TGIF 19 February 2021 – A focus on dollars and sense: the importance of properly quantifying loss

This week’s TGIF considers the decision of the Supreme Court In the matter of IW4U Pty Limited (In Liquidation) [2021] NSWSC 40, where the liquidators failed to recover compensation despite establishing contraventions of directors’ duties following an apparent phoenix.

Key takeaways 

• Claims should focus not only on breach but the quantification of loss suffered and, normally, how that adversely affects the creditors of the company. Without loss, there may not be a proper basis for whatever orders are sought. This is especially important where there may be multiple ways to quantify the impact on creditors.  
  
  
• When engaging an expert witness to provide valuation opinion evidence, they should be appraised of all the relevant facts that impact or could impact the value of the company or assets in question at the time of the valuation.
  
  
• When considering accessorial liability for contraventions of directors duties, the Court will enquire as to whether the accessory had actual knowledge of all of the essential facts of the contravention.

Background

IW4U Pty Limited (Company) operated a labour hire business by supplying staff to work in clients’ warehouses. Mr David Ngaue was the Company’s sole director and shareholder (although by the time of the hearing had passed away), and Mr Herman Astarci was the accountant and tax agent of the Company.

The Company had no written contracts in respect of either their casual labour force or their main customers. Rather, all contracts were conducted on a ‘week-to-week’ and ‘handshake’ basis.

In around 2015, the Company was under significant financial stress as it had significant ATO liabilities, had failed to pay the relevant superannuation guarantee charge for its employees and had been unable to cover overhead expenses. Mr Astarci advised Mr Ngaue that the Company was trading while insolvent and should cease trading.

In May 2015, and upon realising the Company was going to be audited, Mr Ngaue instructed Mr Astarci to incorporate a new company, Employment Services Pty Ltd (Employment Services). Upon incorporation of Employment Services, Mr Astarci was its sole director, secretary and shareholder.

At the end of July 2015, the Company’s business was ‘transferred’ to Employment Services for nil consideration (Transfer). There was no written sale agreement supporting the Transfer. Employment Services started invoicing the Company’s clients.

Liquidators’ Claims 

On 9 June 2017, the Company was wound up in insolvency upon an application by the ATO. Frank Lopilato and Mitchell Herret were appointed as liquidators of the Company (Liquidators).  

The Liquidators alleged that:

• Mr Ngaue had contravened his obligations under section 181 of the Corporations Act (Act) by failing to act in good faith in the best interests of the Company;
• Mr Astarci was an accessory to Mr Ngaue’s contravention under section 79 of the Act; and
• that Employment Services had obtained the benefit of the Transfer even though that transaction was an unreasonable director-related transaction within the meaning of section 588FDA of the Act.

The Liquidators sought to recover compensation quantified by reference to the value of the Company at the time of the Transfer.

The Decision

The Court found that:

• Mr Ngaue had contravened section 181 of the Act by preferring his own interests in completing the Transfer rather than placing the Company into external administration.
  
  
• Mr Astarci engaged in conduct as part of the Transfer which showed he had knowledge of the essential elements of Mr Ngaue’s contravention.
  
  
• The Transfer was an unreasonable director related transaction because Mr Ngaue became the shareholder of Employment Services and it was not reasonable for the Company to have agreed to the Transfer because there was no benefit to the Company in doing so.

Expert Report

The Court turned to the question of the loss suffered as a result of each of the findings referred to above. In support of their claim for damages, the Liquidators relied on an expert report from an accountant who valued the business of the Company on a realisation of future maintainable earnings method at $482,000, taking into account the:

• small number of key customers;
  
  
• fact that key customer relationships were solely established and maintained by the late Mr Ngaue; and
  
  
• the Company’s casual labour force.

Although the Court did not challenge Mr Haley’s methodology, it gave his report no weight and found that his report failed to adequately consider the Company’s dire financial situation including its debts to the ATO and considered that it was entirely unrealistic to suggest a ‘knowledgeable, willing but not anxious buyer’ of the business would have paid a substantial amount to acquire the Company’s informal contracts which were based on handshake arrangements.

The Court considered that the most likely counterfactual was that the Company would have been placed into external administration. As a result the liquidators failed to establish the damage suffered by the Company and its claim for compensation was dismissed.

The Court also observed that the Liquidators had not claimed that they should be entitled to profits gained by Employment Services and so the Court was unable to consider whether it should make an order for compensation on that basis.

We observe that this case did not refer to the Treasury Laws Amendment (Combatting Illegal Phoenixing) Act 2020 (Cth) which commenced on 18 February 2020.  

Comment

It is important to ensure that all the necessary elements of a claim can be made out, including any loss suffered that grounds an order for compensation. Where there are multiple ways to allege that loss has been suffered, liquidators or other claimants should direct their attention to those claims which lead to them obtaining appropriate orders which will benefit company creditors.