March 2011

Proving insolvency: new legislation assists liquidators

Liquidators know that one of the most difficult aspects of pursuing a voidable transaction is the need to prove that the company was insolvent at the time of the transaction in question. Proof of insolvency at any particular time is notoriously difficult, and the legislation provides some assistance to the liquidator by providing for some presumptions of insolvency. They are:

  • A presumption of continuity in that if it is proved, or presumed, that the company was insolvent at any particular time within the recovery period, it is presumed to have been insolvent at all times thereafter.
  • A presumption arising from the failure to keep the required financial records for a particular period, or to retain them for the required period of seven years.

The latter presumption, in particular, often proves helpful, although it should be noted that it does not apply to preference recoveries unless the creditor concerned is a related entity.

Doubtless, then, the liquidator in Fisher v Devine Homes Pty Ltd; Allen v Harb [2011] NSWSC 8 thought he was on a good thing when he brought an action against the former sole director to recover payments made by the company to the director or to "cash". In fact, no financial records at all had been delivered to the liquidator (a default for which the director had been convicted). The director's excuse was that he had, after the company was wound up, delivered some documents including what appeared to be prime financial records of the company such as cheque butts, invoices and receipts, to an accountant who had since disappeared with them and could not be traced.

In applying the presumption as to the keeping of financial records, the court said that it was necessary for the liquidator to show either that no financial records at all were maintained, or that such records as were maintained were inadequate. Since there was evidence that some records had been kept, and no evidence as to whether they were inadequate or not, this part of the presumption did not apply. Nor did the liquidator have more success with the limb requiring retention of the records for seven years. Delivery of the records to the accountant by the director after the winding up order was not authorised by the company, since the director's authority ceased on the making of the winding up order; and it was therefore not possible to identify any "failure" by the company to keep the records. Even if there were, s588E(6) provides that the presumption does not apply where failure to keep or retain records was due solely to the loss or destruction of those records in a way in which the director was not involved.

So this claim failed. The liquidator had more success with an alternative claim for misfeasance by the director under s 598(2) of the Act with respect to third party cheques drawn by the company, mostly in payment of personal obligations of the director or members of his family. The court noted that the liquidator's claim for the payments to the director himself relied solely on the voidable transaction provisions and so it was not necessary to consider whether the misfeasance provisions would have applied to those payments as well. On the face of it they would, and it is not apparent why the liquidator confined his claim in the way he did; a claim for misfeasance in the alternative would surely have enjoyed better success.

Implications for liquidators

The conclusion to be drawn is that reliance on the statutory presumptions of insolvency can be risky and that, unless clear direct evidence of insolvency is available, consideration should be given to the possibility of recovery on a basis which does not require proof of insolvency at the time of the transaction in question, such as a claim for misfeasance or breach of statutory duty. If you are relying on defective or non-existent books to prove insolvency, you will need to be sure that there is evidence that they were, or are, defective, or that books (including prime records such as cheque butts and deposit books) did not exist.

This publication is intended as a source of information only. No reader should act on any matter without first obtaining professional advice.

Peter Kelso