The point at which a company becomes insolvent is not always clear. The Courts will consider “various indicia of insolvency”, including the company’s ability to raise further capital and access to alternative finance. In some situations, a director or related entity may be willing and able to contribute funds to the company to allow it to pay its debts. This can affect whether a company is viewed as solvent or not. Once insolvency is reasonably suspected, directors must prevent the company from incurring further debts or risk being held personally liable for the debts incurred. The Federal Court in Trinick as Liquidator of Forgione Family Group Pty Ltd (in liq), in the matter of Forgione Family Group Pty Ltd (in liq) v Forgione [2015] FCA 642 recently considered these issues.

FACTS

Forgione Family Group Pty Ltd (Company), was incorporated in 1989 and carried on business offering printing services and later a hairdressing salon. Debts began to accrue in 2001 when the company failed to pay debts owed to the Australian Tax Office (ATO). In December 2004, the company was placed into liquidation. At that time, Mr Peter Forgione, the first respondent, was the only director of the company. His father, Mr Frank Forgione, the second respondent, had also been a director of the company until his resignation on 3 June 2014.

The liquidator, Trinick, commenced proceedings against the directors claiming personal liability by Peter and Frank Forgione (Forgiones) in the amount of $234,555.55, with Peter also being personally liable for $32,395.79 for the period in which he was a sole director.

The liquidator argued that the company was insolvent from 1 July 2001 to 20 December 2004 and therefore the Forgiones had engaged in insolvent trading. The Forgiones argued that at the time the relevant debts were incurred, they had reasonable grounds to expect that the Company was solvent and would remain solvent.

WAS THE COMPANY INSOLVENT?

In their defence, the Forgiones argued that the Company was solvent because Frank was ready, willing and able to provide such funding as required to enable the Company to pay its debts as and when they fell due.

The Court found there were numerous opportunities for Frank to demonstrate his willingness to put the Company in funds to pay its debts as and when they fell due. Although he may have proclaimed his intention, he failed to act consistently. Consequently, the Court found that the Company was insolvent from 1 July 2001 and the Forgiones were in breach of their duty to not engage in insolvent trading.

The Court considered whether the Forgiones had allowed the company to incur a debt when there were reasonable grounds for suspecting that the company was insolvent.

 The Court considered the term “suspecting” and referred to an explanation inQueensland Bacon Pty Ltd v Rees:

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.

The Court held the view that a person of ordinary competence would objectively have suspected that the Company was insolvent. The Court found that both the Forgiones had been, or should have been, aware that there were reasonable grounds to suspect that the company was insolvent.

DEFENCE TO INSOLVENT TRADING

Both men claimed that at all material times they had acted honestly in the performance of their duties so even if a contravention of insolvent trading had occurred, they ought to be fairly excused under a provision of the Corporations Actwhich would see them not be liable for the debts that the Company had incurred whilst it traded insolvently.

The Forgiones argued that the Company had engaged an external accountant, Mr Philpot of Lincolns, and they believed that he was fulfilling his responsibility for providing information about whether the Company was solvent. They alleged Lincolns had failed to inform them of the Company’s insolvency, and was late in preparing the company tax returns.

Frank made a number of assertions that the Court was not willing to accept, such as that he would have paid the ATO debt had he known the amount payable, and the only reason he did not supply funds to the company was on the advice of Mr Lean, the company administrator. Frank also claimed that he did not become aware of the company’s liabilities until mid-2004, because Mr Philpott and Lincolns had failed to inform him.

The Court was critical of the Forgiones attempt to “shift the blame” onto others and found the Forgiones had failed to provide Lincolns with the necessary information to permit Lincolns to prepare the tax returns, despite several requests. Also that Peter had failed to ensure that the company met its obligations to the ATO, he drew 122 cheques which were dishonoured and “was content to use the company’s funds for his own personal benefit, including for paying his personal credit card debts and purchasing a motor vehicle”.

The Court said that, despite knowing, from at least 2001 onwards, that the company was unable to pay all of its debts as and when they fell due, and that the ATO liability was increasing, Peter did not appoint an administrator until 1 November 2004, after the company received a winding up application. By then the company was hopelessly insolvent, and the appointment of an administrator did not prevent the company from going into liquidation.

Neither Frank nor Peter were allowed relief under s 1317S of the Corporations Act.

TAKE AWAY POINTS

The duties on directors when faced with insolvency are strict. A director is expected to be aware of the financial state of the company and to prevent further debts being incurred if they suspect the company is insolvent or face personal liability. A director cannot rely on another person where there is information available to the director which indicates potential insolvency, regardless of the knowledge or expertise of the person relied upon. Directors should be constantly mindful in this regard.