A warning and opportunity for liquidators pursuing unfair preference claims

In its recent decision in the ongoing Solar Shop litigation,[1] the Full Federal Court established two key principles which will have significant ongoing implications for the conduct of unfair preference claims:

• Significant failures by a liquidator to comply with discovery obligations can provide a basis for dismissal of an otherwise meritorious unfair preference claim; and
• A company’s debt to the Commissioner of Taxation as recorded in the integrated running account maintained by the Australian Taxation Office (ATO) remains due and payable despite a payment arrangement made under s 225-15 of the Taxation Administration Act 1953 (Cth), a result which will make the Commissioner’s defences against unfair preference claims more difficult.

Background

The liquidators of Solar Shop Australia Pty Limited (the Company) commenced unfair preference claims against the Respondents. A preliminary trial was held on a separate question common to the claims, being the question of when the Company became insolvent within the meaning of s 95A of the Corporations Act 2001 (Cth) (the Act). The primary judge held that the Company became insolvent by 31 July 2011. The liquidators appealed, seeking a finding of insolvency by 31 January 2011 or in the alternative, 30 April or 22 May 2011.

The Fatal Consequences of Delinquent Discovery

Part of the Respondents’ cross-appeal relied upon the liquidators’ failure to make discovery of approximately 1,000 documents which ought to have been discovered at first instance.

In seeking to argue that they had conducted “reasonable searches” as required by the relevant court rules despite their limited pre-discovery review of the available electronic documents, the liquidators contended:

• the 194 boxes of hard copy documents were in a deteriorated and unorganised condition;
• the electronic images of the Company’s servers were not readily available without specialist IT assistance;
• the liquidators were never able to access the Company’s complete email records, which were stored in a “cloud”-based server, and in any event, there was no reason to think that the email cloud database contained any additional information directly relevant to the issue of solvency;
• the failure was minor, inadvertent and did not affect the result of the relief sought by the Respondents.

The Court rejected the liquidators’ arguments, finding that many of the liquidators’ contentions about the electronic records were mere conjecture, as there was no evidence of any attempt to interrogate the cloud or otherwise ascertain the nature and extent of available relevant electronic material and the ease and cost of accessing it.[2] Consequently, the liquidators failed to prove that they undertook a reasonable search of the documents in their control, including by their failure to inform the Court or the Respondents of their intention not to search the cloud server or otherwise explain why they did not have access to a forensic image of the Company’s file servers.[3]

The Court then had to assess the consequences of the liquidators’ breaches of their discovery obligations in light of the facts that those breaches had been revealed only during the appellate process and the liquidators, as the parties in breach, were seeking to set aside the orders made at first instance.

Given that the liquidators had failed to establish the absence of a realistic possibility of the existence of documents which might be deployed by the innocent parties to meet the defaulting party’s claims, the Court held that the liquidators’ appeal should be dismissed, as any consideration of the appeal would be built on a “hypothetical and potentially false basis”.[4]

Accordingly, the liquidators’ ongoing failure to make proper discovery meant that the primary judge’s determination of the separate question should be set aside and the question remitted back to the court below, but expressly on the basis that it would not be open for the court to find that the Company was insolvent on a date before 31 July 2011. The basis for this reservation was that the Respondents should not have to incur the expense of re-litigating issues and the liquidators should not be given a second chance to establish an earlier insolvency date.[5]

ATO debt due and payable despite payment plan

Between 14 January and 30 June 2011, the Company entered into several payment arrangements with the ATO. One of the grounds relied upon in the Respondents’ cross appeals was that the payment arrangements meant that the Company’s debt to the ATO was not due and payable and therefore should not have been considered by the primary judge as relevant to any finding of insolvency.

The Company’s liabilities for GST, PAYG and FBT were recorded in an integrated running balance account maintained by the ATO. The primary judge noted that the Company’s inability to pay these liabilities in full had resulted in numerous “legal warnings” and the ATO’s agreement to an arrangement for payment by instalments.

At both first instance and on appeal, the liquidators established that the payment arrangements were made under s 255-15 of the Taxation Administration Act 1953 (Cth) and that such arrangements did not vary the time at which the Company’s liabilities to the Commissioner of Taxation were due and payable.

In coming to this conclusion, the Full Federal Court made the following findings:

• The payment arrangements were made under s 255-15 and not under the Commissioner’s independent power to enter contracts for repayment of debt by instalments;[6]
• Both ss 255-10 and 255-20 expressly grant the Commissioner the discretion to defer the date when payment becomes due. Given that those provisions permit deferrals by the Commissioner, there was no reason to suggest that an instalment arrangement under s 255-15 should be taken to be a deferral;[7]
• The provisions which allow for the deferral of payment require some formality, such as providing written notice for deferral under s 255-10. Consequently, the Court was hesitant to infer the existence of a deferral that was not clearly disclosed in any written communication;[8]
• The words “due and payable” appearing in s 255-15 do not have a narrower meaning than the meaning of that phrase when determining insolvency under s 95A of the Act.[9]  Accordingly, the purpose of s 255-15 was not simply confined to making it clear that interest continues to run on an unpaid account;[10]
• Section 255-15 reflects “a deliberate legislative policy that regardless of entry into an arrangement, the debt remains due and payable”;[11] and
• The payment arrangements did not constitute a waiver by the Commissioner of the Company’s obligation to pay a tax debt.[12]

Key Takeaways

• This decision confirms that serious and ongoing non-compliance by liquidators with their discovery obligations can in itself result in the failure of an unfair preference claim, regardless of the merits of their claim. If there are particular categories of documents that cannot be accessed or otherwise reviewed at a cost in proportion to the claim’s quantum and in circumstances where the liquidator has good reason to believe that such searches will not reveal additional probative evidence, the Court and the defendant must be informed forthwith of those matters so that appropriate directions confining the scope of discovery can be obtained.
• Payment arrangements with the ATO under s 255-15 do not alter the fact that the underlying debt owed to the Commissioner remains due and payable. This will inevitably compound the difficulties for the Commissioner in either contesting the allegation that a payment to the Commissioner was an insolvent transaction under s 588FC or attempting to establish the subjective and objective elements of the “good faith” defence in s 588FG(2) of the Act.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).