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Proving-up solvency: dont rely on presumptions

Proving-up solvency: dont rely on presumptions

Introduction

It is a regular reminder you have heard your whole professional career: don’t rely on presumptions. Effectively, you mould a fact or piece of evidence to suit the circumstances of what you want to prove or demonstrate.

Obviously, there are circumstances where presumptions are required; maybe due to your instructions or because your opinion relies in part upon another independent expert. These sort of circumstances are covered by APES 215 ‘Forensic Accounting Services’ and each respective State/Federal Court expert evidence rule, whereby experts are required to disclose any such presumptions made and any reasons for relying upon those presumptions.

As an example, the Forensics and Voidables teams recently combined on an engagement, which demonstrated the inherent problems associated with relying upon a presumption. In this engagement, an expert Insolvency Report prepared by a Forensic Accountant on the other side (the Insolvency Report) rested on one complex presumption (to which no-one had previously picked up on). That single presumption could potentially undermine a Liquidator’s right to pursue more than $30 million worth of unfair preference claims.

 

What happened?

The engagement

Our client is the defendant to an unfair preference claim whose action was brought on by a Liquidator. We were engaged to review the Insolvency Report and prepare our own Solvency Report to determine what date the Company (In Liquidation) became insolvent. The following is a brief description of the facts:

  • Our client was being sued for approximately $900,000 and was in the final stages of going to trial;
  • The relation-back period (without being specific) was April 2012 to October 2012, but Receivers were appointed in early September 2012; and
  • The Insolvency Report determined that the Company was insolvent throughout the relation-back period.

Put simply, the relation-back period is the 6 month period extending backwards from the relation-back day (generally, with exceptions, the day of appointment of an Administrator or Liquidator), during which time the Liquidator has the right to claw back any payments made, where they can show the Company was insolvent and the creditor received a preference over other creditors. For further information about the relation-back period or unfair preferences, please refer to our corporate guide to voidables.

 

The presumption

What had previously been missed was that the Insolvency Report relied on one major presumption – whether a single (but significant) related party loan became due and payable during the relation-back period or not. If it did, the Company had no capacity and was thereby insolvent. If it didn’t, the Company (in our view) was solvent. The following is a brief description of the facts:

  • In 2009, a shareholder of the Company (we will call this person, Mr X) entered into a Loan Agreement with the Company, whereby, the Company agreed to buy-back the shares of Mr X for more than $5 million (the Loan), with the Loan to be paid back after the expiry of 2 years from the date of the Loan Agreement (called the Loan Period);
  • Also, in 2009, the Company, Mr X and a Bank, entered into the Subordination Deed, whereby the parties to that Deed agreed that (the Deed):
  1. Until the Bank’s Debt was paid in full, the payment of the Loan was postponed and subordinated despite any other arrangement or agreement to the contrary;
  2. The Deed was a continuing agreement; and
  3. The Deed was expressed to prevail where there was an inconsistency between the Deed and the Loan Agreement.
  • The Insolvency Report presumed, as did the Company, the Liquidators and the Receivers, that the Loan became due and payable following the expiry of the Loan Period. This meant, according to the Insolvency Report, the Company’s working capital would have been insufficient to meet the due and payable debts throughout the relation-back period; and
  • Instead, we demonstrated that in applying the definitions of  current and non-current liabilities (pursuant to AASB 101 ‘presentation of financial statements’) and a literal interpretation of the Deed and the Loan Agreement together, the Loan was due but not payable and therefore not a current liability, during the relation-back period. This meant that the Company’s working capital would have been sufficient to meet the due and payable debts throughout the relation-back period.

 

The outcome

Following a 4 week process of reviewing more than 6,000 discoverable documents and drafting an expert report, we were instrumental in reducing our client’s potential exposure to the unfair preference claim to:

  • Firstly, $330,000, by demonstrating the application of the running account balance defence to the unfair preference claim (i.e. s588FA(3) of the Corporations Act 2001 (the Act));
  • Secondly, $100,000, by assessing our client’s ability to rely on the good faith defence for each payment (i.e. s588FG of the Act); and
  • Thirdly, potentially $nil, by proving that the Company was solvent at all material times during the relation-back period, until the Receivers were appointed (i.e. s588FC of the Act).

 

Takeaway

Don’t rely on presumptions, as they can potentially undermine even the most complex of matters.

SV Voidables are experts in dealing with voidable transactions and preparing expert solvency reports. If you would like assistance with any such reports, please contact our team of expert advisers on 1800 246 801.

 

Article written by Matthew Hudson, Manager, Queensland

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