Alert – Can a company be wound up on the basis of a disputed debt – 1993 reforms clarified and explained?

9 June 2011

Until the 1993 amendments, it was said that a company could not be wound up because of a debt which was the subject of a bona fide dispute. In 1993, the predecessor to the Corporations Act was amended to effectively compel the company to raise the dispute in an application to set aside the creditor's statutory demand. The dispute could not be relied on at the hearing of the winding up proceedings without the leave of the Court, which would only be granted if the matter was relevant to the issue of the company's solvency (section 459S).

But what happens if the winding up application is not brought by a creditor, but by ASIC, and the presumption of insolvency is not based on the failure to comply with a statutory demand, but the presumption arising because a secured creditor has appointed a receiver and manager under its charge (section 459C(2)(c)) - a presumption also introduced as apart of the 1993 reforms?

In ASIC v Lanepoint Enterprises Pty Ltd [2011] HCA 18, the High Court of Australia affirmed a first instance decision of the Federal Court of Australia in which a winding up order was made, overturing the Full Court's decision that the winding up proceedings should be stayed.

This case clarifies for the first time the extent the previous law survived the 1993 amendments and contains important lessons for those bringing or defending winding up proceedings.

Background

Receivers appointed – ASIC commences winding up proceedings

The case is one of the legacies of the collapsed Westpoint Group, in which members of the public invested many millions of dollars to secure an interest in various 'mezzanine' funds, which then made loans to companies owned and operated by the Western Australian property developer, Norm Carey

Here the operations of Lanepoint Enterprises Pty Ltd (Lanepoint) were financed by loans from Suncorp-Metway Limited (Suncorp), and a related 'mezzanine' fund whose responsible entity was Westpoint Management Limited (Westpoint). Lanepoint granted fixed and floating charges to each of them. After provisional liquidators were appointed to Westpoint in February 2006, Suncorp and Westpoint's liquidator both appointed receivers and managers to Lanepoint. In June, ASIC commenced proceedings to have Lanepoint wound up in insolvency.

ASIC relied on section 459C(2)(c), which provides that the Court must presume the company is insolvent if, during the previous three months, a receiver, or receiver and manager, is appointed under a floating charge. This presumption 'operates except so far as the contrary is proved for the purposes of the application' (section 459C(3)). Even so, Lanepoint contended it was solvent.

Lanepoint's financial position – the disputed debt

By the time of the hearing, Lanepoint's debt to Suncorp had been repaid. Its assets were more than $5.7 million, and its liabilities by way of debts and certain company loans were in the order of $17 million. The critical issue was the extent of Lanepoint's debt to Westpoint. Lanepoint's receivers considered the debt to be more than $6.6 million; Westpoint's liquidator agreed. However, Lanepoint alleged account should be taken of a number of adjustments to the inter-company loan account, which reduced the liability by about $5 million. The Receivers did not agree with these adjustments, which were said to result from certain transactions entered into before they were appointed, including two 'round robin' transactions, and a '$2 million run-around'. Lanepoint sought to establish that the changes reflected the true position, which is to say that the transactions in question were bona fide and effective, and that it was therefore solvent. (paragraphs [8] and [9]).

The Court's decisions below

After hearing evidence over 3 days, the trial judge (Gilmour J) did not accept the evidence of Lanepoint's witnesses as to why the inter company loan needed to be corrected, said the presumption had not been rebutted and made the winding up order. On the other hand, the Full Court set aside these orders and stayed proceedings pending the determination of proceedings yet to be commenced by the Westpoint liquidator concerning the inter-company debt, even though he had expressed no intention of commencing them. The basis of the Full Court's decision was that 'ordinarily a company would not be wound-up on the basis of a disputed debt.' (paragraphs [10] and [12]).

Disputed debts prior to the 1993 amendments

In overturning the Full Court's decision and affirming the orders made by he trial judge, the High Court reviewed the differing approaches taken on disputed debts before and after the 1993 amendments that introduced - for the first time - a formal process for setting aside statutory demands.

Before 1993, disputes of this kind were often not raised until the hearing of the winding up application, which was commenced after the expiry of the statutory demand, and the consequent presumption of insolvency had arisen. Best practice saw companies applying for injunctions to restrain the commencement of the winding up proceedings before the demand expired, but this was by no means essential. It was in this context that it was said to be unsafe for a company to be wound up based on a disputed debt. The dispute went to the creditor's standing to bring the winding up proceedings. It was also said to be an abuse of process for proceedings to be commenced to effectively compel a solvent company to pay a disputed debt (paragraph [17]). Given these factors, the Court would exercise its discretion and not make a winding up order, even though the demand had expired and the presumption of insolvency had arisen.

Disputed debts and the current law

The 1993 amendments introduced a wide range of reforms, including the now well-understood procedure for setting aside statutory demands. But, as the High Court points out, other key reforms were introduced, including the introduction of the statutory definition of insolvency in section 95A, the presumption of insolvency where a receiver had been appointed under a floating charge, and giving ASIC standing to commence winding up proceedings. Also, an application to wind up the company in insolvency had to be determined within 6 months unless the period is extended by the Court before it expires. (section 459R) (paragraphs [20] – [23]). 

Of the new procedure the High Court commented that:

'Under the present statutory scheme, where a demand has not been complied with, the statutory presumption of insolvency applies unless the demand is set aside in proceedings brought for that purpose prior to the hearing of the application for an order to wind up. Unless the demand is rendered ineffective, by an order setting it aside, the company is required to prove to the contrary of the presumption. This may be contrasted with the position which formerly pertained, where the presumption that a company was unable to pay its debts could not arise if the debt the subject of the demand was shown to be the subject of a genuine dispute of substance.' (paragraph [28].

'The evident policy … is that there be a speedy resolution of applications to wind up in insolvency' (paragraph [27]).

Where did the Full Court fall into error?

Against this backdrop, the High Court found fault with many aspects of the Full Court's reasoning.

Firstly, it was wrong of the Full Court to rely on pre-existing principles concerning disputed debts, because these emanated from the former law concerning statutory demands - especially that founded on abuse of process - because these proceedings were not commenced by the creditor claiming to be owed the disputed debt, but ASIC, which did not commence the proceedings on the basis of a debt owed to it. 'More fundamentally,' the abuse of process reasoning has no application where the applicant relies on the statutory presumption arising from the appointment of a receiver under a floating charge. And of the current scheme generally:

'The current statutory scheme provides no basis for an assumption in favour of a dismissal or stay of proceedings where a company disputes the existence or amount of a debt.' (paragraphs [29] – [30]).

Secondly, the Full Court were wrong to exercise a discretion in favour of staying the proceedings. On this score, the High Court pointed to a number of factors, not least of which was the fact Lanepoint had not applied for a stay at trial (paragraph [34]), and the lack of utility of staying the proceedings, pending the commencement of proceedings by the Westpoint liquidator to challenge the disputed transactions, which it appeared he had no intention of commencing (paragraph [54]). The Court also rejected as sufficient reasons the absence of the 'necessary parties' to the resolution of the underlying dispute, the need for the Westpoint liquidator to commence his own proceedings and the fact that no harm would be done because Lanepoint was not trading (paragraphs [36] – [38]). 

In short:

'There was no evident reason to postpone the determination of ASIC's application to wind up and Lanepoint's notice of opposition to it. ASIC had the benefit of the presumption of insolvency and Lanepoint was required to prove to the contrary. Lanepoint could point to no further evidence necessary for this purpose the tender of which would warrant a postponement – a postponement which would have added to the considerable delays which had already taken place since ASIC's application had been filed.' (paragraph [52]).

Lessons learned?

So what lessons emerge from this decision?

  1. The High Court has again confirmed the intended operation of the statutory demand procedure, and that its rigours and constraints will and must be upheld by the courts, notwithstanding their discretion when the time comes to make the order.
  2. It highlights the power of the statutory presumption arisingin the event receivers and managers are appointed to a company by a secured creditor under a floating charge. This ground is used surprisingly rarely. Remember, this presumption only applies if the winding up application is filed within 3 months of the receivers being appointed under a floating charge.
  3. Care must be taken when key debts of the company are disputed. If a statutory demand is issued, then an application to set it aside must be filed before it expires. It is highly risky to seek to deal with the matter by way of defence to the winding up proceedings.
  4. It is also relevant when there is a substantive dispute about the company's solvency and it is claimed to form a part of the company's liabilities, noting that if a statutory presumption of insolvency has been triggered, the onus will be on the company to lead cogent evidence to substantiate the company's version of events.
  5. Even before the demand is issued, consideration should be given to the company commencing its own proceedings in connection with the matter. Once these are commenced, they should provide be proper grounds to set aside any statutory demand before they are finally determined.
  6. If a receiver has been appointed by a secured creditor under a floating charge, and yet the debt is disputed, proceedings should be promptly commenced to challenge the receivers' appointment, otherwise other creditors may separately apply to the court for the appointment of a liquidator.
  7. Finally, in any argument that a debt is disputed it is not enough to say that the debt or transaction giving rise to it may be set aside a voidable transaction by a liquidator obtaining orders from the court under section 588FF, because until those orders are obtained the debt and transaction will be enforceable in accordance with its terms.