Navigating statutory demands and the presumption of insolvency

A recent judgment of Chief Justice Blow in ARL2 Pty Ltd v Flex Realty Pty Ltd [2024] TASSC 5 is a reminder of the crucial role that compelling evidence plays in rebutting a presumption of insolvency.

The court ultimately dismissed the plaintiff's winding up application on the ground of insolvency based on the defendant's failure to comply with a creditor's statutory demand. The court held that the defendant met its burden of proving it was solvent.

Background

The plaintiff, ARL2 Pty Ltd (ARL2), sold its rent roll business to the defendant, Flex Realty Pty Ltd (Flex Realty), for $185,000 payable in instalments.

A dispute arose as to how much, if any, of the final component of the purchase price was payable by Flex Realty.

ARL2 served a creditor's statutory demand on Flex Realty for $59,000 plus interest, being the amount that it claimed was payable under the contract of sale. Flex Realty did not comply with statutory demand or have it set aside, creating a presumption that Flex Realty was insolvent.

When ARL2 brought an application to wind up Flex Realty on the grounds of insolvency, Flex Realty contended that it was solvent.

A matter of evidence

The court compared the evidence put forward by ARL2 and Flex Realty, which comprised the lay evidence of directors of each company and expert accounting evidence from each side. The expert engaged by ARL2 opined that Flex Realty was insolvent and not likely to become solvent in the near future. Flex Realty's expert said that it was solvent at all relevant times.

Justice Blow ultimately preferred the evidence of Flex Realty's expert over ARL2's expert as that expert:

• ignored the fact that Flex Realty's business was not a risky one;
• ignored the fact that, at least until it began to incur legal expenses in relation to the proceedings, Flex Realty usually maintained a credit bank balance exceeding $100,000;
• had reasoned that any financial records that he did not sight, if examined, were likely to reveal irregularities or worse;
• did not consider the credit resources available to the company; and
• expressed opinions that appeared to be based on speculation rather than evidence.

The decision

Fullest and best possible material principles

ARL2 submitted that proof of solvency required Flex Realty to bring the "fullest and best possible material" to prove solvency, and that Flex Realty's evidence had not met that standard.

Due to Flex Realty's business being neither complicated nor risky, Justice Blow adopted the less rigorous approach to proof of solvency summarised by Finkelstein J in Commissioner of Taxation v De Simone Consulting Pty Ltd [2007] FCA 548. Finkelstein J said that whether a company is solvent is both a question of law and a question of fact, and that the fullest and best evidence available will depend upon the particular facts of a case. In an "ordinary" case, being where the business of a company is more complicated, risky or there is reason for doubt, it is likely that audited accounts or evidence of ownership or valuation from independent sources will be required. In other cases, there will be many instances where proof of that sort is not required, such that there is no good reason to put the company to the time, trouble, and expense of producing audited accounts.

Key findings

The business of Flex Realty was neither complicated nor risky. His Honour did not regard the failure to pay the debt as an indication of insolvency. Rather, it ceased making payments due to intransigence and/or bad advice from a previous solicitor. His Honour held that a lot of the usual symptoms of insolvency were absent in this case:

• there was no suggestion that Flex Realty had ever been late in paying any trade creditor;
• only one creditor contacted Flex Realty about a payment when it learned of winding-up proceedings;
• Flex Realty had no ongoing losses;
• Flex Realty did not have poor cash flow;
• Flex Realty's directors had a practice of monitoring cashflow;
• Flex Realty's assets consistently exceeded its liabilities;
• Flex Realty did not have any problems selling stock or collecting debts;
• there was no suggestion that any suppliers had placed Flex Realty on cash-on-delivery terms; and
• there were no disputes between Flex Realty's directors.

His Honour did not consider a need to see sworn evidence from independent valuers in relation to the directors' real estate assets, or sworn affidavits from valuers or audited financial statements, to reach a conclusion as to the solvency of Flex Realty.

His Honour was satisfied on the balance of probabilities, that Flex Realty operated a profitable business, had substantial cash and credit resources, was able to pay its debts as and when they become due and payable, and was likely to remain able to do so for the indefinite future. As such, Flex Realty was found to be solvent and the application was dismissed.

Key takeaways

The fight is not over on a winding up application if an otherwise solvent company has failed to comply with a creditor's statutory demand and is deemed to be insolvent. The company has the burden of gathering the "fullest and best evidence" of solvency depending on its circumstances. That requires good books and records to be maintained by the directors in the first place. From there, the opinion of a well-briefed, independent and objective accounting expert will usually be required to assist the court to satisfy itself on the question of solvency.

Authors: Keiran Breckenridge, Special Counsel and Lilli Borozan, Lawyer.

Our experienced insolvency and restructuring team is expert in what is required to prove (or disprove) insolvency and manage insolvency processes. We have a wide network of accounting experts we can draw on to assist company directors who are facing such issues.