TGIF 4 December 2020 – Supreme Court refuses to wind up company based on outstanding debt alone

This week’s TGIF looks at recent litigation involving Henclo Investments Pty Ltd, where the NSW Supreme Court refused an application to wind up a company on the basis that an outstanding debt alone is insufficient to show insolvency.

Key takeaways 

• In cases where a plaintiff cannot rely on a presumption of insolvency, and must prove actual insolvency, the existence of outstanding debts (even significant ones which are undisputed) are only a factor in determining a company’s financial position and are insufficient by themselves to demonstrate insolvency.
  
  
• A defendant’s failure or refusal to participate in a debt or winding up proceeding is not enough to infer insolvency without more. In order to have any persuasive weight, there should already be an inference of insolvency which the non-participation can bolster.
  
  
• It is crucial to check the source of any financial documents the court is being shown, as financial records of a parent company are of little value to winding up proceedings for a subsidiary (save in circumstances where they might represent the value of the subsidiary’s assets).

In recent litigation involving Henclo Investments Pty Ltd, the NSW Supreme Court refused an application to wind up a company in circumstances where actual insolvency was not shown by an outstanding debt alone. (Re MSB Capital Holdings Pty Ltd [2020] VSC 775).

The application

Henclo had applied for the defendant company to be wound up after it failed to pay an outstanding judgment debt. The debt had been the subject of a letter of demand. However, Henclo never issued a statutory demand. As such, it could not rely on a presumption of insolvency and had to prove the defendant’s ‘actual insolvency’.

The defendant had not appealed the judgment debt, nor replied to the letter of demand when the application was brought. It was also not present or represented in the proceedings.   

By the time the application came before Matthews JR, all of the formal matters (i.e. service and notices) had been established. The only question before his Honour was whether Henclo could demonstrate the defendant’s ‘actual insolvency’.

Applicable law

The Court identified that in order to find the defendant was ‘actually insolvent’ it had to be satisfied that, as matter of commercial reality, the defendant was unable to meet its liabilities.

In answer to this, Henclo submitted:

• financial records of the defendant’s parent company showing a deficiency in assets and lack of income;
  
  
• the defendant’s failure or refusal to participate in either the original decision to issue the judgment debt, or the application for winding up; and
  
  
• the undisputed unpaid debt.

What did the Court decide?

The Court did not consider the financial records persuasive, largely because they were mistakenly presented as evidence of the defendant’s financial position. After pointing this out, Matthews JR considered the documents to be irrelevant to the defendant’s financial position (except insofar as they demonstrated the assets of the defendant).

The Court also considered the non-participation of the defendant to be irrelevant. In this respect, Matthews JR called Henclo’s reliance on the defendant’s non-participation ‘troubling’ and said it would realistically only be persuasive if there was already an inference of insolvency that could be bolstered by non-participation.

The only relevant factor, according to Matthews JR, was the presence of an undisputed and unpaid debt. However, his Honour found that the presence of such a debt is not conclusive. Rather, it is merely a factor which may be taken into account when assessing the solvency of a company. It is not sufficient alone for the purposes of demonstrating actual insolvency.

Matthews JR emphasised that the crux of proving actual insolvency is a matter of showing the defendant is not merely refusing to meet its liabilities, but that it is unable to meet them. If there is uncertainty as to whether a company can pay its debts, a court should not declare it to be insolvent.

Comment

In cases where a company has failed to pay an undisputed debt, consideration should be given to the option of issuing a statutory demand to secure the benefit of a presumption of insolvency. However, if a statutory demand is not issued (or not possible), it is important to show more than the mere existence of an undisputed unpaid debt to prove insolvency. Other indicators courts have used include: evidence of continuing losses; overdue taxes; issuing of post-dated cheques; and an inability to produce timely and accurate financial information or make reliable forecasts.