+ Insolvent Trading

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The specific facts of the case, McLellan v Carroll [2009] FCA 1415, are noteworthy: the defendant’s honesty, the fact that he had followed the advice of an accountant experienced in the industry and an insolvency practitioner, and did not profit personally from his actions, were key to persuading the court to relieve him of responsibility for the trading debts of the company.

Facts

Mr Carroll was the sole director of a company which processed raw timber.   In 2003, he arranged for the company to acquire and install specialised equipment including kilns in an effort to expand the business.

The new equipment never worked properly.  This adversely affected the company’s cash-flow and ultimately its solvency.

In March 2005, he retained Mr Bright, an external accountant specialising in the timber industry, to assist with the company’s problems. Mr Bright confirmed that the company’s losses were caused by the amount of timber being damaged in the kiln drying process.  He informed Mr Carroll in June 2005 that the business was close to insolvency and required more funding to keep it going.

Funding was raised from borrowings but losses continued. Mr Carroll made several attempts to improve the company’s financial position. One included an invitation to the kiln manufacturer to invest in the business. The manufacturer declined the offer. 

By March 2006, the company’s ability to borrow further working capital had been exhausted. On 3 May 2006, the ATO telephoned Mr Carroll and informed him that the company owed back taxes totalling $110,000 and that immediate arrangements were required to reduce the debt.  A week later Mr Carroll appointed Andrew McLellan as the company’s administrator and a creditor’s resolution to wind up the company followed shortly thereafter.

Claim and defences

Mr McLellan sued Mr Carroll alleging contravention of s 588G. He claimed $426,000 under s 588M in respect of debts incurred after December 2005 (“the relevant period”). Mr Carroll defended the action and relied on s 588H(2), arguing that he had reasonable grounds to expect and did expect that the company was solvent during the relevant period and would remain so.  He also relied on s 588H(3), claiming that Mr Bright was a competent and reliable person and that Mr Carroll had reasonable grounds to believe and did believe that Mr Bright provided Mr Carroll with adequate information about whether the company was solvent.   In the alternative, Mr Carroll sought exoneration under s 1317S and s 1318. 

Judgment

Goldberg J concluded that all the elements of s 588G were made out and rejected Mr Carroll’s defence under s 588H(2).  He also rejected his defence under s 588H(3). In this regard, the evidence supported the finding that Mr Bright had only been engaged to prepare cash flows and financial statements and not to fulfil the role of a competent and reliable person responsible for providing adequate information about whether the company was solvent.

His Honour then turned to consider the application of ss 1317S and 1318.  He concluded that Mr Carroll had acted honestly throughout the relevant and adopted the criteria for determining such honesty set out by Palmer J in Hall v Poolman (2007) 65 ACSR 123 at 193-194:

“…[W]hen considering whether a person has acted honestly for the purposes of a defence under ss 1317S(b)(i) or 1318 …, the court should be concerned only with the question whether the person has acted … without deceit or conscious impropriety, without intent to gain improper benefit or advantage for himself, herself or for another, and without carelessness or imprudence to such a degree as to demonstrate that no genuine attempt at all has been made to carry out the duties and obligations of his … office. … If failure to consider the interests of the company as a whole, including the interests of its creditors … is the result of error of judgment, no finding of failure to act honestly should be made ….”

His Honour noted that during the relevant period:

1. Mr Carroll was told by Mr Bright on a number of occasions that Mr Bright did not believe that the company was insolvent. Having regard to Mr Bright’s qualifications and particular experience in the timber industry, which Mr Carroll knew, it was reasonable for Mr Carroll to rely on what Mr Bright told him. Mr Bright’s judgment in this respect, in retrospect, may not have been accurate but it was advice given to Mr Carroll and it was not unreasonable for Mr Carroll to rely on that advice.
2. Stock sales were increasing and Mr Carroll was monitoring stock levels.
3. Mr Carroll sought advice from an insolvency practitioner who had told him that if he believed the business was viable, he would need to find an investor or further capital.
4. Mr Carroll thereafter took active steps to seek out investors and to factor book debts.

His Honour concluded that Mr Carroll was faced with difficult decisions and noted with approval the following passage from Palmer’s judgment in Hall v Poolman (at 194):

“… It is sometimes a difficult decision for a director of a trading Corporation suffering from liquidity problems to decide whether, and when, to abandon hope of a change in the company’s fortunes and to summon the administrators.  There are often pressing interests involved in the decision: the jobs of employees will be lost, the investment of shareholders will evaporate, and a promising venture in which a great deal of personal effort may have been expended will end in failure.  On the other hand, the livelihood of creditors whose businesses depend on reasonably prompt payment might also be ruined if a company continues to trade while insolvent….”

His Honour also noted that Mr Carroll did not profit personally by permitting the Company to trade insolvently throughout the relevant period and concluded that Mr Carroll ought to be excused under s 1317S of the Corporations Act. He made an order to that effect.

Goldberg J. dealt with the question of costs on 14 December 2009. He stated that the liquidator was justified in bringing the action and had made no error of judgment in prosecuting it. He accepted that a grant of relief under s 1317S  is in the nature of an indulgence and in exercising his discretion, ordered that Mr Carroll pay the plaintiff’s costs including reserved costs.

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