Repayment Arrangements – Smith vs Bone

When payment arrangements with the Australian Taxation Office will not “defer” corporate debt and restore a company to solvency – Smith v Boné [2015] FCA 319

In this recent “insolvent trading” case the director of Petrolink Pty Ltd (“Petrolink”) defended the Liquidator’s claim by pointing to the GFC and the payment arrangements he had negotiated with trade creditors and the Australian Taxation Office.

We expect that the Liquidator was not concerned by the director’s submission that a reasonable person would not have suspected that the company was insolvent because the GFC was a once in a lifetime event.

We suggest however that the Liquidator would have been concerned that the payment arrangements negotiated by the director with the Australian Taxation Office might be taken to have had the effect of deferring that debt and in turn making Petrolink solvent.

The Liquidator of Petrolink commenced proceedings against the director for insolvent trading under s 588G of the Corporations Act 2001 (Cth) (“the Act”).

On 7 April 2015 Gleeson J handed down judgment.

Judge Gleeson commented that the defendants [including director Mr Boné] did not explain how the GFC and the company’s lengthy experience are matters that could have alleviated the suspicions of a director of reasonable competence and diligence arising from the facts I have identified.

More important was Judge Gleeson’s answer to the question of Petrolink’s insolvency. Was Petrolink insolvent despite the fact that its major creditor, the Australian Taxation Office, had agreed to a payment arrangement and trade creditors were not pursuing overdue debts?

The director argued that a reasonable person of ordinary competence would not have suspected Petrolink was insolvent during the relevant period because:

• The GFC was a once in a lifetime storm that could be weathered;
• There were very few of the usual indicia of insolvency;
• Petrolink’s creditors were happy to trade with Petrolink during the period and did not take action to recover their debts; and
• The tax debt owed to the Australian Taxation Office was being managed through an instalment plan (from June 2009 to December 2011).

The director also raised ss 1317S and 1318 of the Act, arguing that he had acted honestly, fairly, in good faith and in a common sense manner, as judged by the standards of others in a similar professional background.

Were the debts due and payable?

It was observed by the Court that the books and records evidenced that Petrolink did not trade profitably for any of the years ended 30 June 2009, 2010 and 2011. Petrolink was then wound up in December 2011.

To identify the date on which Petrolink became insolvent the Court engaged in the considerable task of assessing each of the six written payment arrangements entered into with the Australian Taxation Office between 30 June 2009 and 7 December 2011. The Court drew attention to the fact that Petrolink had failed to comply with each of those arrangements. Further, each of the payment arrangements had consisted of a number of smaller payments leading up to a large lump sum payment sufficient to discharge the debt and as a result may not have had the effect of “deferring” the debt.

The amounts payable under the sixth payment arrangement were:

• 30 December 2009 $5,000.00
• 30 January 2010 $5,000.00
• 28 February 2010 $5,000.00
• 28 March 2010 $474,588.58

The amounts payable under the final payment arrangement were:

• 11 April 2011 $2,500.00
• 11 May 2011 $2,500.00
• 13 May 2011 $541,761.38

Ultimately Judge Gleeson found that the payment arrangements negotiated with the ATO did not have a material effect on the solvency of Petrolink because of the shortness of their duration and the fact that none of them had the effect that Petrolink was not required to pay its outstanding tax liability imminently. The payment arrangements in fact demonstrated that Petrolink was continuing to experience common features of insolvency:

The Court was satisfied that Petrolink was insolvent from 12 May 2010 and the Liquidator was found to be entitled to recover from the director the amount of approximately $669,582.86.

In reaching the above decision the Court conceded that a director could take some comfort from their ability to negotiate payment arrangements but nonetheless concluded that a diligent director would have recognised that in this case the payment arrangements negotiated with the ATO did not affect the status of debt as due and payable.

Trade creditor arrangements

The Court commented that the director may well have thought that the arrangements negotiated with trade creditors were suitable but the evidence demonstrated that his efforts did not cause these creditors to defer Petrolink’s payment obligations.

The director contended that Petrolink had payment arrangements with 19 trade creditors. However, the Court found that those creditors were merely acquiescing in receiving payments by instalments, rather than making express agreements to extend credit. In view of this there could be no doubt that the debts to those creditors were due and payable.

In assessing a company’s solvency, the Court acts on the basis that a contractual debt is payable at the time stipulated for payment in the contract unless there is evidence to suggest otherwise. Having regard to these factors and Petrolink’s arrangements with trade creditors, the Court determined that a director of ordinary competence would have had reasonable grounds to suspect Petrolink was insolvent and that Petrolink had simply managed its relationship with trade creditors by failing to pay tax debts owed to the Australian Taxation Office.

Was the director’s liability reduced?

Whilst the Court did not find the director to have acted dishonestly the Court was not satisfied that his behaviour warranted exclusion from liability under ss 1317 and 1318 of the Act.

The Court did not accept the director’s conduct in dealing with its creditors was fair in the circumstances and in this respect referred to four payment arrangements between Petrolink and the ATO which were entered into in circumstances where Petrolink had no clear plan as to how it would meet payment under those arrangements.

The Court commented that the director’s conduct in dealing with its creditors strongly suggested an attitude on the director’s part that he was entitled to decide what was in the best interests of the creditors. This type of conduct was not such that the director ought to be excused from liability for his contraventions of s 588G of the Act.

Lessons to be learnt

This decision is a reminder to directors to seek legal advice when their company is struggling to pay its debts, even where they are exceptional at negotiating payment plans with creditors. The case is also a reminder for Liquidators that the Courts will see past excuses and make sizable orders for compensation for insolvent trading where a director has failed to act diligently and in accordance with their duties as imposed by the law.