Hawkins v Bank of China

(1992) 26 NSWLR 562

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(Decision by: Gleeson CJ) Court:

Judges:
Gleeson CJKirby P
Sheller JA

Subject References:
Companies
Directors and officers
Personal liability
For "debts incurred"
Company executing guarantee
Contingent liability for liquidated amount
Whether debt incurred
Winding up
Conduct and incidents of liquidation
Liability of officers for misfeasance
Liability for "debts incurred"
Company executing guarantee
Contingent liability for liquidated amount
Whether debt incurred
Guarantee and Indemnity
Guarantee
Construction and effect
Nature of obligation
Whether to pay unliquidated damages or liquidated debt
When "debt incurred"

Legislative References:
Companies (New South Wales) Code - s 556(1)(a); s 556(1)

Hearing date: 5, 6 March, 1 May 1992
Judgment date: 1 May 1992

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Decision by:
Gleeson CJ

GLEESON CJ . The issue in this appeal concerns the application to a guarantee of the provisions of s 556 of the Companies (New South Wales) Code , which makes officers of companies in certain circumstances personally responsible for company debts. That legislation has now been replaced, but it is still a source of potential civil and criminal liability. Moreover, the language of the section was taken up in s 592 of the Corporations Law .

The action involves a claim by the respondent, the Bank of China, against the three appellants, for an amount slightly in excess of $5 million. A company named Equiticorp International plc (Equiticorp) in January 1989 entered into a guarantee in respect of the liabilities to the Bank of two other companies in the same group. The Bank alleges that Equiticorp thereby incurred a debt in circumstances giving rise to statutory liability on the part of the appellants for the payment of that debt. Two of the appellants were directors of the company and one of whom took part in its management. The liability was claimed to have arisen by reason of the provisions of s 556.

The relevant provisions are as follows:

"556. (1) If --

(a)

a company incurs a debt, whether within or outside the State;

(b)

immediately before the time when the debt is incurred--

there are reasonable grounds to expect that the company will not be able to pay all its debts as and when they become due; or

there are reasonable grounds to expect that, if the company incurs the debt, it will not be able to pay all its debts as and when they become due; and

the company is, at the time when the debt is incurred, or becomes at a later time, a company to which this section applies,

any person who was a director of the company, or took part in the management of the company, at the time when the debt was incurred is guilty of an offence and the company and that person or, if there are 2 or more such persons, those persons are jointly and severally liable for the payment of the debt.

Penalty: $5,000 or imprisonment for 1 year, or both.

(2) In any proceedings against a person under subsection (1), it is a defence if the defendant proves--

that the debt was incurred without his express or implied authority or consent; or

that at the time when the debt was incurred, he did not have reasonable cause to expect--

that the company would not be able to pay all its debts as and when they became due; or

that, if the company incurred that debt, it would not be able to pay all its debts as and when they became due."

The facts relied upon by the Bank are as follows.

At the end of 1988, the two companies earlier mentioned were jointly and severally indebted to the Bank in an amount of $5 million, being the balance of moneys owing on the maturity of certain bills of exchange. The Bank obtained from Equiticorp an agreement to guarantee those obligations. On 4 January 1989, Equiticorp executed a document described as a "Guarantee and Indemnity". That document referred in its recitals to the financial accommodation that the Bank had provided to the two companies. It provided as follows. (The Bank was referred to as the "Lender", the two companies were referred to as the "Borrower" and Equiticorp was referred to as the "Covenantor"):

"1. The Covenantor hereby unconditionally and irrevocably guaran tees to the Lender the due and punctual payment by the Borrower of all moneys from time to time owing and payable by the Borrower to the Lender in terms of the Financial Accommodation and the due performance and observance by the Borrower of all the Borrower's obligations under all agreements and securities relating to Financial Accommodation and further guarantees to pay to the Lender all fees, interest, charges, disbursements and expenses incurred by the Lender which in terms of all agreements and securities relating to Financial Accommodation are recoverable from the Borrower (all such aforesaid moneys being hereinafter included within the term 'the Moneys Hereby Secured').

2. The Guarantee given herein shall be enforceable at any time upon demand being made by the Lender after the Borrower shall have defaulted in performance or observance of any of the obligations on its part contained in respect of any Financial Accommodation. On any such default occurring the Covenantor will forthwith upon first demand pay to the Lender the Moneys Hereby secured notwithstanding that at the time the Lender may not have made demand, commenced proceedings, realised securities or otherwise taken steps against the Borrower or any other party to recover the Moneys Hereby Secured.

...

9. Although as between the Borrower and the Covenantor the liability of the Covenantor to the Lender may be that of surety only, nevertheless as between the Covenantor and the Lender the liability of the Covenantor shall be deemed to be the liability of a principal debtor and such liability shall not be affected or diminished, nor shall any security collateral hereto be released or discharged by any of the matters hereinbefore mentioned, or by any other act, omission, matter or thing whatsoever whereby the Covenantor as a surety only would have been so released."

The Bank alleges that immediately before the execution of the guarantee there were reasonable grounds to expect that Equiticorp would not be able to pay its debts as and when they became due.

It may be that there are disputes between the parties as to the liability of Equiticorp to the Bank under the guarantee. There may also be disputes about the financial position of Equiticorp as at 4 January 1989, and about the state of knowledge of that financial position on the part of the appellants. If there are such disputes, they are not presently significant, because Rogers CJ Comm D, pursuant to the provisions of Supreme Court Rules 1970, Pt 31, ordered that there should be determined separately from any other question in the proceedings a question of law raised by the appellants as to the meaning and effect of s 556 in a case such as the present. The appellants contend that, in the events that happened, there was no relevant debt incurred by Equiticorp within the meaning of s 556 and, therefore, there could be no personal liability under that section. This contention was based upon two grounds, one depending upon the construction of s 556 and the other depending upon the construction of the instrument of guarantee and indemnity. For the purpose of the argument it may be assumed that Equiticorp is itself liable to the Bank in the amount claimed, although the precise nature of that liability requires further consideration.

The question formulated for separate determination was as follows:

"Whether, by entering into a Guarantee and Indemnity, bearing date 4 January 1989, between Equiticorp International plc and the Bank of China, Equiticorp International plc incurred a debt within the meaning ofs 556 (1) of the Companies (NSW) Code ."

Rogers CJ Comm D answered that question in the affirmative, and it is against that answer that the present appeal is, by leave, brought.

Much of the argument in the appeal turned upon the question of when, if Equiticorp incurred a debt to the Bank, that debt can be said to have been incurred. The interest that was shown in that question did not result from the circumstance that there was, in the present case, any material change in the financial position of Equiticorp over some relevant period of time. In the events that happened, the two principal debtors went into provisional liquidation within a few weeks of the execution of the guarantee, and demand was made upon the guarantor. The respondents were not concerned to argue that a debt had been incurred at a later time rather than an earlier time. Rather, their argument was that no debt was ever incurred within the meaning of s 556. That argument was supported by an examination of the problems said to exist in deciding when any such debt might be said to have been incurred.

The nature of the liability, both civil and criminal, created by s 556 is unusual, and it depends upon a combination of facts and circumstances some of which may require retrospective consideration of events. For example, the section may be invoked in relation to a company that was not a company to which it applied when the relevant debt was incurred, but which became such a company at a later time. Section 553 provides that s 556 applies, inter alia, to a company that has been wound up or is in the course of being wound up, or that has ceased to carry on business, or is unable to pay its debts. In the present case, Equiticorp is said to be a company to which s 556 applies because of events that occurred after 4 January 1989.

The identification of the time when the debt was incurred is central to the operation of s 556, because that is the time by reference to which the relevant expectations as to the company's financial capacity are to be judged. When one is concerned with a company that has become insolvent, expectations of the kind in question may change over time, and such changes may be rapid.

As was observed by senior counsel for the appellants, the operation of s 556 may be clear enough in cases where the incurring of a debt is the result of a single act. Thus, for example, if a company borrows money there may be little difficulty about deciding when the resulting debt was incurred. On the other hand, debts often come into existence as a consequence of events that occur over a period of time, during which the financial position of the company in question may undergo significant change. Decided cases in relation to the section show that courts have, on occasion, had difficulty with the question of the time when a debt has been incurred: eg, Russell Halpern Nominees Pty Ltd v Martin [1987] WAR 150; John Graham Reprographics Pty Ltd v Steffens (1987) 12 ACLR 779; 5 ACLC 904; Hussein v Good (1990) 1 ACSR 710; 8 ACLC 390.

Where a debt results from a guarantee, the sequence of events is commonly as follows. At the time of the execution of the guarantee, the guarantor undertakes a contingent liability. The contingencies normally include, although they are not necessarily limited to, default on the part of the principal debtor, and the making of demand upon the surety by the creditor. At the time of executing the guarantee, such a liability would not normally be shown as, or included in, a liability in the company's balance sheet, but it would be referred to in a note to the accounts. Of course, the circumstances of any individual case may require special consideration, and I refer only to the usual position. (For an example of a different case, see Wood Hall Ltd v Pipeline Authority (1979) 141 CLR 443 .) Subsequently, events may occur by reason of which the contingent liability matures into a presently payable debt. (As to when this gives rise to a loss or outgoing incurred for the purpose of s 51 of the Income Tax Assessment Act 1936 (Cth): see, eg, Hooker Rex Pty Ltd v Federal Commissioner of Taxation (1988) 79 ALR 181 at 188-190; 19 ATR 1241 at 1247-1248; 88 ATC 4392 at 4399.)

Guarantees are sometimes executed in advance of any principal debt coming into existence. A person may execute a guarantee in favour of a bank in a case in which the bank has not yet made an advance to its customer. In such circumstances it is not normally said that the guarantor, upon the execution of the guarantee, incurs a debt. Nor would it normally, and apart from some special context, be said that a person who gives a guarantee in respect of a debt incurred by another thereupon himself incurs a debt, at least if the principal debtor is apparently solvent and not in default.

Equally, however, on any use of language, in the events that have occurred in a case such as the present, there ultimately comes a time when the guarantor would be said to be indebted to the creditor. In the present case, a guarantee was executed, the principal debtors became insolvent and went into default, and demand was made by the creditor under the guarantee. In those circumstances it seems difficult to deny that at some stage Equiticorp incurred a debt to the Bank.

The difficulty about concluding that such a debt was only incurred when demand was made is that it produces a result which in many cases involving the application of s 556 would be unjust, and, indeed, absurd. Suppose, for example, that company A gave a guarantee to a bank in respect of the liabilities to the bank of company B, and the guarantee was executed in Year 1. At the time, both companies were financially sound. Suppose that some years later, at a time when both companies are in serious financial difficulties, company B goes into default and the bank then calls upon the liability of company A under the guarantee. It would be unjust to fix the directors of company A with criminal or civil responsibility under s 556 by reference to expectations as to the financial capacity of company A at the time when the bank made a demand under the guarantee, because the commitment was undertaken in Year 1 and (let it be assumed) could not thereafter be abrogated. Yet that would be the consequence that would follow if company A were treated as having incurred a debt to the bank when demand was made. All parties to the present appeal agreed that such a result would be unacceptable. The respondents contended that the way to avoid that consequence is to treat the debt as having been incurred at the time of the execution of the guarantee. The appellants contended that the way to avoid that consequence is to construe s 556 as having no application at all to the contracting of a contingent liability such as that which exists under a guarantee, even if the liability ultimately becomes an actual liability.

Whilst for purposes of construing s 556 it is important to bear in mind problems that might arise in addition to that with which we are concerned, it is unnecessary for us to attempt to resolve all the difficulties that could arise in the application of the section. There may be many cases where, for one reason or another, it is difficult to determine when a company has incurred a debt. We, however, are concerned only with one such case, that is to say, the case of an obligation flowing from a guarantee.

Before going to the appellants' primary submission, it is convenient to deal with a subsidiary argument which directs attention to the nature of Equiticorp's obligations under the guarantee. This argument begins with the proposition that a liability cannot be a debt for the purposes of s 556 if it entails an obligation to pay unliquidated damages as distinct from a liquidated sum. This was not challenged by the respondent, and it is unnecessary to examine the proposition further, or to seek to explore the boundaries between liquidated and unliquidated claims: cf Jelin Pty Ltd v Johnson (1987) 5 ACLC 463. The argument goes on to contend that, as a matter of construction of the guarantee presently in question, any liability under it is a liability for damages, and there is no debt involved: cf Sunbird Plaza Pty Ltd v Maloney (1988) 166 CLR 245 at 254-257.

As Mason CJ pointed out in Sunbird Plaza , a creditor's rights against a guarantor depend upon the terms of the guarantee and the nature of the obligation performance of which is guaranteed. In the present case the obligations of the two members of the Equiticorp group to the Bank were simply to pay their debts to the Bank. They had received financial accommodation from the Bank, and the Bank and the two companies were referred to in the instrument of guarantee and indemnity as lender and borrowers respectively. The relevant terms of the instrument are set out above. Clause 1 provides that Equiticorp guarantees the due and punctual payment of moneys owing to the Bank by the two borrowers. Clause 2 provides that, on default by the borrowers, Equiticorp will on demand pay to the Bank the moneys secured, that is to say, the moneys owing by the borrowers to the Bank including fees, interest and similar charges.

Mason CJ said (at 255):

"... If the subject of the guarantee is payment of a debt or a sum of money which has accrued due, the creditor may, on default by the principal debtor, sue the guarantor instead of the principal debtor for the debt or sum of money, his claim being for a liquidated amount. If, on the other hand, the subject of the guarantee is the performance of some other obligation, then the person having the benefit of the guarantee may, upon default, sue the guarantor for damages for breach of contract."

The present case falls within the first of those two categories. The Bank's claim against Equiticorp is properly to be regarded as a claim for a liquidated sum: cf Hyundai Heavy Industries Co Ltd v Papadopoulos [1980] 1 WLR 1129; [1980] 2 All ER 29 ; Re Standard Insurance Co Ltd (In Liq) and the Companies Act 1936 (1969) 91 WN (NSW) 654 at 657-658; [1970] 1 NSWR 392 at 395 per Street J. For that reason the appellants' subsidiary argument must fail.

The same conclusion presents an initial difficulty for the appellants' main argument. Equiticorp (on the factual assumptions made for the purposes of the separate question of law being considered) owes a debt to the Bank. The Bank's claim for a liquidated sum flows from the making of a conditional agreement and the subsequent fulfilment of the condition, that is to say, the failure of the borrowers to pay their debts to the Bank, and the making of demand upon Equiticorp.

It may be accepted that in some commercial or legal contexts it would be unusual to describe Equiticorp as having incurred the debt in question upon executing the guarantee. It is equally true, however, that even in those contexts it would be natural and proper to say that at some stage Equiticorp incurred a debt to the Bank. The appellants (for reasons explained above) are concerned to argue that Equiticorp did not at any stage incur a debt to the Bank within the meaning of the section. This demonstrates that, whichever way the present dispute is resolved, the result will involve some departure between the language of the statute as construed by the Court and the use of language in the contexts to which reference has just been made. The appellants submit that there was no debt incurred by Equiticorp for the purposes of s 556. The respondent submits that a debt was incurred when the guarantee was executed. The alternative possibility, that a debt was incurred when the borrowers defaulted and the Bank made demand on Equiticorp, would, in many cases, if not the present, produce a practical result that is agreed on all sides to be unjust and absurd.

The circumstance that the parties before the Court reject the last- mentioned possibility does not mean that we can disregard it. However, it is clearly correct to characterise the result that would follow as one to be avoided if at all possible. In the case of a guarantee, months or years may elapse between the time when the guarantor becomes irrevocably committed to the conditional liability which is involved, and the time (if ever) when the creditor has a presently enforceable right to recover a liquidated sum from the guarantor. The financial circumstances of a guarantor company may alter substantially over that period. To relate the operation of s 556, which imposes civil and criminal liability on certain individuals associated with the guarantor company, to the company's financial circumstances at the later time would involve attributing to Parliament an intention to produce a result that would work such obvious unfairness in many cases that a court would avoid such a conclusion unless the language of the statute permits no other outcome.

It is necessary, of course, to guard against the error of considering the operation of the statutory language only by reference to the problem currently under consideration. Words such as "conditional" or "contingent", when used in relation to different types of obligation, can have different shades of meaning. There are types of contractual arrangement, of which the cases on s 556 referred to above provide examples, where it is entirely reasonable for a provision such as s 556 to operate upon the basis that a debt is incurred, not when a contract is entered into, but when some later event under the contract occurs.

The present problem appears to owe a good deal to a change in statutory language which was evidently intended to solve one problem, but which raised another. The Companies Act , 1961, in Pt X, Div 4, contained provisions applicable to winding up, and subdiv (4) provided for offences against the legislation. Subsection 303(3) made it an offence for an officer to be knowingly a party to the contracting of a debt provable in the winding up where there was no reasonable or probable ground of expectation of the company being able to pay that debt. Debts provable in a winding up included (by virtue of s 291) "all debts payable on contingency". The expression"contracting of a debt" is one of considerable legal antiquity, and there can be no doubt that if that form of statutory language had been retained the outcome in the present case would be that for which the respondent contends. Equiticorp would have contracted a debt payable on a contingency when it executed the guarantee, and that would have been the time at which to consider expectations as to its capacity to honour its obligations: Shapowloff v Dunn (1981) 148 CLR 72 at 78 per Stephen J. The Companies Act 1961 was amended in 1964 by a provision (s 304(1A)) which empowered courts to impose civil liability on a person convicted of an offence under s 303(3). There were further amendments in 1971 (by Act No 61 of 1971) which introduced a somewhat different set of provisions on the same subject, but which also turned upon the notion of contracting a debt. However, in an apparent attempt to extend the reach of the legislation, it was not confined to companies that were wound up. In 1982, the Companies (New South Wales) Code replaced the Companies Act 1961, and s 556, with which we are presently concerned, came into effect. It used the expression "incurs a debt" instead of the earlier concept of contracting a debt provable in the winding up. That language may have, in certain respects, cast a wider net than the earlier language, but it created the problem in this case. Where a company enters into a guarantee, and the conditional liability later becomes absolute by reason of default on the part of the principal debtor and demand by the creditor, does the company "incur" a "debt" and, if so, when?

It would be contrary to a number of decisions on s 556 of the Code and s 592 of the Corporations Law to confine the operation of s 556 to simple cases where the making of a contract and the subjection of one party to a presently enforceable obligation to pay a liquidated sum to another are for practical purposes contemporaneous: see, eg, Rema Industries and Services Pty Ltd v Coad ; Re Taspac Thermoforming Pty Ltd (1992) 7 ACSR 251. That would also be inconsistent with the statutory history (cf Shapowloff v Dunn ) and it would defeat the manifest purpose of the legislation, whatever difficulty there may be in defining the precise limits of that purpose cf Metal Manufacturers Pty Ltd v Lewis (1988) 13 NSWLR 315. The undertaking of liabilities by way of guarantee is such an obvious means by which companies come to owe debts that it is unlikely that it was intended to be beyond the purview of s 556, especially when it was clearly within the purview of the earlier statutory provisions on the same subject. There is nothing in the Parliamentary history of the legislation to indicate that it was intended in this respect to narrow the scope of the relevant provisions. On the contrary, there are repeated references to widening their scope.

Senior counsel for the appellants correctly observed that s 556(1) was never intended to cover the entire range of activities that might be described as fraudulent or insolvent trading, and he pointed to the more general provisions of s 556(5). Even so, to treat guarantees as falling outside s 556(1), especially when they had been caught by the earlier legislation, would produce a surprising result.

Reference was made to other provisions of the Code in which it is evident from the context. That the term "debt" has not been used so as to include contingent liabilities. There is, however, little assistance to be gained from such an exercise because of the differing contexts in which the term appears. For a similar reason authorities relied upon by the appellants concerning garnishee proceedings do not help to resolve the present problem.

The words "incurs" and "debt" are not words of precise and inflexible denotation. Where they appear in s 556 they are to be applied in a practical and commonsense fashion, consistent with the context and with the statutory purposes.

"Debt" is capable of including a contingent liability. The word was used in that sense in s 291 of the Companies Act 1961, which referred to "debts payable on a contingency". That expression did not involve a contradiction in terms. Dictionaries define "debt" as a liability or obligation to pay or render something. Such a liability may be conditional as well as present and absolute. In Williams v Harding (1866) LR 1 HL 9, there was an issue as to the effect of a statute dealing with insolvency which made a debt incurred by a non-trader insufficient to found an adjudication of bankruptcy unless it was contracted after a certain date. The debt in question in that case was a liability to pay calls made by a joint stock company. The question was whether the appellant's debt was contracted when he signed the deed of settlement making him a shareholder, or when the calls were made. It was held that the former was the case. Lord Cranworth LC said (at 21) that the date of the appellant's debt was when he executed the deed, and Lord Chelmsford (at 24) referred to the amount of the calls as a debt to which the appellant was "antecedentally liable".

Similarly, the word "incurs" takes its meaning from its context and is apt to describe, in an appropriate case, the undertaking of an engagement to pay a sum of money at a future time, even if the engagement is conditional and the amount involved uncertain. Once it is accepted that "debt" may include a contingent debt then there is no obstacle to the conclusion that, in the present context, a debt may be taken to have been incurred when a company entered a contract by which it subjected itself to a conditional but unavoidable obligation to pay a sum of money at a future time. This is such a case.

I would answer the separate question raised for decision in the affirmative.

The appeal should be dismissed with costs.