Insolvency
Series No 1
Proving
Solvency
Introduction
• Discussions of solvency usually
are nothing more than
restatements of the same old
statements of principle.
• These discussions rarely
examine the evidentiary
requirements necessary to
satisfy the required standard of
proof.
Why?
• Proving solvency becomes
necessary in many ways,
namely:
-
the rebuttal of the Section
459C presumption.
-
defence of a voidable
transaction under Section
588FF.
-
opposition to the making of a
sequestration order on the
basis of solvency.
Statutory Definition
•
Section 95A provides:
“Solvency and Insolvency
(1) A person is solvent if, and
only if, the person is able to
pay all the person’s debts, as
and when they become due
and payable.
(2) A person who is not solvent is
insolvent.”
Classic Statement
• In Sandel v Porter, Barwick CJ
observed:
“The debtor’s own moneys are
not limited to his cash resources
immediately available. They
extend to moneys which he can
procure by realisation by sale or
by mortgage or pledge of his
assets within a relatively short
time …
Classic Statement Cont’d
The conclusion of insolvency
ought to be clear from a
consideration of the debtor’s
financial position in its entirety
and generally speaking ought not
to be drawn simply from evidence
of a temporary lack of liquidity. It
is the debtor’s inability, utilising
such cash resources as he has or
can command through the use of
his assets, to meet his debts as
they fall due which indicates
insolvency.”
Common Problem
• Balance sheet solvency is for
the most part irrelevant to the
definition.
• Accountants are trained to
consider balance sheet
solvency.
• However, balance sheet
solvency can be useful in
identifying the value of assets
against which monies can be
raised.
Onus
• In so far as the company seeks
to rebut the section 459C
presumption then:
-
the company bears the onus of
proof;
-
the Court must be presented
with the “fullest and best”
evidence of the financial
position of the company.
Onus Cont’d
• As Spiegleman CJ observed in
Switz Pty Ltd v Glowbind Pty Ltd:
“The process of proving solvency is
not some kind of forensic game.
Solvency is a matter peculiarly
within the knowledge of the
company. The primary source of
information on the solvency of the
company must be the company
itself.”
• So if the Company fails to
disclose something and gets
caught then the Court can never
be satisfied as to solvency.
Expert Report
• An external and independent
expert should prepare a special
purpose report as to solvency.
• It is not sufficient for the
company to use:
-
its own internal accountants;
-
external accountants;
-
tax compliance accountants,
to prepare the report.
Expert Reports Cont’d
• The expert must carry out their
own audit to satisfy themselves
of the business and reporting
system of the company.
• Any report must bring liabilities
to account at the day of hearing.
• Bold assertions of solvency
arising from a general review of
accounts (even by qualified
accountants) are not sufficient.
Expert Reports Cont’d
• The expert report must be
based on independent third
party valuation of company
assets.
• Any internal company document
should be independently verified
by external accountants or
insolvency practitioners.
• Remember that the insolvency
practitioner and any valuer
providing valuation evidence will
be cross-examined.
The Evidence
• Unaudited accounts are not
ordinarily probative of solvency.
• Unverified claim of ownership
should be disregarded.
• Unverified valuations of property
are not ordinarily probative of
solvency.
• The nature of company assets
and ability to convert those
assets into cash in a short time
can be relevant.
The Evidence Cont’d
• Value of equity in leased assets
should be regarded with
suspicion.
• Loans treated as non current
should be examined closely.
• Any gap in financial records
must be explained.
• Loans to director or related
entities should be examined to
assess recoverability or be
disregarded.
The Evidence Cont’d
• Failure to verify the acquisition
costs of assets must be
explained.
• Trade debtors are an unreliable
source of funds and should
generally be discounted.
• Financial accounts produced
internally by well known
software packages are
unreliable.
Statutory Obligations
• In trying to demonstrate solvency,
companies often forget or ignore
debts which are not immediately
due eg:
-
PAYG installments may not be
due until 28 days after the end
of the quarter however,
deductions will have already
been made from employee
wages;
-
GST will often be collected but
not yet due to be remitted.
Statutory Obligations
Cont’d
-
Statutory obligations such as
Workcover often will not be
payable until after end of a
quarter;
-
The issue of solvency cannot
be addressed unless all
statutory returns are lodged.
Practical Difficulty
• The statutory demand regime is
now operating in a very robust
manner so if the presumption
arises the only defence is that
under Section 459C and in turn
Section 459S.
• A Company has 7 days after
determination of a Section 459G
Application to comply with a
demand.
Practical Difficulty Con’td
• A creditor can apply for winding
up and have a return date in
under 2 weeks.
• A company is unlikely to gather
evidence to prove solvency in 2
weeks
• The company needs to act
quickly.
A Solvent Company
• In the event the Section 459C
presumption is rebutted then the
winding up application should
be properly dismissed.
• A creditor can then sue in a
court of competent jurisdiction to
recover the debt.
Conclusion
• It may be argued that the
burden placed on a company to
demonstrate solvency is too
onerous.
• However, the Company is in that
position because it failed to
satisfy or set aside a statutory
demand and thus allowed the
statutory presumption to arise.