Turns on the terms – when does a creditor suffer loss because of a company’s insolvency?

This week’s TGIF considers whether a flexible payment arrangement between a subsidiary and its holding company creditor meant the parent suffered no loss on the insolvency of the subsidiary.

What happened?

On 17 August 2017, the West Australian Court of Appeal published its reasons in Perrine v Carrello [2017] WASCA 151 drawing a close to the long-running dispute between the Perrines and the liquidator (Liquidator) of their failed pod-home building company (PodCo).

The Liquidator was successful, at least in part, at first instance and had obtained orders under s 588M of the Corporations Act that the Perrines were liable to pay the Liquidator the sum of $1.35 million (plus interest) on the ground that, as directors, they had failed to prevent insolvent trading by PodCo thereby causing loss to a creditor of PodCo, its parent company (HoldCo).

The Perrines appealed the reasoning of the primary judge but did not challenge the conclusions that:

• PodCo was insolvent;

• there were reasonable grounds for suspecting insolvency; or

• they were aware that there were grounds to suspect that PodCo was insolvent.

The focus of the appeal was on whether there were any losses suffered by HoldCo because of the company’s insolvency which turned on the characterisation of a flexible payment arrangement between PodCo and its parent company creditor.

Background facts and the payment arrangement

In the course of its operations, PodCo utilised office equipment, facilities and staff provided by HoldCo and was charged for using this infrastructure, at commercial rates, by way of a running account.

Payment of this running account was ‘flexible’ in that PodCo only made payments when it had funds to do so. In addition, HoldCo agreed it would never demand payment if to do so would be detrimental to PodCo’s cash flow and, further, it could release the obligation to pay at any time.

The appellants sole ground of appeal was that, in light of the terms described above, the primary judge had erred in holding that these amounts invoiced, and recorded in the accounts of PodCo, could be considered a loss suffered by HoldCo because of PodCo’s insolvency.

The submissions centred on the conditional nature of the agreement for payment and the contention that, unless those conditions were satisfied (i.e. PodCo had funds to pay), payment was not required and thus HoldCo had suffered no loss.

The decision

The Perrines’ appeal was dismissed.

Did the terms of the arrangement mean that HoldCo had suffered no loss?

The Court held that, notwithstanding the arrangement for deferral of payment, HoldCo had suffered a loss in the amount of the invoices.

This was because the payment arrangement, whilst flexible, only deferred payment “as and when” (not “if and when”) PodCo was in funds. As such, HoldCo would remain a creditor until such time as payment could be made.

The relevant starting point for assessing the loss suffered by HoldCo is to compare the position before, and after, the date of insolvency. If PodCo was solvent, HoldCo would be paid the amount of the debt. If it was insolvent, HoldCo would receive nothing; consequently, the loss was the amount of the unpaid invoices.

Was the liquidator required to establish that PodCo would have come into funds so as to trigger the obligation to pay the invoices?

The second limb of the appellants’ argument focused on, in light of the terms of the arrangements, whether the Liquidator needed to prove that PodCo would come into funds to enliven the obligation to pay the invoice. It was said that, in the absence of such proof, the invoices were not ‘due and payable’ and thus it could not be established that HoldCo would have been paid and therefore suffered loss.

The Court did not accept this submission and considered the debts the subject of the invoice were ‘due and payable’ within the meaning of s 95A of the Corporations Act.

In the circumstances, it was not incumbent upon the Liquidator to prove receipt by PodCo of future cash flow to pay HoldCo as the amounts were due when the invoice was issued. By reason of PodCo’s insolvency, HoldCo lost the amount of the unpaid invoices.

Corrs comment

Flexible payment terms are common within closely-held corporate groups particularly in relation to intercompany loan accounts. Many such loans, as in the circumstances of this case, are recorded on running accounts and payment by the subsidiary can be made infrequently and on an ‘ad-hoc’ basis.

When considering the recoverability of these loans, in circumstances where a director has been found to have contravened the insolvent trading provisions, a liquidator can, under section 588M, effectively “step into the shoes” of the holding company creditor and seek to recover the amount which may have been regarded by the parent as simply a bad debt.

Before undertaking this step, it will be important to carefully analyse the payment terms so as to inform whether those debts are ‘due and payable’ and the holding company has arguably suffered a loss. If so, this may provide an avenue of recovery for a liquidator to sue the director/s for the loss suffered by the parent company for the benefit of all unsecured creditors.