Earlier this year, Emerson Lewis acted for a liquidator in a successful application for the joinder of fifteen (15) defendants to a single proceeding in the Supreme Court of New South Wales. More recently, Emerson Lewis successfully acted for the liquidator again in a separate question on solvency.
The decision of In the matter of MK Floors (NSW) Pty Ltd (in liq) and MK Floors (QLD) Pty Ltd (in liq)  NSWSC 1718 provides a useful summary of the Court’s approach to determining whether a company was insolvent as part of unfair preference proceedings pursuant to Part 5.7B of the Corporations Act 2001 (Cth)(Act).
MK Floors NSW Pty Ltd (in liq) (MK NSW) and MK Floors QLD Pty Ltd (in liq) (MK QLD) were wholly owned subsidiaries of MK Australia Pty Ltd (in liq) and conducted businesses as installers of commercial flooring for builders and developers.
Following the appointment of external administrators, proceedings were commenced by Steve Naidenov of Aston Chace Group as Liquidator against multiple defendants pursuant to which the Liquidator contends that each defendant received an “unfair preference” within the meaning of section 588FA of the Act.
On 16 June 2020, the Supreme Court of New South Wales ordered that the question of whether MK NSW and MK QLD were insolvent within six months of entering into external administration be determined as a separate question.
After the service of the Liquidator’s detailed expert reports on solvency but prior to the hearing of the separate question, the Liquidator served notices to admit facts on each of the defendants. The effect of having served those notices was that all active defendants ultimately admitted that MK NSW and MK QLD were insolvent as contended by the Liquidator.
Justice Gleeson answered the separate question in favour or the Liquidator after observing at  that “viewed objectively, and taking into account the immediate future, I am well satisfied that each of MK QLD and MK NSW was insolvent on 10 April 2016 and at all times thereafter to 10 October 2016”.
In answering the separate question, the Court provided a useful summary of the approach to be taken by a Court when making a determination as to solvency. Among other things, the Court noted that:
- in determining solvency, s 588FC directs attention to the ‘cash flow test of insolvency’ found within the provisions of 95A of the Act;
- the question of solvency is an objective question of fact to be ascertained from a consideration of the company’s financial position taken as a whole, having regard to commercial realities and whether assets can be realised to meet a company’s liabilities as they fall due;
- drawing upon Barrett J’s observations in Sutherland & Another (as joint liquidators of Australian Coal Technology) v Hanson Construction Materials Pty Ltd and Others (2009) 254 ALR 650A, his Honour noted that determining the question of insolvency is contingent on whether the company’s inability to pay is temporary. Whilst some consideration must be applied in relation to the ability to pay debt “in the immediate future” (per Giles JA in Lewis (as liq of Doran Constructions Pty Ltd (in Liq) v Doran and Others (2005) 219 ALR 555), for a company to be insolvent, the company must show an “endemic shortage of working capital” as opposed to a “temporary lack of liquidity” (Australian Coal Technology at );
- the onus of proving insolvency at the relevant times rests with the liquidator.
Application of principles to the facts in this case
The Liquidator provided separate expert reports for MK NSW and MK QLD in which he expressed the opinion in relation to each company that it was insolvent from 29 February 2016 and remained insolvent from that date. The reports adopted a common methodology of conducting a cash flow test, focusing on the liquidity and viability of the business of each company.
In each report, the Liquidator analysed the extent of the cash and other assets of each company that cold be readily converted into cash, compared with debts due and payable and to become due and payable in the immediate future. The Liquidator provided detailed evidence of the cash deficiency position of the companies for each month in the period leading up to the external administration.
The expert reports also set out a number of the other “indicia of insolvency” referred to in Australian Securities and Investments Commission v Plymin and Ors (2003) 46 ACSR 126, including but not limited to:
- overdue Commonwealth and State taxes owed by MK QLD and MK NSW;
- special arrangements with creditors;
- the deteriorating relationship between the companies and their trade creditors;
- the difficulties that the companies faced in procuring supplies given that creditors were placing their accounts on hold.
It is clear from the decision that the Court was satisfied with and embraced the Liquidator’s overall approach to proving insolvency. By way of example, the Court held that a number of assumptions that were taken by the Liquidator were reasonable, including the assumptions that:
- a discount/provision of 5% for uncollectable debts was appropriate and sufficiently generous;
- the amounts shown for stock on the companies’ management accounts were readily available to meet debts;
- non-circulating assets are not usually available for debt reduction and payment of liabilities as the sale of such assets would cause major disruption to a company’s business;
- MK NSW and MK QLD did not have any ability to raise equity capital or alternative finance to pay its debts.
His Honour ultimately noted that both MK NSW and MK QLD experienced an “endemic shortage of working capital” in and after April 2016 and that the financial picture of each company at the beginning of April 2016 is one where the debts due and payable and to become due and payable in the immediate future far exceeded the extent of cash and other liquid assets available to each company.
The key takeaways form the decision are that any insolvency evidence by a liquidator should, at a minimum:
- provide a detailed month by month analysis of a company’s available cash resources as compared with its monthly liabilities in order to demonstrate the deficiency at each point in time;
- set out the other usual “indicia of insolvency”.
The decision demonstrated that the service of notices to admit facts, particularly in situations where liquidators commence unfair preference proceedings against multiple defendants, is a useful litigation tool to assist in the process of proving insolvency.
Given that insolvency in respect of each company has now been proved by the Liquidator, this means that there is now a binding determination on solvency and no risk of inconsistent findings on solvency in the ongoing proceedings with the remaining defendants.
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