Court decision on director's liability for insolvent trading reiterates importance of good recordkeeping and ATO compliance

The Federal Court's recent decision in Stone (Liquidator), in the matter of RIC Admin Pty Ltd (in liq) v Mandalinic (No 2) [2024] FCA 164 demonstrates the analysis the courts will undertake in determining a director's personal liability for insolvent trading, even when the director does not appear for the hearing. The case reiterates how crucial it is for directors to maintain adequate books and records of the company and to comply with ATO reporting and payment requirements.

Background

The defendant was the sole director of RIC Admin Pty Ltd (in liq) (Company), a construction consulting service company providing administrative services. From the Company's registration for GST on 1 January 2017 until its winding up on 13 November 2019, it was delinquent in reporting and paying its Pay As You Go Withholding (PAYGW) liabilities. By the time of its winding up, its running balance account stood at $2,014,386. In addition, an Australian Taxation Office (ATO) audit found that the Company was not entitled to certain GST input tax credits, resulting in a GST shortfall to the ATO of $474,801. Administration penalties of $237,400 were also imposed by the ATO.

Further, between 1 July 2016 and 29 March 2019, the director caused the Company to pay to him $422,400 in weekly increments of $4,400.

The liquidator sought to recover from the director personally:

• $2,489,187 as debt incurred by the Company while he was a director and the Company was insolvent; and
• $422,400 as an unreasonable director-related transaction.

Insolvent trading analysis

Failure to keep records

The liquidator issued notices to the director, the ATO and former external accountants of the Company to produce its books and records. He received some documents. The Court accepted the liquidator's evidence that crucial documents were missing - such as BAS documents, income taxation returns, PAYGW payment summaries, and source documents to support MYOB bank transaction entries - and that the Company had not satisfied the minimum requirements of the Corporations Act 2001 (Cth) for keeping books and records. The Court held that a presumption of insolvency arose because of that failure.

Technical solvency analysis

The liquidator conducted cashflow and balance sheet tests to assess solvency of the Company. He found the Company's minimal net profits were insufficient to meet its outstanding PAYGW tax liabilities. The Company's current ratio, being current assets divided by current liabilities, was 0.02 in circumstances where a ratio below 1.0 indicates a working capital deficiency. Accordingly, the Company's deficiency was severe. The balance sheet test demonstrated net liabilities over $2,000,000.

When the liquidator factored in information from an ATO audit, a net GST shortfall and penalties further reduced the Company's current ratio to 0.0147. It was hopelessly insolvent from a cashflow perspective.

Commercial solvency analysis

The Court also accepted the liquidator's assessment on the oft-quoted indicators of insolvency identified by Mandie J in Australian Securities and Investments Commission v Plymin (2003) 175 FLR 124. In relation to the Company, these included:

• overdue Commonwealth taxes;
• no evidence of access to alternative finance;
• no evidence of any ability to raise equity capital;
• a statutory demand issued by the ATO; and
• an inability to produce accurate financial information when requested in respect of the Company’s trading performance and financial position, and to make reliable forecasts in respect of both.

The Court concluded that the Company was insolvent from 25 August 2017.

Director's liability for insolvent trading

The Court had no hesitation in finding that, as the defendant was a director throughout the period when the Company incurred but did not pay significant tax liabilities and penalties while it was insolvent, he be personally liable for that insolvent trading to the tune of $2,489,187. The Court determined that a reasonable person in a like position in a company in the same circumstances would be aware of reasonable grounds for suspecting insolvency at the time the debts were incurred.

Unreasonable director-related transactions

The Court was also satisfied that the Company's weekly payments of $4,400 to the director, totalling $422,400, were unreasonable director-related payments and voidable rather than proper fees for director services. There were no source documents for the payments, no agreement with the director to provide services, no deductions from the payments for tax or remissions to the ATO, and they were made to the director when the Company was otherwise not complying with its PAYGW obligations.

The Court inferred that the director made the payments to himself "with reckless disregard to the financial position of the Company…that amounted to 'stripping benefits out of companies to their own advantage': Vasudevan at [24]".

Key takeaways

It is hoped that cases such as this will have a deterrent effect on directors of companies who fail to maintain adequate books and records to explain the transactions of their companies, and who disregard their company's reporting and payment obligations to the ATO. These are fundamental obligations of company directors. Unfortunately, such behaviour continues across our economy.

In this case, the director has declared himself bankrupt with the effect that these liabilities, including the judgment of over $3,000,000, may never be fully satisfied. We will be interested to see if the liquidator and the ATO press (and fund) the director's bankruptcy trustee for a deep investigation into his affairs.

For more information on insolvency matters and any of the topics raised above, please contact a member of our team.