Australia: Lessons from Smith v Boné: Repayment arrangements and risks to directors

Last Updated: 25 May 2015
Article by Emily Plucknett and Toby Boys

Most Read Contributor in Australia, August 2019

The decision of the Federal Court in the case of Smith v Boné1 provides important judicial guidance on the requirements of the strict statutory duty upon directors to ensure that their company does not trade whilst insolvent.

The case examines in detail the impact that steps such as entering into repayment arrangements with creditors, including the Australian Taxation Office, may have upon the solvency of a company.

Remarkably, in this case, the director was found to have breached the insolvent trading legislation even though the company had entered into payments arrangements with the ATO which seemingly had the effect of deferring the time for payment.

The decision highlights the dangers for any director who fails to seek advice as to their company's solvency when seeking to trade out of financial difficulty.

Factual background

The case concerned an action by Petrolink Pty Ltd and its liquidator for relief against the first defendant, Barry Boné, in respect of losses suffered by creditors of Petrolink due to debts incurred whilst the company was insolvent. Mr Boné was the sole director of Petrolink.

The liquidator contended that Petrolink become insolvent on 30 June 2009, and remained insolvent until the company was placed into liquidation in December 2011.

Mr Boné conceded that Petrolink was insolvent from July 2011 only.

Effect of payment arrangements on debts due and payable

Section 588(1) of the Corporations Act 2001 (Cth) imposes a strict duty upon directors to prevent a company from engaging in insolvent trading. The Court considers the company's solvency "at the time when the company incurs a debt".

In considering the ability of Petrolink to repay its debts when due and payable, the Court reviewed the records of Petrolink to discern the nature of arrangements entered into with its trade creditors and with the ATO.

In particular, the Court considered whether numerous written and oral payment arrangements with the ATO from June 2009 to December 2011 resulted in the tax liabilities the subject of the arrangements to no longer become due and payable, so that they could not taken into account in assessing the company's insolvency.

The Court found that the payment arrangements did not mean that the payments were no longer "due and payable". The effect of the payment arrangements was that the debt was merely deferred, but they remained "due and payable" at all times2.

The Court also reviewed the company's ability to pay its debts owed to trade creditors, in circumstances where Petrolink was "managing" its cash flow by paying creditors in installments. The Court found that there was unsatisfactory evidence as to the existence of the payment arrangements, in that generally Petrolink's creditors were acquiescing to receiving payment by installment rather than making explicit agreements to extend credit.

Accordingly, the Court considered that the repayment arrangements entered into by Petrolink as a whole demonstrated that the company was experiencing common features of insolvency. The Court, therefore, was satisfied that all debts incurred by Petrolink from May 2010 onwards were incurred at a time when the company was insolvent.

Personal liability of Mr Boné

The Court then considered whether Mr Boné had reasonable grounds for suspecting Petrolink's insolvency, and was therefore liable for insolvent trading under the Corporations Act.

The Court found that Mr Boné had reasonable (and, in fact, ample) grounds to suspect that Petrolink was insolvent, with the overall picture being one in which Petrolink was "managing" its relationships with its trade creditors by failing to make tax payments. In reaching that conclusion the court had regard to:

  • the company's inability to pay its tax liabilities at all times;
  • the company's progressive inability to pay trade creditors in a timely manner; and
  • advice received by Mr Boné in June 2010 that Petrolink had engaged in insolvent trading, albeit with the support of creditors, and may engage in insolvent trading in the future.

The Court confirmed that a director of reasonable competence may have taken some comfort from their ability to negotiate payment plans with the ATO, but the court also considered that a director would have recognised that those plans did not affect the status of the tax debt as one that was "due and payable".

The Court concluded that a director of ordinary competence would have had no real idea where the money to pay the company's debts would be found and the director ought to have concluded that Petrolink was insolvent.

Defence to insolvent trading

Mr Boné raised defences to the liquidators' claim against him.

In particular, under section 588H of the Corporations Act, it is a defence to proceedings for insolvent trading if, at the time the debt was incurred, the person had reasonable grounds to expect that the company is solvent and would remain so or, alternatively, took all reasonable steps to prevent the company from incurring the debt.

Mr Boné sought to rely upon the payment arrangements with the ATO as reasonable grounds for expecting that Petrolink was solvent, in addition to the company's generation of significant revenue.

The Court was quick to find that those matters were insufficient to demonstrate a reasonable expectation that the company was solvent. The court noted that the payment arrangements did not have the effect that Petrolink's tax debts were no longer due and payable. The fact that the company was generating significant revenue meant little while its debts remained unpaid.

Similarly, the Court rejected an argument that steps taken by Mr Boné to scale back Petrolink's operations and to reduce the number of employees supported a finding that reasonable steps were taken to prevent the company incurring debt within the meaning of section 588H.

Discretion to exclude from liability

Mr Boné sought relief from liability under to section 1317S or 1318 of the Corporations Act. Those provisions confer a very wide discretion on the court to allow company officers to escape liability under section 588G of the Act "in situations where it would be unjust and oppressive not to do so"3.

The question before the Court was whether Mr Boné "acted honourably, fairly, in good faith and in a common sense manner, as judged by the standards of others of a similar professional background"4.

While Mr Boné failed to respond to the clear signs that the company was insolvent, the Court was satisfied that Mr Boné did not conduct himself dishonestly.

However, the Court could not accept that Mr Boné's conduct was of a kind that warranted him being excused from liability. In this regard, the Court found that Mr Boné:

  • did not actively seek professional advice about the company's solvency;
  • was never advised during the period from May 2010 that Petrolink was solvent; and
  • was advised in June 2010 that Petrolink had previously engaged in insolvent trading, albeit with the support of creditors, and may engage in insolvent trading if it continues to trade.

Having regard to the payment arrangements entered into with the ATO, the Court could not be satisfied on the evidence before it that a reasonable, commercially experienced director would have made the arrangements without a clear plan as to how it the company would meet its obligations.

The Court commented that Mr Boné's conduct in dealing with the ATO and its trade creditors was not fair in the circumstances. To the contrary, the Court found that the conduct strongly suggested an attitude on Mr Boné's part that he was entitled to decide what was in the best interests of the creditors and that, in the case of the ATO, Petrolink was entitled to negotiate multiple repayment plans, even if full repayment would take years.

As such, the Court found that Mr Boné's conduct fell well short of the kind that would justify an exclusion from liability for contravention of section 588G.

The Court was satisfied that Mr Boné should pay compensation of $669,582.86, the total amount of the debts incurred and remaining unpaid during the period of insolvency, less a small amount for a shareholder loan made by Mr Boné prior to May 2010.

Lessons from Smith v Boné

The decision highlights that directors must carefully consider their statutory duties to ensure their company does not trade whilst insolvent when seeking to trade a company out of a difficult financial position.

Directors should not assume that entering into payment arrangements with creditors, including the ATO, will be sufficient to prevent the Company from being insolvent. Repayment arrangements are unlikely to change the status of debts which are due and payable, and the arrangements should not be relied upon in determining whether a company may be trading whilst insolvent.

While the provisions which aim to prevent insolvent are not intended to "hamstring" a company, nor require that every transaction be scrutinised because of an academic possibility that the company is trading whilst insolvent, the decision acts as a reminder to directors that they need to have regard to their company's ability to pay its debts as and when they become due for payment.

Additionally, the decision highlights the need for directors to seek appropriate advice in relation to their company's financial position in order to be capable of reaching a reasonably informed opinion as to the company's financial capacity.

The insolvent trading laws under the Act lack flexibility - once a director is unable to form a view, based on reasonable evidence, that the company is solvent the director must cease incurring liabilities or risk being personally liable under section 588G of the Act.

On the other hand, the irony of the situation is that most directors, particularly of smaller companies, have signed personal guarantees in respect to the company's debts, so there is incentive for directors to take steps to save the company's (and their own) fortunes, even that action puts the director at risk of liability under the "insolvent trading" provisions of the Corporations Act.

Footnotes

1 Smith v Boné, in the matter of ACN 002 864 002 Pty Ltd (in liq) [2015] FCA 319

2 This finding is consistent with section 255-15 of Schedule 1 to the Tax Administration Act 1953 (Cth). Whilst section 255-10 of Schedule 1 permits the Commissioner of Taxation to defer the time at which a liability becomes due and payable, the Court was satisfied that none of the numerous payment arrangements were to this effect.

3 As established in Daniels v Anderson (1995) 37 NSWLR 438 at 525; Hall v Poolman [2007] NSWSC 1330; (2007) 65 ACSR 123 at [315]

4 As established in Australian Securities and Investments Commission v Edwards (No 3) [2006] NSWSC 376; (2006) 57 ACSR 209 at [10]

This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.

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