Keith Smith East West Transport Pty Ltd v Australian Taxation Office

[2002] NSWCA 264

---

(Judgment by: Mason P)

Between: Keith Smith East West Transport Pty Ltd (in liq) and Anor
And: Australian Taxation Office

Court:

Judges:
Mason PHandley JA
Giles JA

Subject References:
CORPORATIONS
insolvency
taxation assessed and paid by company
whether company was insolvent at the time of payment or if it became insolvent as a result of the payment
unfair preference
Corporations Act, s95A and Part 5.7B
statutory presumption of insolvency
financial records of company
credibility of witnesses
proof of insolvency
a conclusion as to solvency or otherwise can only be made having regard to the total position at the relevant time
whether appropriate to consider a creditor's willingness to defer enforcement action subject to satisfactory arrangements for the reduction of debt

Legislative References:
Corporations Act 2001 - s95A; Part 5.7B

Case References:
Abalos v Australian Postal Commission - (1990) 171 CLR 167
Brooks v Heritage Hotel Adelaide Pty Ltd - (1996) 20 ACSR 61
Sandell v Porter - (1966) 115 CLR 666
Southern Cross Interiors Pty Ltd v Deputy Commissioner of Taxation - (2001) 53 NSWLR 213
Sutherland (as liquidator of Sydney Appliances Pty Ltd (in liq)) v Eurolinx Pty Ltd - (2001) 37 ACSR 477

Hearing date: 11 July 2002
Judgment date: 14 August 2002

---

Judgment by:
Mason P

1 The second appellant is the official liquidator of the first appellant, having been appointed by resolution of creditors on 7 June 2000. The appellants sued the respondent (ATO) in the District Court to recover as unfair preferences three payments made by the company on account of tax liabilities. The payments were made on 18 January 2000 ($22,000), 21 February 2000 ($22,000) and 17 May 2000 ($171,786.28).

2 Two issues were fought at trial in relation to each payment, namely:

1.

Did the plaintiffs establish that Keith Smith East West Transport Pty Ltd (the company) was insolvent at the time of the payment, or that it became insolvent as a result of the payment? (On this issue the plaintiffs bore the onus, subject to the availability of a provision establishing a presumption of insolvency in some circumstances); and

2.

Did the defendant establish a defence within s588FG of the Corporations Act 2001? Good faith not being in issue, the specific matter (on which the defendant bore the onus) was whether the defendant had no reasonable grounds for suspecting that the company was insolvent at those times or would become insolvent as mentioned in s588FC(b) and whether a reasonable person in the defendant's circumstances would have had no such grounds for so suspecting.

3 The defendant, the present respondent, succeeded on both issues.

Legislative Background

4 "Unfair preferences" are defined in s588FA of the Corporations Act 2001 and the right to recover monies paid under them is conferred by the combined operation of ss588FC, 588FE and 588FF. The present claim is based upon alleged insolvent transactions occurring during the six month period ending on the relation-back day (7 June 2000) (see s588FE(2)).

5 Section 95A provides that a person is solvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable; and that a person who is not solvent is insolvent. The parties were agreed that the principles determining when insolvency is established in accordance with s95A are as discussed by Palmer J in Southern Cross Interiors Pty Ltd v Deputy Commissioner of Taxation (2001) 53 NSWLR 213.

6 It is of course essential that, in relation to each of the three alleged "insolvent transactions" (ie payments), the appellants establish that they were entered into "at a time when the company [was] insolvent" or that "the company [became] insolvent because of, or because of matters including ... entering into the transaction" (s588FC).

7 Section 588E creates certain presumptions for the purpose of recovery proceedings, relevantly:

(3)

If:

(a)

the company is being wound up; and

(b)

it is proved,... that the company was insolvent at a particular time during the 12 months ending on the relation-back day;

it must be presumed that the company was insolvent throughout the period beginning at that time and ending on that day.

....

(9)

A presumption for which this section provides operates except so far as the contrary is proved for the purposes of the proceeding concerned.

8 In its application to these proceedings, s588E(3) means that if the appellants prove that the company was insolvent at a particular time during the 12 months ending on 7 June 2000, it must be presumed that the company was insolvent throughout that 12 month period. Before us, the appellants invoked the benefit of this presumption on the basis of proof that the company was insolvent at the commencement of the 12 month period, ie on 8 June 1999.

9 If insolvency is presumed in the appellant's favour by virtue of sub-s(3) then that presumption is capable of rebuttal by the respondent, in accordance with sub-s(9).

Overview of trial

10 At trial, the appellants sought to prove insolvency at the three dates by tendering various financial records of the company and by calling three witnesses: the company's accountant Mr Heckendorf, the official liquidator (ie the second appellant) and Mrs Myra Smith, a director and the financial controller of the company.

11 Mrs Smith's husband and fellow director, Valentine Keith Smith, was unable to give evidence due to illness. He had been chairman and, I assume, managing director of the company. A severe illness which afflicted him in mid-2000 was one of the factors which moved the directors on 25 May 2000 to resolve to call the requisite meetings for a creditors' voluntary winding up. It was not the only reason. According to the minutes of the directors' meeting on 25 May 2000 the directors were then of the view that the company could no longer continue trading and pay its creditors in full.

12 In the 1980s Mr and Mrs Smith formed a partnership which grew into a substantial inter- and intra-State trucking business operating out of Dubbo and Narromine. Its contract cartage income was in excess of $2 million in each of 1997/1998 and 1998/1999. The partnership traded under the name "Keith Smith East West Transport". It appears to have been the lessee of some (possibly all) of the vehicles used in the trucking business.

13 In about 1984 the company was formed as a tax effective vehicle for operating some of the business and holding some of its assets. Its trading name was the same as that of the partnership, except for the addition of "Pty Ltd". There is a good deal of evidence as to the confusion created by the co-existence of these similarly named entities.

14 The second appellant said (Black 37-8):

The partnership was just set-up for tax reasons which the entries would be processed and finalised at 30 June 1999 and that it was not necessarily a reflection at 31 May of the position that suited both the company and the partnership at that point in time. The accountants always make those final year end adjustments to juggle it between the partnership, may be entries have not been processed or juggled or finalised the journals at 30 June as all companies do.

15 Mrs Smith made no bones about the fact that she relied significantly upon the accountant Mr Heckendorf for the maintenance of proper accounting records and arranging legal and tax effective transactions touching the partnership and the company and any dealings between those two entities.

16 The learned trial judge, Gibb DCJ, was not satisfied that the plaintiffs had established the insolvency of the company on the relevant dates. Since she was not satisfied that the company was insolvent at any relevant time, the s588FG defence was, she acknowledged, somewhat academic. Nevertheless it was considered. Good faith not being in issue, the critical question was what a reasonable person in ATO's circumstances would have suspected.

17 Judge Gibb proceeded on the basis that a reasonable person in the position of the Commissioner of Taxation should be credited with financial and accounting qualification and sophistication as befitted the holder of that office and the skills available to the ATO, albeit that the individual officers were not so qualified and did not seek assistance from a colleague with appropriate qualifications (Red 60H). Her Honour tested the availability of the defence upon the basis of that which was actually put before the Commissioner of Taxation, via his officers. Based on the information communicated to the ATO by the company, principally from Mr Heckendorf, her Honour concluded that there were no reasonable grounds for suspecting that the company was insolvent at the time of the payments or that it would become insolvent; and that a reasonable person in the circumstances of the Commissioner or each of the relevant officers would have had no such grounds for so suspecting.

Trial judge's findings on insolvency

18 Judge Gibb expressed her conclusions on insolvency in the following terms (Red 57):

Conclusion of insolvency

To the extent that the accountant, Mr Heckendorf, and the liquidator, Mr Duncan, purported to express expert opinions on the company's solvency at any relevant time, I do not accept those opinions for the reasons discussed earlier.

The only conclusions that I am able to reach on the variable and unreliable evidence are that:

•

not all sums payable and paid to the company for cartage services were received by the company, and in some cases the funds received were not transferred into the company's accounts;

•

I do not know what, if any consequence that had upon the company's assets or liabilities as disclosed in the accounts tendered;

•

sums equating to both partnership distributions and drawings (the "paper only transactions") were not expended by the partnership nor paid by the company, despite having been recorded in the "FI" accounts and the partnership accounts;

•

both the company and partnership accounts are unreliable, and the same uncertainty and unreliability afflicts the schedules of trade creditors and debtors prepared as at 22 July 1999;

•

the company accounts are inconsistent, unreliable and occasionally contradictory. I am not satisfied that they identify or disclose the company's liabilities and assets in a way that permits any proper determination of the solvency of the company at any particular point in time; and

•

I have no confidence in the quantification of either the assets or the liabilities as disclosed [in] accounts tendered in respect of the company or the partnership.

I do not know whether reversing or disregarding the "paper only" transactions would have the effect of demonstrating that the company was solvent or insolvent. I am able to reach no conclusion about the company's financial state or solvency. I find all the relevant evidence to be unreliable.

The plaintiffs have failed to discharge their onus, and their claim fails. I am not satisfied on the civil standard that the company was insolvent at any relevant time.

19 These conclusions are supported in detail in the preceding pages of the judgment. For example, Judge Gibb said (Red 40):

All three of the plaintiff's witnesses - the company's accountant, director and liquidator - described the arrangements between the company and the partnership as being purely for taxation purposes. The liquidator testified that various transactions were whatever "suited" the company or partnership. All three explained discrepancies or lacunae in the structure or accounts on the basis that the arrangements and structure were only for "tax purposes".

None of witnesses explained the financial structure of the business or nature of the legal or accounting relationship between the company and the associated partnership with any consistency. None reconciled the various sets of accounts with any consistency or credibility. Nor did the witnesses provide any effective explanation of the varying company's accounts, or identify its assets or liabilities.

Ms Smith was vague and uncertain, although I accept honest to the best of her recollection. She said that the arrangements between the company and the partnership were whatever her accountant had established. Mr Heckendorf was imprecise, contradictory, and contradicted the accounts. The liquidator's evidence about the relationship and arrangements between the company and the partnership and the company was vague, based upon hypothesis, and reliant upon that which had been conveyed by the accountant, his records, and the company's report as to affairs.

Mr Duncan knew virtually nothing of the company's business and made no inquiry about invoices rendered or independent verification. He made no independent investigation of or inquiry into the arrangements between the company and the partnership, nor any independent assessment of the state of the company's finances. He relied upon the company's accountant and was unable to provide any satisfactory explanation for the opinions he (Mr Duncan) proffered as to the company's solvency. Mr Duncan did not explain satisfactorily (or in some respects, at all) what the company did, what were its assets or liabilities, or its financial status. He was unable to explain the basis for the opinions, which he ventured. To some slightly lesser extent, the evidence of the accountant, Mr Heckendorf suffered from the same deficiencies. Mr Heckendorf's explanations about the company and the business were contradicted by his accounts and Ms Smith, whose evidence I prefer to that of Mr Heckendorf. There is no satisfactory explanation of the company's accounts, of which there are different versions.

The evidence of each witness was explored only lightly in cross-examination. Nonetheless, I am unable to accept the evidence of either the company's accountant, Mr Heckendorf, or the liquidator, Mr Duncan, each of whom I found to be a very unsatisfactory witness, and neither of whom was able to provide any satisfactory explanation as to the basis of his opinion. To the extent that either Mr Duncan or Mr Heckendorf purported to be an expert witness, and could not explain the basis of his opinions or the accounts upon which he relied, his evidence was not accepted.

Later her Honour said (Red 42):

The company was placed in the hands of the liquidator in June 2000. The liquidator, Mr Duncan, paid no real attention to the other (and older) party to the structure: the partnership VK & ME Smith trading as Keith Smith Transport. However, a substantial part of the company's claimed liabilities comprises debts said to be due to the partnership, (inter alia) by way of management fee and loan account. Both the basis and quantum of those debts is uncertain. Different versions were provided by the various witnesses, and in some cases, the same witness gave more than one version. Different sums are recorded in different sets of accounts. The liquidator made no independent investigation of the business structure; or of the company's accounts or its assets or liabilities despite his duty to recover the company's assets.

Later her Honour said (Red 43):

I accept Ms Smith's version, and prefer that to Mr Heckendorf's version. The reality was that the partnership received the money and transferred some of it to the company. The business' approach to financial matters - partnership and company collectively - was simple. I accept Ms Smith's evidence as given in cross-examination thus:

A. Everything that was paid - except for the repayments of the leases for vehicles, everything else came out of the company account.

Q. But the receipts of money for the jobs that were done went into the partnership account?

A. Yes.

Later her Honour said (Red 47):

The evidence does not reveal any inquiry having been made as to the company's legal entitlements or its rights in respect of any assets, including receipt of payments for cartage services provided by the business. I do not have the benefit of any independent or objective professional assessment of the relationship between the company and the partnership. I do not know what were the company's assets at any relevant time. Nor do I know what were the arrangements between the company and the partnership, or what were the company's legal entitlements.

The defendant submitted that Mr Heckendorf's conclusions on the solvency of the company as at July 1999 were unreliable and there could be no confidence that the company's accounts had the correct assets and liabilities listed. That is so. I found Mr Heckendorf to be a less than reliable witness about the company's financial status. I am conscious that he was not cross-examined in any detail on these matters. I do not accept his evidence where he was contradicted by relevant records or Ms Smith. My observations of Mr Heckendorf's demeanour in the witness box, particularly in cross-examination, equally led me to form an adverse view of his credibility.

Neither the company accountant nor its liquidator had any idea of the size or dimensions of the cartage business. Mr Heckendorf thought that the business - through the partnership - owned about five trucks, each worth about $250,000 to $300,000, all of which were encumbered to various finance companies. Mr Duncan, made the same estimate of about four or five trucks, and said that the transport route was:

Dubbo to regional centres and then they subcontracted out if it had to go to Perth or those types of places.

...

... The major expenses they have are leasing payments for trucks, wages, fuel and tyres. That is what the business is made up of and they are fairly consistent, that each month a company this size would use $20,000 a month fuel and it would remain consistent month to month...

But "A1" and "F1" 30 June 1999 accounts record that the company paid $839,237.47 for fuel and oil that year - about $69,936 per month - and $772,150.37 in the previous financial year. Ms Smith (whose evidence I accept) said that the company never had less than 8 trucks, and had 10 just before it went into liquidation. The trucks were "Road trains, triples and road trains and B doubles and singles" which were "on the road all the time" (in some cases 24 hours a day) and travelled "from Dubbo, Australia wide basically. They could go anywhere", including Perth, and Ms Smith said:

In about the month before we finished up we were running a B double a week plus a road train a week to Perth.

I prefer Ms Smith's estimation of the size of the company's business, and accept that. I accept Ms Smith's evidence that the business had 8 to 10 trucks on the road, including 2 travelling to Perth, in the month before the business ceased. If income was received for those freight services, it was paid into the partnership's account, regardless of whether it was an entitlement or asset of the company.

20 It will be seen that the judge concluded that Mrs Smith and Mr Duncan were essentially dependent upon the financial records of the company as the basis for their expressed opinions as to the insolvency of the company at the relevant times. Those records in turn depended substantially upon the testimony of Mr Heckenberg, their principal creator. Her Honour was unimpressed with that testimony and the accuracy of those records, not just because of an adverse view formed from observing his testimony but also because of inconsistencies and improbabilities in the financial records themselves. For example, there were two sets of company accounts for the year ended 30 June 1999 and Mr Heckendorf was unable, when pressed, to say which was correct or to reconcile the differences. Certain primary records were also missing.

21 I state at the outset that the appellants fall well short of persuading me that her Honour's assessment was ill-founded, a fortiori in light of the principles in Abalos v Australian Postal Commission (1990) 171 CLR 167. Indeed, the appellants only faintly sought to contend otherwise, preferring to attempt to circumvent the ultimate conclusions in the judgment by reference to an argument which (for a time) seemed both plausible and detached from the adverse credibility findings of the primary judge. The argument was ingenious but ultimately flawed.

Facts relevant to appellant's challenges on insolvency issue

22 To put the findings of the trial judge in proper context and to understand the appellants' challenges to them it is appropriate to look at the key events in chronological sequence:

Appellants' submissions on insolvency

23 The appellants necessarily challenged both limbs of her Honour's reasoning. However, the primary attack focused upon the conclusion on the insolvency issue.

24 It was submitted that the company was clearly insolvent at the relevant times, notwithstanding difficulties with determining the full extent of that insolvency due to the unsatisfactory nature of the accounting records upon which the liquidator relied in forming his stated opinion that the company was insolvent.

25 Counsel for the appellants, Mr Aitken advanced his primary submission in this manner: The letter of 14 May 1999, standing alone, is strong evidence of insolvency in that it acknowledged a long-standing inability to pay a substantial company indebtedness (ie for tax) as well as an underlying cause, namely "a number of large bad debts". The presumption of continuance carried that evidence through until at least 8 June 1999, with the consequence that s588E(3) cast upon ATO the burden of rebutting the statutory presumption of insolvency throughout the ensuing 12 month period down to the commencement of the creditors winding-up on 7 June 2000.

26 Next, it was submitted that the arrangement reached in early August 1999 for the progressive reduction of the tax debt by instalments did not displace the company's insolvent status because (a) it was never legally binding (Foakes v Beer (1884) 9 App Cas 605) and (b) in any event the arrangement broke down in November-December 1999.

27 Next, it was submitted that the discharge of the outstanding tax liabilities on 17 May 2000, using the greater part of the moneys realised from the sale of the book debts to Orix, was itself a transaction made when the company was insolvent or which had the effect of rendering the company insolvent.

28 It may be seen that these submissions seek to by-pass the trial judge's credit-based findings about the true state of the company's balance sheet throughout the relevant period. The appellants seek to concentrate on the debit side of the ledger, indeed primarily if not solely upon the tax liabilities on that side as distinct from other company indebtedness.

29 This however is the essential fallacy in the attempt to skirt around the findings made by the trial judge. A conclusion as to solvency or otherwise can only be made having regard to the total position at the relevant time (see generally Sandell v Porter (1966) 115 CLR 666 at 670-1). Whether or not a company has the capacity to pay a particular debt necessarily depends inter alia upon the pool of assets available to meet it and the existence and press of other company creditors. The assets available to the company depended upon the true relationship between the company and the partnership and this was not established, at least to the extent of proving the company's insolvency.

30 There are additional difficulties.

31 The first two transactions were the payments of $22,000 in January and February 2000. These were instalments pursuant to the arrangement for gradual reduction of outstanding indebtedness that had been made in August 1999.

32 As well as invoking the statutory presumption said to flow from proven insolvency as at 8 June 1999, the appellants submitted that these payments were made at times when the company was demonstrably insolvent. One branch of this argument sought to address the tax liability divorced from other company assets and liabilities at the relevant times and I have already addressed the deficiencies of that approach. But if one assumes that it were possible to look at tax liabilities in isolation, the question arises whether the appellants are correct in their submission that the Court should effectively disregard the arrangement entered into between the ATO and the company.

33 According to the appellants, it is necessary to focus exclusively upon the total tax debt due at any point of time and to disregard entirely the ATO's willingness to defer enforcement action subject to satisfactory arrangements for the gradual reduction in the debt. The appellants pointed to no authority supporting such an approach to the issue of solvency. Indeed there is much authority to the contrary, because it is clear law that the statutory test of solvency looks at matters on a "cash flow" basis rather than a simple "balance sheet" basis (Brooks v Heritage Hotel Adelaide Pty Ltd (1996) 20 ACSR 61 at 64. See generally Keny, "The Insolvency Factor in the Avoidance of Antecedent Transactions in Corporate Liquidations" (1995) 21 Mon L R 305). This does not mean that a company debt is not due and payable at the time stipulated by the creditor (see generally Southern Cross Interiors); but it does mean that, in assessing solvency, the Court will pay regard to an express or implied agreement between a company and its creditor for an extension of the time stipulated for payment (Southern Cross Interiors at 225 and authorities cited at [54](v), Sutherland (as liquidator of Sydney Appliances Pty Ltd (in liq)) v Eurolinx Pty Ltd (2001) 37 ACSR 477).

34 The evidence shows that the ATO was willing to hold its hand between August 1999 and March 2000 and that the arrangement for gradual reduction in the tax indebtedness was substantially adhered to during this period. In the chronology set out above I have highlighted the material indicating why the company's failure to adhere to the letter in November-December 1999 is not determinative. Insolvency was not established at the time of the first two payments sued for.

35 By March 2000 it was however clear that the company was in default in its arrangement with the ATO. However, the critical time for determining solvency with respect to the payment of $171,786.28 was 17 May 2000. That payment represented the realised value of most of the company's principal asset, namely its book debts. Those debts had been assigned to Orix under the factoring agreement.

36 The leading case of Sandell v Porter recognises, in the words of Barwick CJ (at 670):

Insolvency is expressed in s95 [of the Bankruptcy Act 1924 (Cth)] as an inability to pay debts as they fall due out of the debtor's own money. But the debtor's own moneys are not limited to his cash resources immediately available. They extend to moneys which he can procure by realization by sale or by mortgage or pledge of his assets within a relatively short time - relative to the nature and amount of the debts and to the circumstances, including the nature of the business, of the debtor. The conclusion of insolvency ought to be clear from a consideration of the debtor's financial position in its entirety and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity. It is the debtor's inability, utilizing such cash resources as he has or can command through the use of his assets, to meet his debts as they fall due which indicates insolvency.

37 Approaching the matter this way, the factoring arrangement may be seen as involving the realisation of company assets, yielding sufficient cash to pay the ATO with a comparatively small surplus.

38 Accordingly I would reject the challenge to the findings rejecting the appellants' claims of insolvency on the three dates.

39 It therefore becomes unnecessary to consider the challenge relating to the s588FG defence.

40 The appeal should be dismissed with costs.