INSOLVENT TRADING AND RELATED ENTITIES AS LAST CREDITOR PRIORITY

By Georgie Cape, Law Clerk, MST Lawyers and Alicia Hill, Principal, MST Lawyers

The recent case of Perrine v Carrello [2017] WASCA 151 demonstrates that flexible payment arrangements between related entities may still be considered debts and that if this debt is incurred while the company is insolvent, it may constitute insolvent trading, rendering directors personally liable for the debt. The Court not only ordered the directors to repay to the company the losses suffered but also said the related entities would not be entitled to any distribution in the liquidation until all other creditors had been paid.

What happened?

Mr and Mrs Perrine were directors and shareholders of Perrine Architecture Pty Ltd (PA). PA owned a majority shareholding in a subsidiary company called Perrinepod Pty Ltd (Perrinepod), of which Mr and Mrs Perrine were also directors.

PA provided Perrinepod with its office, facilities and staff at commercial rates. The payments for this infrastructure were made under a flexible arrangement, namely ‘as and when’ Perrinepod had funds available to make a payment.

Before the appointment of a liquidator, Perrinepod had outstanding invoices owed to PA of $1.35 million.

On 1 March 2012 Mr Carrello (Liquidator) was appointed as the liquidator of Perrinepod.

 The Liquidator commenced proceedings against the directors, seeking remedies on the basis that:

  1. Mr and Mrs Perrine, as directors of Perrinepod, failed to avoid incurring debts whilst the company was insolvent;
  2. Perrinepod’s insolvent trading was PA’s liability as it is the holding company of Perrinepod; and
  3. The transactions were voidable for which PA is liable to pay compensation.

 The majority of the claim was based upon insolvent trading claims, which will be the focus of this article.

Trial

The insolvent trading claims against Mr and Mrs Perrine, in their role as directors, were based upon the alleged infringement of section 588G of the Corporations Act 2001 (Cth) (the Act) that sets out the director’s duty to prevent insolvent trading.

Section 588M of the Act provides that where a director contravenes section 588G, and as a result, the creditor suffers loss or damage, the liquidator may recover the amount of the loss or damage from a director.

The insolvent trading claim against PA enabled a liquidator to recover loss or damage from a holding company of the company in liquidation.

The primary judge, Justice Chaney, found that Perrinepod was insolvent from 16 July 2010 and debts incurred after that date were done so while trading while insolvent. It was found that there were reasonable grounds for suspecting that Perrinepod was insolvent at this time and that Mr and Mrs Perrine were aware of this and did not have reasonable grounds to suspect otherwise.

Justice Chaney, therefore, found that Mr and Mrs Perrine were liable to pay the Liquidator $1.35 million with interest, as they had failed, as directors, to prevent insolvent trading by Perrinepod which consequently caused financial loss to PA, a creditor.   

His Honour also ruled that the sums paid by Mr and Mrs Perrine to cover Perrninepod’s creditors not be available to pay the debts to PA until Perrinepod’s other unsecured debts had been paid in full. This order was made pursuant to section 588Y(2) of the Act.

This section states that the Court may order that the compensation to be paid to a company is not to be paid unless all of the other company’s unsecured debts have been paid in full where:

  1. a Court orders a person to pay the company compensation due to loss or damage suffered by a person in relation to a debt because of the company’s insolvency; and
  2. at the time the debt was incurred, the person who suffered loss or damage knew the company was insolvent at that time.

The Court found Mr and Mrs Perrine were aware of Perrinepod’s insolvency at the time of incurring debts to PA. As the directors and controlling minds of both companies, it was reasoned that PA knew of Perrinepod’s insolvency at the time the incurred debt. This provided grounds for the Court to order that the amount to be paid to PA not be made available unless all of Perrinepod’s other unsecured debts had firstly been paid in full; causing payments to PA to be a last priority for the Liquidator.

 Appeal

 Mr and Mrs Perrine appealed the decision of Justice Chaney to the Western Australia Court of Appeal (the Court).

Mr and Mrs Perrine’s grounds for appeal included that the primary judge erred in law in holding that loss or damage was suffered by PA in relation to a debt because of Perrinepod’s insolvency. They alleged that the Liquidator failed to prove that PA had suffered loss or damage because of the agreed payment arrangements.

Mr and Mrs Perrine alleged that Justice Chaney found that subject to the payment agreement, Perrinepod would not pay its debts unless it had the funds to pay and payment would not be detrimental to Perrinepod’s finances. As Perrinepod was unable to pay, Mr and Mrs Perrine claimed that no debt existed and hence PA had suffered no loss.

The Court rejected Mr and Mrs Perrine’s arguments and dismissed the appeal.

Martin CJ, Mitchell JA and Beech JA held that:

  1. contracts involving future debts or flexible debts in relation to time can be incurred;
  2. the payment arrangement involved Perrinepod making payments ‘as and when’ as opposed to ‘if and when’ it had sufficient funds available; and
  3. that weight must be given to Perrinepod’s conduct and intentions.

Justice Chaney’s decision was upheld, including making the related entity, PA, the last priority for any payments to be made by the Liquidator.

Important Points For  Company Directors

This case emphasises the importance of a director performing their duty to prevent insolvent trading.

Directors should exercise extra caution where creditor companies are related entities as these companies may still incur debts despite having flexible payment agreements between associated entities. Directors should analyse payment terms to determine when their debts are payable and monitor the financial viability of a company. Trading should cease when the company is suspected to be insolvent (unless the safe harbour regime has been lawfully activated). If trading while knowingly insolvent continues, directors can be found to be personally liable to pay the debt incurred by the insolvent company.

The decision also reiterates that liquidators can seek orders that entities related to the insolvent company be paid after other creditors from funds obtained from liable directors of an insolvent company.

If you would like to discuss any aspect of this article further, please do not hesitate to email Alicia Hill or phone +61 3 8540 0200.