By Ewurama Appiah, Law Clerk at Matthews Folbigg in the Insolvency, Restructuring and Debt Recovery Group
Proving solvency (or insolvency) can be a critical, complicated, and costly aspect of insolvency litigation. However, it is not always necessary to have an expensive expert to establish solvency. The Supreme Court of Queensland recently handed down a judgment in favour of a respondent to a winding up application, in which the respondent’s solvency was established by documents other than external expert reports.
The Court’s judgment confirms that the onus of proving solvency in winding up applications is on the Respondent opposing the winding up order. However, the judgment helpfully assists those companies with simpler operations and limited documentation to possibly reduce costs and rely upon alternative documentation that is not as costly as independent expert reports or audited accounts. Whether, and in what circumstances it is wise to do so will still remain a question requiring careful consideration and advice by companies facing a winding up application.
Fresh Outdoor Carport and Pergola Pty Ltd v Style Group Construction Pty Ltd [2024] QSC 43, (“Fresh Outdoor”) concerned an application to wind up Style Group Construction Pty Limited (“SGC”), based upon SGC’s failure to comply with a creditor’s statutory demand. This failure meant that not only was SGC presumed to be insolvent (s 459C Corporations Act 2001 (Cth) (“the Act”), but that without the court’s leave it could not rely upon any ground of opposition it could have used to try and set aside the creditor’s statutory demand (s 459S). Fortunately for SGC the Court accepted its arguments that it was solvent, so the question of leave did not need to be considered.
What was interesting about Fresh Outdoor was the Court’s willingness to consider the financial documents alone to determine solvency, without the benefit of an expert opinion. The Court’s satisfaction with this sort of evidence is a reminder to both creditors and debtors (as well as to liquidators and bankruptcy trustees in insolvency cases), that in the right case (which is not every case) a court may be persuaded by proficient records other than independent solvency reports or audited accounts when considering questions of solvency.
Facts of the Case
- SGC is a small construction company run by two directors; Mr He and Mr Seeman. In April 2020, SGC finalised renovation work for a Mr Ma (“the homeowner”), who 2 years later discussed with Mr He to add a pergola to his house. The Court accepted that Mr He gave advice to the homeowner, but SGC did not enter into any written agreement with the homeowner or Fresh Outdoor Carport Pty Limited (”FOC”); who built the pergola.
- FOC invoiced SGC for work carried out at the homeowner’s residence. SGC made two payments totalling $35,000 on behalf of Mr Ma (who was unfamiliar with account details resulting from his poor command of English).
- In January and February of 2023 however, SGC received two emails from FOC for payment of further invoices totalling $35,000. SGC rejected the invoices and requested that the invoices be sent to Mr Ma.
- Instead, FOC served SGC with a Creditor’s Statutory Demand for the outstanding invoices totalling $35,000 in August 2023.
- SGC failed to respond to the Creditor’s Statutory Demand, and so FOC filed an application seeking a winding up order on the basis of SGC’s presumed insolvency.
- SGC opposed the winding up application on the basis of solvency, and also the dispute regarding who was responsible for FOC’s invoices.
Solvency and Winding Up Companies
The Court’s only question concerned the solvency of SGC. Because it was able to determine this issue, it did not need to consider the balance of SGC’s application or the question of leave under s 459S to adduce evidence that should have been brought in opposition to FOC’s creditors statutory demand.
- Section 95A of the Act provides that a person is solvent if and only if the person is able to pay the person’s debts when they become due and payable.
- Section 459A of the Act allows a company to be wound up on the basis of its insolvency.
- As mentioned above, section 459C of the Act gives rise to a presumption of insolvency where a company fails to comply with a statutory demand.
Therefore, SGC was presumed to be insolvent and in opposing the winding up application bore the burden of proving that it was, in fact, solvent.
Solvency without a Solvency Report
It is common in a contested winding up application for the defendant (and sometimes also the plaintiff) to put on expert evidence regarding solvency. This is often in the form of an affidavit and report from a suitably qualified accountant regarding the financial position of the defendant. A plaintiff may file expert evidence in reply. The costs of preparing such reports, as well as cross-examination of the experts in court, can be significant.
In Fresh Outdoor, SGC took a different path, only filing evidence from its director and also its accountant (as well as an affidavit from the company’s solicitor that he held the disputed sum in his trust account as further evidence of SGC’s solvency).
FOC, the creditor, challenged this approach, arguing that an inference should be drawn against SGC because by not filing evidence in the form of an “independent solvency report and / or audited accounts” SGC had not filed the “fullest and best evidence” that it could have.
The Court rejected this argument, finding that each case turns on its own facts; that whether such evidence was required depends on the circumstances of each case, including the quantum of the alleged debt and other creditors, and the nature and size of the business, and that “as a matter of common sense” the costs of obtaining audited accounts/an independent solvency report “would have been disproportionate to the amount of the alleged debt in this case”.
In considering the evidence it did have, the Court was satisfied that affidavits filed on behalf of SGC showed significant cash flow and savings with no future liabilities. The most recent financial statements for FY23 and interim financial statements as at 31 December 2023 were in evidence, the most recent of which revealed the following:
- a total trading income of $1,828,644;
- gross profit from trading of $480,531;
- current assets of $1,297,337;
- cash assets in the amount of $933,302;
- gross profit from trading in the amount of $480,531; and
- total equity of $461,752 in the Balance Sheet.
The Court was therefore satisfied SGC had a positive net asset position. In addition, bank statements from the Respondent’s trading account and savings account over a 19-month period to 31 January 2024 showed debits and credits in excess of $13 million and $545,646.56 in savings. The Court did not accept FOC’s argument that this sum ‘miraculously appeared’ after the winding up application was filed, and instead was satisfied that on balance, these were monies of SGC and could be taken into account in determining solvency.
Further, from the information before it, the Court was satisfied that none of the usual indicia of insolvency were present in SGC, such as “continuing losses, negative liquidity ratios, overdue taxes, poor relationships with lenders, inability to borrow funds, no access to alternative funding, cash on delivery requirements imposed by suppliers, post-dating of cheques and payments to creditors of rounded sums.”
The Court rejected submission that the director’s long terms loans were ‘propping up’ SGC and accepted the director’s evidence that he did not intend to call up these loans and that he intended to continue to enable SGC to fund ongoing operations.
The Court concluded that SGC was solvent and the only reason the debt was not paid was because of a dispute over liability for payment rather than an inability to pay its debts as and when they fell due.
Astutely, the Court found it reasonable to infer “the issue is really one of costs”. The Court dismissed the application and stood the matter over to hear submissions as to costs. It is likely that this issue will be a lively one where SGC can claim success and an entitlement to have its costs paid, whilst FOC might argue that SGC chose not to defend the Statutory Demand and was presumed to be insolvent, and that it was reasonable to therefore file the winding up application. It will be interesting to see what orders the Court makes in the end.
You can read the full judgment here.
Matthews Folbigg Lawyers has a specialist team dedicated to Insolvency, Restructuring and Debt Recovery. If you would like more information or advice in relation to Insolvency, Restructuring or Debt Recovery practice and procedure, please contact Stephen Mullette or Jeffrey Brown on (02) 9806 7459 or (02) 9806 7446, or email stephenm@matthewsfolbigg.com.au or jeffreyb@matthewsfolbigg.com.au
