courts when the Commissioner claims such an indemnity is the same as that which applies to an insolvent trading claim by a liquidator against the directors of a company, and there are defences available to directors who are faced with a claim for indemnity by the Commissioner.

In Southern Cross Interiors Pty Ltd (in liq) v DCT & Ors [2001] NSWSC 621 the Supreme Court of New South Wales dealt with precisely this situation. Southern Cross, had traded as a carpentry and interior fit-out business. Mr and Mrs Clark were its directors.

The Deputy Commissioner of Taxation received a (late) payment of a taxation debt just prior to the commencement of the winding up of Southern Cross.

The Liquidator of Southern Cross made a claim against the Deputy Commissioner, and the Deputy Commissioner claimed indemnity from Mr & Mrs Clark.

The Deputy Commissioner defended the Liquidator’s claim, arguing that because creditors were willing to continue to extend credit and allow payment beyond their normal trading terms, Southern Cross was not insolvent when it paid its taxation debt. It was argued that a debt could be "due" and yet not "payable", because of leniency of creditors. The Court referred to this argument as an "incipient heresy" and held that the following principles apply:

whether or not a company is insolvent is a question of fact to be ascertained from a consideration of the company’s financial position taken as a whole
in considering the company’s financial position as a whole, the Court must have regard to commercial realities. Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security, and when such realisations are achievable:

in assessing whether a company’s position as a whole reveals surmountable temporary illiquidity or insurmountable endemic illiquidity resulting in insolvency, it is proper to have regard to the commercial reality that, in normal circumstances, creditors will not always insist on payment strictly in accordance with their terms of trade but that does not result in the company thereby having a cash or credit resource which can be taken into account in determining solvency;

the commercial reality that creditors will normally allow some latitude in time for payment of their debts does not, in itself, warrant a conclusion that the debts are not payable at the times contractually stipulated and have become debts payable only upon demand;

in assessing solvency, the Court acts upon the basis that a contract debt is payable at the time stipulated for payment in the contract unless there is evidence, proving to the Court’s satisfaction, that:

there has been an express or implied agreement between the company and the creditor for an extension of the time stipulated for payment; or
there is a course of conduct between the company and the creditor sufficient to give rise to an estoppel preventing the creditor from relying upon the stipulated time for payment; or
there has been a well established and recognised course of conduct in the industry in which the company operates, or as between the company and its creditors as a body, whereby debts are payable at a time other than that stipulated in the creditors’ terms of trade or are payable only on demand:
it is for the party asserting that a company’s contract debts are not payable at the times contractually stipulated to make good that assertion by satisfactory evidence.

In so doing, the Court has conveniently summarised an area of insolvency law that has proved difficult for Judges and legal practitioners for a number of years; just how is the leniency of and informal accommodation by creditors taken into account when assessing whether a company is insolvent?

The second issue dealt with by the Court was whether Mrs Clark had a defence to the Deputy Commissioner’s claim to indemnity against her. Her defence was that she did not participate in the management of Southern Cross, and this was for "a good reason".

This is yet another example of what has been referred to as "sexually transmitted debt". The evidence disclosed that Mrs Clark had no idea what being a company director involved. She didn’t know what the balance of the company’s cheque account was, nor did she ever see any company financials.

On the other hand she did sign documents from time to time, and even signed cheques, when they were put before her by Mr Clark to sign.

The Court held:

The civil law knows how to relieve people from the legal consequences of their acts or omissions according to well defined principles. Duress, non est factum, undue influence, deceit, misleading and deceptive conduct, and unconscionable conduct are but some of the bases upon which a Court acts to protect a person from the legal consequences and liabilities of his or her acts, whether voluntary or involuntary.

In my opinion, any reason which the law holds sufficient, according to accepted legal principle, to excuse a person from the legal consequences of his or her acts or omissions is a "good reason" for the purposes of a defence…

Further:

… if a woman already has some knowledge and experience of business and of the responsibilities of a company director before she accepts a directorship at her husband’s request, it will be very difficult indeed for her to convince the Court that she had a "good reason" for not participating in management simply because she left business matters to her husband. In those circumstances, she would be expected to know that her duties as a director overrode the exigencies of the marital relationship.

On the other hand, if a woman, inexperienced in business and completely unaware of the responsibilities of company directorship, is told by her husband, whom she trusts and believes to be honest and to be knowledgeable in such matters, that some formality requires her to be appointed as a director to a family company and that management of the company may be left entirely to him, then, in my view, she has a "good reason" for not participating in management for such time as she genuinely remains in ignorance of her duties.

It will be a comparatively rare case in which a wife is able to establish such a defence on the facts…