Theres solvency and then theres solvency

Theres solvency and then theres solvency

In the recent case of Delta Coal Mining (in Liquidation) (Delta) (NSD 577 of 2020) the Liquidators initially commenced proceedings to recover Unfair Preference claims against the Australian Taxation Office (ATO) and subsequently 28 other creditors. All of these proceedings were joined, among the reasons for this was that it would allow for the date of insolvency of Delta to be determined once for all creditors (Preference Recoveries).

As part of the Preference Recoveries, the Liquidators instructed an expert to produce a solvency report to establish the date when the Company became insolvent.

Following the commencement of the Preference Recoveries, the liquidators commenced a claim for Insolvent Trading against three of the directors of Delta (Insolvent Trading Claims).

Following the commencement of the Insolvent Trading Claims, the three directors of Delta launched a cross claim against three parties regarding potentially negligent advice that they had received regarding the solvency of Delta prior to its liquidation (Cross Claim).

The second action, being the Insolvent Trading Claims caused a dilemma for the Court, either the 29 Preference Recoveries could be delayed in order to allow new evidence to be produced regarding the solvency of Delta by the Directors of Delta as part of their Cross Claim, or the two matters could proceed separately which may lead to the Court deciding that Delta had two different dates of Insolvency.

In the end the Court decided that the second option was better. The major factor in this decision were that despite there being considerable overlap in the determining of solvency between the Unfair Preference and Insolvent Trading cases the key issues in determining solvency or Insolvency were different.

Key to this was the difference in how claims are made under an Unfair Preference and an Insolvent Trading claim.

  • In an Unfair Preference claim the Liquidator has to prove that the transaction occurred when the Company was insolvent then the creditor can rely on a defence of good faith, i.e. that they did not know that the Company was insolvent.
  • However under an Insolvent Trading claim the Liquidator has to prove that the Company was insolvent or became insolvent as a result of a transaction and that there were reasonable grounds for suspecting that the Company would become insolvent. Because of this directors (in defence) are more likely going to rely on evidence internal to the company, that creditors would not necessarily have access to.

When might it be reasonable for a Liquidator to consider two dates of Insolvency?

If the Courts accept that two separate dates of insolvency exist then does this mean that a liquidator could determine two separate dates of insolvency?

Liquidators will often look for the lowest hanging fruit and pick off the easiest claim to build a war chest to tackle the harder more expensive claims.

For this reason it might be reasonable for a liquidator to initially ignore the question of solvency outside of the Unfair Preference relation back period given that:

  • Unfair Preference claims only look back on six months prior to the relation back day (RBD).
  • Insolvent Trading, or other voidable transaction claims against directors or related parties can look back on a much longer period.
  • If liquidation funds are limited it would likely be cheaper to produce a report proving insolvency 6-12 months prior to the RBD than it would be to prove solvency 3 years prior to the RBD.
  • A solvency report going back 3 years might result in more expensive litigation as litigants dispute a longer period of potential insolvency which inevitably leads to more evidence and potentially more arguments at trial.

Technically, I believe a liquidator could produce two reports with different dates of insolvency, however under these circumstances it might be appropriate to instruct an expert to answer the following question

‘was the Company insolvent at date x (the start of the Unfair Preference relation back period) and if not was it insolvent at some later date?’

This would be preferable to instructing an expert to determine the date of insolvency as it would leave scope for further reports, which would not contradict the initial instruction.

In summary:

I believe that a liquidator might find it reasonable to limit the scope of an initial solvency report on commercial grounds, or produce a second report covering a longer period when further recovery action becomes more likely and the additional expense can be justified, therefore the decision that two dates of insolvency could be used is appropriate.

 

 

 

Mark Ellis

About the author

Mark Ellis

Associate Director

Meet our Team of Experts

Since joining Rodgers Reidy in 2010, Mark has worked on various insolvency and forensic files. As manager of the forensic accounting team, Mark has the charge of producing expert reports in relation to business valuations and loss & damage claims, as well as preparing solvency reports for other practitioners and reviewing solvency related and voidable transaction claims.

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