By O’Brien Palmer

INSOLVENCY AND BUSINESS ADVISORY

First published on the website, www.obp.com.au

‘There is always death and taxes: however, death doesn’t get worse every year’– author unknown

Based upon our recent experiences, it would appear that the Australian Taxation Office (‘ATO’) is becoming much more aggressive in relation to the collection of overdue PAYG and taxes. More particularly, we have:

• noticed an increase in the number of winding up applications filed by or on behalf of the ATO.
• been provided with copies of notices issued by mercantile agents engaged by the ATO to recover debts that had only recently become overdue.
• met with directors who have been served with a Director Penalty Notice (‘DPN’) pursuant to Section 222AOE of the Income Tax Assessment Act.

This aggressive attitude adopted by the ATO will in all probability impact adversely on thousands of Australian businesses already suffering from poor cash flow.

According to an article which appeared in The Australian newspaper on 20 May 2010, credit reporting agency, Dunn & Bradstreet, has reportedly downgraded the risk profiles of almost 80,000 companies after watching payment terms deteriorate in the first quarter of this year. The expectation is that many of those businesses are now more likely to experience financial distress over the next year.

In light of the foregoing, we thought it timely to comment upon the weapons in the ATO’s arsenal for the recovery of taxation liabilities owed by corporate debtors.

Director Penalty Notices

A discourse on DPN’s is outside the scope of this newsletter. Suffice to say that a director in receipt of a DPN has fourteen days from the date of the notice in which to cause the company to undertake one of the following alternative courses of action:

• discharge the debt in full, or
• enter into an arrangement with the ATO for the payment of the debt, or
• appoint an Administrator or Liquidator to the company.

If the director(s) fail to comply with the DPN by not causing the company to undertake one of the alternatives set out above within the specified time period, then each director is liable to pay by way of penalty an amount equal to the unpaid debt.

The DPN is a powerful weapon that should focus the attention of the directors on addressing the problems affecting the financial position of their company. Directors who neglect to deal with a DPN could face personal financial consequences that could be significant. Yet notwithstanding this, we have encountered a number of directors who for a variety of reasons have ignored a DPN whilst others have convinced themselves as to the viability of their businesses and accepted personal liability totally ignoring the advice of their accountants and/or solicitors. We do not monitor what later happens to those that we meet, however in some cases it has been brought to our attention that the outcomes have been disastrous for those concerned.

It is therefore vital that directors maintain a working knowledge of the financial position of the company under their control particularly when it comes to cash flow and the incurring of taxation and other liabilities. The reality is that a company under financial stress will often defer payment of taxation liabilities thus preserving cash for other outgoings considered more vital. This approach may well ease cash flow constraints short term. However, the unpaid taxation liabilities remain and will continue to accrue. In our experience, directors who proactively seek to address the problem in a timely and considered manner are likely to achieve a more satisfactory outcome as compared to those who seek to find a solution under direct pressure from the ATO.

Statutory Demands

Like any creditor, the ATO can issue a Statutory Demand under Section 459E(2)(e) of the Corporations Act (‘the Act’) for payment of a debt within 21 days after service. The debtor company must within the time period specified either pay the debt in full or make an application to the Court to have the demand set aside pursuant to Section 459G of the Act. Alternatively, the debtor company can take pre-emptive action by:

• appointing an Administrator. Such an appointment is normally made in circumstances where there is some prospect of a Deed of Company Arrangement (‘DOCA’) being propounded; or
• appointing a Liquidator to wind up the affairs of the company.

If no action is taken by the directors in response to the Statutory Demand, then almost certainly the ATO will commence winding up proceedings.

There are many and varied reasons why directors fail to respond to a Statutory Demand. In many instances, the companies in question will have ceased to trade and have no assets in which case the directors will often not care if the company is liquidated. Other companies will be trading and have assets. It is not uncommon for directors of these companies to simply ignore the Statutory Demand by putting it into the ‘to-hard basket’. For others, the Demand may not be received. One reason for that might be the failure by the Company to notify ASIC of a change in the address of its registered office.

Winding Up Proceedings

The serving of a winding up summons will certainly focus the attention of the directors especially if the business conducted by the company is considered to be viable. In these circumstances, the directors will urgently seek advice as to their options under the Act. By that stage, the options are not what they were.

One option might be to attend Court and oppose the application to wind up. However, as the Statutory Demand has expired, there is a presumption of insolvency pursuant to Section 459C(2)(a) of the Act. Therefore, if the directors want to oppose the application, then they will have to satisfy the Court that the company is in fact solvent and that there is some compelling reason why it should not be wound up. Proving solvency can be difficult and the process is likely to be costly.

The directors may consider they have the option of pre-empting the ATO by appointing their own Liquidator. However, pursuant to Section 491 of the Act, a company cannot be wound up voluntarily if an application has been filed to wind up the company in insolvency. Therefore this is not an option available to the directors.

Another option available to the directors is to appoint an Administrator to take charge of the affairs of the company. Whilst technically possible, there is a complication. Pursuant to Section 440A of the Act, the Court is to adjourn an application to wind up a company already in administration, if the Court is satisfied that the continuation of the administration is in the interest of creditors.

The complication arises from the interpretation of the phrase ‘the Court is satisfied’. In our experience, this means that there will need to be evidence put before the Court that will lead the Court to conclude there is a real likelihood that a DOCA will be propounded and that the return under the proposed DOCA will be greater than if the company was wound up. From a practical point of view, it is not always possible to settle upon the likely terms of a DOCA within the time left before the winding up application is heard. In addition, the costs of attending Court and presenting a case can be significant.

In light of the foregoing, it is imperative that Statutory Demands are dealt with within the stipulated time period as this keeps all options open to the debtor company thus giving it the best chance of achieving an optimum outcome.

In the event a company is wound up by order of the Court, then all is not lost. Pursuant to Section 482 of the Act, the Court has the power to stay or terminate the winding up. For such an order to be made, the applicant which is usually the directors, will need to satisfy the Court that the company is solvent and should be allowed back into the market place.

Section 260-5 Notices

Another weapon available to the ATO is the issuance of a notice (commonly referred to as a ‘garnishee’) pursuant to Section 260-5 of the Income Tax Assessment Act which allows the ATO to collect monies from third parties in satisfaction of taxation liabilities due by other entities.

We dealt with this subject matter in a newsletter issued in April 2006, a copy of which can be found on our web site. For the purposes of this newsletter, all we can state is that we have not encountered any such notices over recent times.

Conclusion

The team at O’Brien Palmer is committed to assisting our contacts help their clients understand and navigate the complex realms of insolvency. As part of that commitment, we would be pleased to answer any of your questions regarding our services. We also offer a complimentary and obligation free initial consultation to establish the nature of the problem and the manner in which we can be of service.

By Russell Cocks, Solicitor

First published in the Law Institute Journal

Introduction

The holding of meetings of creditors is a necessary and important part of the corporate insolvency regime and is the primary mechanism for creditors to exercise their rights in dealing with insolvent companies.

The necessity to hold such meetings arises from the operation of numerous sections contained in Parts 5.3 to 5.6 of the Corporations Act 2001 (‘the Act’). Regulations 5.6.11 to 5.6.36A of the Corporations Regulations 2001 govern the meeting process.

This technical guide will address the right of creditors to vote at meetings and summarise the manner in which resolutions are carried.

Who is a creditor for voting purposes

The term ‘creditor’ is not defined in the Act. Generally, a ‘creditor’ is taken to mean a person who has a debt or claim against a company that is provable in a winding up. Pursuant to section 553(1) of the Act, debts or claims provable in every winding up means;

‘all debts payable by, and all claims against, the company (present or future, certain or contingent, ascertained or sounding only in damages), being debts or claims the circumstances giving rise to which occurred before the relevant date, are admissible to proof against the company’.

For the purposes of voluntary administration, a ‘creditor’ is taken to have the same meaning as set out above: Selim v McGrath[2003] NSWSC 927 at 68.

Section 553(1) of the Act refers to ‘debts’ and ‘claims’. A debt may be defined as a liquidated sum in money which is due from the debtor to the creditor: Rothwells Ltd v Nommack (No 100) Pty Ltd [1990] 2 Qd 85 at 86. The term ‘a liquidated sum’ refers to an agreement between the parties of a precise amount. This is contrasted to a ‘claim’ which is unliquidated which requires the court to determine the amount payable. The classic example of an unliquidated claim is a claim for damages for breach of contract.

Section 553(1) also refers to future and contingent debts or claims. An often used definition of ‘contingent creditor’ is a person towards whom, under an existing obligation, the company may or will become subject to a present liability upon the happening of some future event or at some future date: Re William Hockley [1962] 1 WLR 555.

The importance of these words lies in their insistence that there must be an existing obligation and that out of that obligation, a liability on the part of the company to pay a sum of money will arise in a future event, whether it be an event that must happen or only an event that may happen: Re William Hockley [1962] 1 WLR 555.

‘A future claim is distinguishable from a contingent claim in that, while both are foundered on an obligation existing as at the commencement date of the winding up, a future claim will arise at some time thereafter while a contingent claim may arise. A typical example of a future claim is a claim for rent that will become due under a lease which is in existence at the commencement of the winding up’: Community Development Pty Limited v Engwirda Construction Company [1966] (120 CLR 455 at 459).

Notwithstanding the broad meaning of ‘creditor’, there are certain debts that are not provable in a winding up. These include debts that are court imposed penalties (s 553B of the Act) and debts that are not legally enforceable such as debts arising from illegal transactions, statute barred debts and court imposed penalties.

Creditors who may vote

Pursuant to regulation 5.6.23(1), a person is not entitled to vote as a creditor at a meeting of creditors unless his or her debt or claim has been admitted wholly or in part by the administrator or liquidator, or he or she has lodged with the chairperson of the meeting particulars of his or her debt or claim, or if required, a formal proof of debt.

Regulation 5.6.23(2) states that:

a creditor must not vote in respect of:

1. an unliquidated debt; or
   
2. a contingent debt; or
3. an unliquidated or a contingent claim; or
4. a debt the value of which is not established,

unless a just estimate of its value has been made.

This regulation is consistent with section 554A(2) of the Act which states that where the liquidator admits a debt or claim as at the relevant date that does not bear a certain value, he or she must either make an estimate of the value of the debt or claim, or refer the question of the value of the debt to the court.

In addition, regulation 5.6.24 deals with the debts or claims of creditors holding security. These claims will be discussed later herein. There are further regulations (5.6.23(3) and 5.6.46) dealing with bills of exchange, promissory notes and other negotiable instruments or securities that are outside the scope of this technical guide.

Entitlement of unsecured creditors to vote

Debts and Claims Not Requiring a Just Estimate

The power to either admit or reject a proof of debt or claim for the purposes of voting is given to the chairperson pursuant to regulation 5.6.26(1). Notwithstanding the unqualified reference in that regulation to proofs or claims being admitted or rejected, a chairperson can partially admit a debt or claim: Expile Pty Limited v Jabb’s Excavations Pty Limited and Anor [2004] NSWSC 284 at 37.

Generally speaking, the admitting for voting purposes of claims not requiring a just estimate, is a relatively simple process as most debts or claims, such as those of trade suppliers, can be easily established to the chairperson’s satisfaction. However, the process can become quite complicated, especially when dealing with contingent and unliquidated claims. Meetings involving large numbers of creditors can also present problems as proofs of debt and particulars of debts and claims are often handed up for adjudication immediately before the commencement of the meeting. In such circumstances, there is no time for extensive debate and deliberation on the merits of a claim nor is it possible to undertake extensive enquiry in relation to those claims.

As stated above in regulation 5.6.23(1), a chairperson will admit a creditor to vote in circumstances where that:

1. creditor’s proof of debt has been admitted, either in part or in full;
2. creditor has furnished to the chairperson particulars of the debt or claim, whether it be formally by way of a proof of debt not yet admitted or informally by way relevant documentation such as copy statements and invoices.

In relation to those creditors who fall under category (ii) above, a chairperson will be mindful of the significant difference between establishing an entitlement to vote at a meeting and establishing an entitlement to participate in a dividend distribution. This means that in the case of the former, a person need only establish a prima facie entitlement to vote as compared to the latter where there is a much greater burden of proof.

Obviously the adequacy of the particulars provided in support of a debt or claim will vary enormously and depend on the circumstances. In addition, the chairperson may have preexisting knowledge of a debt or claim, gained from access to a company’s books and records or from discussions with directors where such matters as disputed debts or claims are raised. A chairperson when adjudicating for voting purposes upon proofs of debt not yet admitted and particulars of debts or claims, will be looking to ensure:

1. that the debt or claim was incurred with the company concerned;
2. that the date the debt or claim was incurred predates the date of administration or liquidation;
3. that the documentation provided in support of the debt or claim is adequate to prima facie establish the existence of a liability for a debt or claim;
4. whether there are any claims for set off;
5. whether the debt or claim is subject to any security;
6. whether the debt or claim is disputed by the directors.

If the chairperson is in doubt as to whether a proof of debt or claim should be admitted or rejected, then in accordance with regulation 5.6.26(2), he or she must mark the proof of debt or claim as objected to and allow the creditor to vote, subject to the vote being declared invalid if the objection is sustained. However this regulation will only apply where there is actual doubt in respect of whether the proof should be admitted or rejected as compared to doubt as to the value which should be assigned to the claim.

Debts and Claims Requiring a Just Estimate

Debts and claims requiring a just estimate comprise contingent and unliquidated debts and claims and debts the value of which has not been established. Before these creditors can be admitted to vote, regulation 5.6.23(2) requires a just estimate to be made of the debt or claim. These debts or claims should be dealt with as follows:

1. if an estimate has been made of the debt or claim by the person attending, then the chairperson will need to assess whether or not the estimate is just. If so, the claim should be admitted for voting purposes;
2. if no estimate has been made or if the chairperson considers the estimate made by the person is not just, then the chairperson, acting reasonably, will need to make the just estimate of value and permit the person to vote for that amount;
3. if a just estimate cannot be made, then the person should not be allowed to vote (regulations 5.6.23(2));
4. if the claim cannot be quantified by a just estimate, but it appears that the person is a creditor for at least some amount, then it is appropriate to admit the person for voting purposes at a nominal value of one dollar;
5. if a just estimate has been made as required by the regulation, but the chairperson remains in doubt as to whether the person should be allowed to vote at all, then the chairperson must mark the proof or claim as objected to in accordance with regulation 5.6.26(2).

Entitlement of secured creditors to vote

In order to vote, a secured creditor must pursuant to regulation 5.6.24(1), estimate in its proof of debt or claim, the value of the security held otherwise the security is surrendered. The creditor is entitled to vote only in respect of the balance, if any, due to the creditor after deducting the estimated value of that security: see regulation 5.6.24(2). If the secured creditor votes in respect of the whole debt or claim, then the creditor is taken to have surrendered the security, unless the court on application, is satisfied that the omission to value the security arose from inadvertence: see regulation 5.6.24(3).

Importantly, regulation 5.6.24(4) states that regulation 5.6.24 does not apply to meetings of creditors convened under Part 5.3A of the Act dealing with voluntary administration, or meetings held under a deed of company arrangement.

Two interesting questions arise, namely:

1. Can a secured creditor vote in a winding up without surrendering its security notwithstanding the provision of regulation 5.6.24(1)?

The answer to the question is yes but only if voting is on the voices rather than a poll, the reason being that voting on the voices or by a show of hands does not involve voting on the whole of the debt. This is because when a vote is taken on the voices or by a show of hands, each creditor who votes has one vote only and thus the outcome is determined by numbers, not the value of debt: Selim v McGrath[2003] NSWSC 927 at 81. That being said, if the secured creditor uses the full value of its debt when voting by way of a poll, then it has surrendered its security in doing so.

1. Does a chairperson have a duty to inform a secured creditor when voting of its actions or omissions?

We consider that a chairperson has no such duty to inform. However, a chairperson, acting reasonably when determining the voting entitlements of a secured creditor, would in the ordinary course look at the value, if any, that had been attributed to the security. If no value was attributed to the security, then it is likely that a discussion would ensue and in our opinion that discussion would eventually lead to a prudent chairperson, informing the creditor of the consequences of its actions.

Voting on resolutions

Outcome of voting on the voices

Pursuant to regulation 5.6.19(1), a resolution put to the vote of a meeting of creditors must be decided on the voices unless a poll is demanded, before or on the declaration of the result of the voices by:

1. the chairperson; or
2. at least 2 persons present in person, by proxy or by attorney and entitled to vote at the meeting; or
3. by a person present in person, by proxy or by attorney and representing not less than 10% of the total voting rights of all the persons entitled to vote at the meeting.

Unless a poll is demanded, the chairperson must declare that a resolution has been carried, or carried unanimously, or carried by a particular majority, or lost: see regulation 5.6.19(2). A declaration is conclusive evidence of the result to which it refers, without proof of the number or proportion of the votes recorded in favour of or against the resolution, unless a poll is demanded: see regulation 5.6.19(3).

Notwithstanding these regulations, many chairpersons will ask creditors to vote by raising their hand as this gives a more accurate counting of the vote.

If a poll is demanded, then regulation 5.6.20 states that the chairperson is to determine the manner in which it is to be taken and the time at which it is to be taken.

Outcome of voting by way of poll

If a poll has been demanded, then pursuant to regulation 5.6.21(2), a resolution is carried if:

1. a majority of the creditors voting (whether in person, by attorney or by proxy) vote in favour of the resolution; and
2. the value of the debts owed by the corporation to those voting in favour of the resolution is more than half the total debts owed to all the creditors voting (whether in person, by proxy or by attorney).

Conversely, regulation 5.6.21(3) states that a resolution is not carried if:

1. a majority of creditors voting (whether in person, by proxy or by attorney) vote against the resolution; and
2. the value of the debts owed by the corporation to those voting against the resolution is more than half the total debts owed to all creditors voting (whether in person, by proxy or by attorney).

To put it more simply, for a motion to be carried, there will need to be a majority in number and value of creditors voting for the motion. For a motion to be lost, there will need to be a majority in number and value voting against the motion. It will therefore be obvious that it is possible for a motion to be neither carried nor lost. This outcome is provided for in regulation 5.6.21(4) which states that, if no result is reached under sub-regulations (2) or (3), then the chairperson may either;

• exercise a casting vote in favour of the resolution, in which case the resolution is carried; or
• exercise a casting vote against the resolution, in which case the resolution is not carried; or
• not exercise a casting vote, in which case the resolution is not carried.

Exercising the chairperson’s casting vote

The chairperson has been given the power to exercise a casting vote in order to quickly resolve a deadlock. It is most often used in the context of voluntary administration where the future of a company is to be determined. The chairperson’s use of the casting vote has been examined extensively by the courts. The main legal principles that govern the use of that vote are summarised here under: see Provident Capital Limited v Kelso Building Supplies Pty Ltd (In Liquidation)(Receiver & Manager Appointed) [2008] FCA 868 at 19.

1. The chairperson should exercise the casting vote to resolve a deadlock unless there is some good reason to refrain from doing so. Failure to exercise the casting vote for some irrational or irrelevant reason is inconsistent with the person’s duty;
2. The chairperson must weigh up all relevant factors and act honestly and according to what he or she believes to be in the best interests of those affected by the vote, and for a proper purpose;
3. The exercise of the casting vote is most appropriate in circumstances where either creditors with a majority in value have such an overwhelming interest that it is inappropriate to allow a majority in number who do not have the same monetary interest to carry the day, or vice versa;
4. However, there is no presumption in favour of the majority in value, although any large disproportion between the values of the debts of the numerical minority and the numerical majority will be a factor to be taken into account. In favouring the numerical minority, the chairperson will need to be satisfied that he or she is acting in a manner consistent with (ii) above.

By way of general comment:

1. 1. When determining the future of a company under administration, the chairperson would normally exercise a casting vote consistent with the opinion expressed in his or her section 439A report.
   2. Before exercising a casting vote, the chairperson must declare his or her rational for exercising the vote (whether for or against a resolution) or choosing not to exercise the vote. The reasons are to be minuted: see Code of Professional Practice for Insolvency Practitioners issued by the Australian Restructuring Insolvency & Turnaround Association 2015 at 24.7.4 page 187.
   3. Exercising a casting vote in favour of a resolution approving remuneration is generally unacceptable and considered to be a breach of fiduciary duty: see Code of Professional Practice for Insolvency Practitioners issued by the Australian Restructuring Insolvency & Turnaround Association 2015 at Pg 188.
   4. Exercising a casting vote in favour of a resolution to remain in office is generally acceptable if it can be shown to be in the interest of the administration of the company: see Krejci as liquidator of Eaton Electrical Services [2006] NSWSC 782.