Quantifying a Claim for Insolvent Trading - Case Update
The recent decision in Re Swan Services Pty Limited (in liq)
In a wide-ranging decision, Justice Black sitting in the Supreme Court of NSW has clarified the principles relevant to quantifying the compensation payable by a director to a liquidator under s 588M, Corporations Act for contravention of the duty to prevent a company trading while insolvent. The outcome is important for insolvency professionals (and their funders) when assessing the expected recovery in an insolvent trading action, and so in weighing the benefits (and costs) to a liquidation estate of bringing an action.
The key point
Resolving the contest between the Liquidators and the defendant directors, Justice Black determined that compensation for "loss and damage" requires that account be taken of matters that will reduce the amount of that loss and damage. That is, the compensation payable under s 588M, Corporations Act is not the gross amount of debts incurred during the period of trading in contravention of s 588G of that Act; recoveries by a liquidator that will allow distributions to creditors - such as a successful unfair preference recovery - are to be taken into account. Importantly, this may also include contingent recoveries, not yet realised by a liquidator at the time of the hearing of the action.
So, when assessing an insolvent trading action, it is critical that insolvency professionals consider what recoveries have been or might in future be realised by the liquidation estate, which will reduce the "loss and damage" occasioned by the contravention of the insolvent trading prohibition. Charging ahead on the simple basis of the debts incurred during that contravention will not suffice.
Conducting that assessment early will be important for insolvency professionals in making decisions about the economic merits of pursuing a claim at all - the cost of often complex and slow insolvent trading litigation may not be justified, once the true value of the claim is known.
Some more detail
The Liquidators had established that the relevant companies were insolvent for a period prior to their placement into administration, and that various debts had been incurred during that period. From that point, Justice Black concluded that the defendant directors were in contravention of s 588G, Corporations Act - there were grounds to suspect that the companies were insolvent during the relevant period, when the debts were incurred. It was also found that the directors could not avail themselves of the defences in s 588H, Corporations Act or the exculpatory provisions in s 1317S of that Act.
So, the directors were liable, but for how much? The Liquidators claimed the gross amount of the debts incurred during the period of insolvent trading, but that was contested by the directors.
The central issue was whether or not a $2,500,000 unfair preference recovery made by the Liquidators from the ATO ought to reduce the compensation recoverable from the directors. That is, was the unfair preference recovery relevant to determining the "loss and damage" to be compensated by s 588M?
There are a number of competing decided cases on this issue, across several Australian jurisdictions. In some instances, courts had determined that the compensation required by s 588M was the gross amount of the debts incurred in contravention of s 588G - this was because no other approach was commercially expedient. Other instances resulted in Courts determining to bring other liquidation recoveries to account when assessing the compensation payable by a director under s 588M, on the basis that the provision seeks to compensate loss and damage suffered in relation to a debt incurred in contravention of s 588G, not simply the debt itself.
As noted above, in Re Swan Services, Justice Black determined that compensation for "loss and damage" requires that account be taken of matters that will reduce the amount of that loss and damage. In doing so, the Judge followed the more recent NSW decisions, and did not follow earlier decisions in other jurisdictions.
Is this right?
In our view, Justice Black's decision is correct in principle.
Section 588M was inserted into the Corporations Law in 1992, as a consequence of recommendations made in the Harmer Report in relation to reform of insolvent trading provisions generally. Both the commentary in the Harmer Report and the material set out in the Explanatory Memorandum to the Corporate Law Reform Bill 1992 make it quite clear that Parliament intended the courts to engage in a common sense assessment of compensation required to make good loss and damage from contravention of the insolvent trading duty - the Harmer Report expressly contemplates avoiding a rigid approach to that task.
An approach of simply taking the gross debt amount as setting the sum of compensation payable for a contravention of s 588G would not give effect to that expressed intention of Parliament. Further, that approach would not give effect to the distinction between compensation for loss and damage, and the debts that are to be the subject of compensation. Finally, as Justice Black found in Re Swan Services, this approach could lead to the odd situation where compensation is recoverable that is more than the total unpaid claims of creditors.
So, while challenging for insolvency professionals, in requiring an assessment of other liquidation recoveries as a part of establishing the amount of compensation payable under s 588M for a contravention of s 588G, Justice Black's decision is, in our view, the right decision. It is now incumbent on insolvency professionals to bring greater rigour to their quantification of insolvent trading claims.
Further learnings from the decision
The above point aside, the decision in Re Swan Services covers a range of other issues of everyday importance to insolvency professionals. Those issues include (a) the availability of the presumption of insolvency provided for in s 588E of the Corporations Act, (b) the relevant considerations when assessing insolvency generally, (c) the elements of the defences to insolvent trading in s 588H of the Corporations Act and (d) the principles relevant to determining whether or not a person was a de facto (or "shadow") director of a company at particular times. Justice Black's decision is well worth a more comprehensive review.