It’s tempting for a company director to not respond to a liquidator’s request to produce financial records if they contain incriminating material, but is it wise?  

In In the matter of Substance Technologies Pty Ltd [2019] NSWSC 612, a decision of the Supreme Court of New South Wales (24 May 2019), Justice Rees considered a liquidator’s application for orders that the directors personally pay some $170,000 to the company for debts incurred to the Australian Taxation Office (ATO) and Ausgrid whilst the company was insolvent, largely because they failed to keep / produce financial records.

The Facts

Until late 2013, Substance Technologies Pty Ltd (in liquidation) (the Company) operated a scrap metal yard at Cooma in New South Wales. From at least 2009, the Company rarely made a profit, and by 30 June 2013, had accumulated losses of $374,373, and an ATO account balance (BAS) payable of $13,929.36.

In early 2014 it purchased scrap metal from Ausgrid, but did not pay the invoiced cost of $78,463. On 2 January 2015, Christopher Thaler, the sole director of the Company resigned and his son Andrew Thaler was appointed director in his stead.

During Andrew’s directorship, Ausgrid entered judgment for the debt, and subsequently had the Company wound up on 27 June 2016.

The liquidator made 3 requests to Andrew to deliver the company’s financial records. Andrew ignored the requests.

The law on directors personal liability

The law makes company directors personally liable, if there is good reason.

Section 588G and related provisions [of the Corporations Act 2001] serve an important social purpose. They are intended to engender in directors of companies experiencing financial stress a proper sense of attentiveness [to] avoid any increase in the company’s debt burden. The provisions are based on a concern for the welfare of creditors exposed to the operation of the principle of limited liability at a time when the prospect of … loss to creditors has become real.

  • Barrett J in Woodgate v David (2002) 55 NSWLR 222 at [36]

Section 588M provides that a liquidator is entitled to recover from the directors, as a debt due to the company, an amount equal to the loss or damage occasioned by insolvent trading.

Specifically, a director must have contravened section 588G by (a) being a director when the company incurs the debt; and (b) the company is / becomes insolvent at that time; and (c) there were reasonable grounds for suspecting that the company is insolvent; and if the director or a reasonable person in their position would have been suspected that the company would be insolvent by incurring the debt, and did not prevent the company incurring the debt.

The arguments raised by the directors to defend the liability claim

The Court dealt with eight interesting arguments ranging from Blackstone’s Commentaries to the privilege against self-incrimination raised by the two self-represented directors.

  1. The debts no longer exist because they have been written off

The Court: “If a bad debt proves to be recoverable, in whole or in part, then the creditor remains entitled to payment and to adjust its accounts to reverse the write-off and recognise the income. This is consistent with accounting standards”.

2.   The creditor has been dissolved, and therefore the debts have been extinguished

Quoting Sir William Blackstone, Commentaries on the Laws of England (1753) - Ausgrid had been dissolved and a new corporation had taken over the contracts.

The Court: “The law of corporations has evolved significantly from 1753 to the enacting of the Corporations Act 2001. … it is sufficient to note that statute overrides the common law [and] its new persona is ... the same legal entity as Ausgrid.”

3.   Taxes are not debts incurred

      The Court: “more recent authorities indicate that taxes are debts incurred by the taxpayer for the purposes [of section 588G(1)(a)].”

4.   The obligation to keep financial records was satisfied

      (relying on the fact that the company’s accountant was able to prepare tax returns and financial statements for the financial years ended 30 June 2009 to 30 June 2013)

      The Court: “the obligation to keep financial records under section 286(1)(b) is twofold: firstly, to keep records which record the company’s transactions … and, secondly to retain those records for seven years. … Andrew did not provide any records to the liquidator despite repeated requests.”

5.   The financial records were not produced relying on the privilege against self-incrimination

      The Court: “it is likely that the directors’ privilege against self-incrimination has been abrogated by section 530A of the Corporations Act”. And

      “Section 588E(4) makes clear that the presumption of insolvency arises where the company has failed in ... its obligation to keep records … for the seven year period for which records ought to have still been in the company’s possession when it when it went into liquidation”.

6.   The company was not insolvent - the ATO debt could be paid and tax losses were an asset

      The Court: “Christopher said the company could have paid the entire balance of the ATO running account by borrowing funds from himself and his wife” but no loan was made.

      “Accumulated tax losses are not an asset that can be sold by the company to pay its debts as and when they fall due.”

7.   Both directors said they did not suspect insolvency

      The Court: Reviewing the company’s bank account balances, the payment of its tax obligations and financial statements “a director would have been left in no doubt that the company was insolvent from November 2009 on.”

8.   The company would pay the Ausgrid debt from profits on sale of the scrap metal

      The Court: “There is no evidence that the company expected to earn such profits before the invoices were due for payment, nor that the company had other means of paying the invoices”.

Were the directors jointly liable or only for debts incurred during their directorships?

Christopher and Andrew were directors during different timeframes. In Christopher’s case, he was a director when the company first fell behind with its tax payments and incurred the debt to Ausgrid. In Andrew’s case, he was a director when the company’s debt to the ATO and Ausgrid increased due to penalties, interest and costs orders.

The liability of successive directors has not been previously been judicially considered. The Court decided that a director is liable only if they were a director of the company at the time the debt was incurred. Therefore:

  • Christopher was liable to the ATO for $23,083.09, and to Ausgrid for $78,463 and interest to 2 January 2015 of $2,162.71.
  • Andrew was liable to the ATO for $3,564.71 for penalties and interest, and to Ausgrid for interest and costs of $9,677.30 incurred from 2 January 2015.

Christopher and Andrew were jointly ordered to pay the liquidator’s costs of the proceedings.

Lessons

  • Failing to produce financial records in response to a liquidator’s request will open the gate to personal liability of the directors of the company. That is because section 588E(4) makes clear that the presumption of insolvency arises from the failure to keep records.

 

  • Financial records of a company need to be kept for seven years to comply with section 286(2).
  • Directors unable to produce financial records would benefit from legal advice because there are several defences available which were not raised in this case.

Directors are liable for prosecution by ASIC for destroying company records. In a recent case, a company director was convicted and sentenced to a one-year, $500 good behaviour bond and ordered to pay $22,000 in reparation. See ASIC media release