In our May 2011 edition of Business Debrief,  we posted an article in relation to proposed changes to the Director Penalty Notice (“DPN”) provisions.

The changes were wide reaching and were designed to deter fraudulent phoenix activity by company directors. In essence the proposed changes were as follows:

• the director penalty regime to be extended to superannuation guarantee amounts, making directors personally liable for their company’s failure to pay employee superannuation;
• the Australian Taxation Office (ATO) to be given the power to commence recovery against directors under the director penalty regime, without providing a 21 day grace period, for certain unpaid company liabilities that remain unreported after three months of becoming due; and
• in certain circumstances directors and associates of directors will be prevented from obtaining credits for withheld amounts in their individual tax returns where the company has failed to pay withheld amounts to the ATO.

The legislation to enact these changes was introduced into the House of Representatives on 13 October 2011 which was immediately referred to the House of Representatives Standing Committee on Economics (“the Committee”) in order to allow a review of the public submissions on the proposed changes.

UPDATE

The Committee has decided to remove the proposed changes relating to the extension of the ATO’s DPN powers from the current legislation and in response to the public submissions received, the Committee made the following recommendations:

1. The Government investigate whether it is possible to amend the law to better target phoenix activity;

2. The Government explore whether to expand and strengthen the defences for company directors available;

Notwithstanding the recommendations, the Committee noted as follows:

“…the committee is of the view that the Bills show great potential in striking a reasonable balance between the interests of the victims of phoenixing, many of whom are low income earners, and compliant company directors. The committee has recommended two refinements to the Bills, but the committee remains of the view that stronger legislation in dealing with phoenix operators will be required.”

The Assistant Treasurer, Bill Shorten noted in November 2011 that “some further consultation and possible modification to the phoenix company measures may be required to ensure the proposed amendments do not affect company directors inappropriately in certain circumstances. After further consideration the Government intends to bring the provisions back to Parliament next year.”

As such, the existing DPN regime will remain in place, including the maintenance of the 21 day notice period that is currently given to company directors prior to the ATO commencing recovery action under the DPN regime, however it will be interesting to see what amendments, if any, are made to the proposed legislation in the forthcoming months.

Pursuant to the Corporations Act 20001, a liquidator has the ability to recover, for the benefit of all creditors, certain payments (known as unfair preferences) made by the company to creditors in the six months before the start of the liquidation.

In essence, a creditor receives an unfair preference if, during the six months prior to liquidation, the company is insolvent, the creditor suspects the company is insolvent, and receives payment of their debt (or part of it) ahead of other creditors. To be an unfair preference, the payment must place the creditor receiving it in a more favourable position than other unsecured creditors. A Liquidator does not have an automatic right to claw back the payments if a creditor refuses to repay these monies and the Liquidator in this instance would need to obtain a Court Order requiring payment from the creditor. However it is common for preference claims being commercially settled out of court.

The elements required for a Liquidator to prove preference claims

In order for a Liquidator to successfully prove a preference claim, the following must be established;

-          The company (in Liquidation) and the creditor were parties to the transaction;

-          The transaction took place within six months before the commencement of the winding up (this is extended to four years for payments to related parties)

-          The payment is made by the company when it was insolvent or the company became insolvent as a result of the transaction; and

-          The payment resulted in the creditor receiving more than they would have received in a Liquidation scenario

Defences available for creditors

The Corporations Act provides creditors with defences to unfair preference claims.  In order for a creditor to properly defend a preference claim, they must establish;

-          It became party to the transaction in good faith;

-          At the time it became party to the transaction, it had no reasonable grounds for suspecting the company was insolvent or would become insolvent as a result of the transaction; and

-          It provided valuable consideration as part of the transaction

Continuing Business Relationship

A common defence available to creditors is whether the transaction in question could be considered a part of a continuing business relationship – such as a running account. The running account defence is that during the course of the relationship, if the level of the company’s indebtedness to its creditor increases and decreases from time to time as a result of a series of transaction, then all the transactions are considered as one single transaction. For example, during the period payments are made by the company, a creditor continues to provide goods or services. In this case, an unfair preference is only in existence if the value of payments during the relevant period is greater that the value of goods or services provided to the company during the relevant period.

Recent case law on preference claims

The courts have been quite busy in recent times dealing with preference claims by Liquidators. The following are two notable cases.

In Clifton (as liquidator of Adelaide Fibrous Plasterboard Linings Pty Ltd (in liq)) &Anor v CSR Building Products Pty Ltd [2011] SASC 103, the Supreme Court of South Australia had to consider the ‘good faith’ and ‘running account’ defences contained in the Corporations Act.

In this case, the court held that the defendant had failed to establish the ‘good faith’ defence however was successful in establishing the ‘running account’ defence in respect of two of the five payments that the liquidator had sought to recover as unfair preferences.

The reason the ‘good faith’ defence was not successfully proven was due to the existence of strong insolvency indicators. However, knowledge or even actual suspicion of insolvency in this case did not stop the creditor relying upon the ‘running account’ defence for a payment received.

The other recent decision was in the Federal Court of Australia in the case Roufeil v Gliderol International Pty Limited [2011] FCA 847, where it was made clear that to successfully maintain a defence to an unfair preference claim the creditor must prove on both a subjective and objective basis that the creditor had no grounds for suspecting the insolvency of the company.

In this case the creditor tried to establish a defence by arguing that at the time it received the payments, it had no reasonable grounds to suspect of the payee’s insolvency.

The court held that the basis of the creditor’s defence was insufficient given that:

(a) subjectively, the basis of the credit manager’s conclusions about lack of reasonable grounds to suspect insolvency was insufficient; and

(b) objectively, the history of the creditor’s dealings with the insolvent presented grounds which would have led a reasonable person in the creditor’ position to suspect insolvency such as the creditor ceasing its commercial relationship due to failure of the insolvent to pay any of its invoices after a specified date coupled with a statutory demand issued to the insolvent not being satisfied.

Common signs of a preference payment

A Liquidator’s duty when investigating the affairs of the company is to identify potential preference claims. The following are strong indicators which Liquidators look out for when trying to identify preferential payments they may be able to claw back;

-          Payments made after supply has stopped or threats are made to stop supply;

-          Payments made outside normal trading terms;

-          Payments made after legal recovery action has commenced;

-          Payments are made in lump or rounded sums

Conclusion

It is very rare for creditors to refuse payments from struggling companies with the possibility the payments they receive may be clawed back in the future– however creditors must accept the risk that in the event the payee becomes insolvent, they may have a Liquidator knocking on their door attempting to recover the payments.

The Aussie dollar recently fell to a 10 month low against the US dollar recently closing at US97 cents providing some relief for the industry’s export prospects.

In addition to unfavourable foreign exchange fluctuations, the manufacturing industry has been dealing with one crisis after another. This includes the hotly debated carbon tax and the uncertainty it has brought to the industry in terms of future job losses, investor confidence and cautious spending by businesses.

Higher interest rates coupled with an increase in wages and input costs continue to impact on profit margins and the well publicised skills shortage is another area which has yet to be resolved.

A review of the latest Australian Industry Group-PWC Performance of Manufacturing Index (“PMI”) only confirms the dire straits of the industry. The PMI provides a general indication of whether the manufacturing industry is expanding or contracting where a score above 50 points indicates expansion. For the month of August 2011 the PMI remained well below the 50 point level at 43.3. Over the last six months, the PMI has been recorded above 50 just once.

The PMI reviews the manufacturing industry across 12 subsectors, yet only two subsectors experienced expansions during August 2011 being food and beverage and clothing and footwear. In the past 6 months, several subsectors including textiles, food & beverages, transport equipment, paper printing and publishing and basic/fabricated metals have consistently recorded declines in activity.

Credit reporting agency Dun & Bradstreet have also recently downgraded its ratings for the industry citing that one in 10 businesses in the manufacturing industry may experience financial distress over the next twelve months. The agency defines financial distress as forced business closures (e.g. winding up) or external control (e.g. appointment of a Receiver and Manager or Administrator). Dun & Bradstreet’s ratings are based on each Company’s Dynamic Risk Score which is a general assessment of its financial position.

Even some of the so called bigger players in the industry are not insulated from the industry’s downturn with Bluescope Steel and OneSteel announcing thousands of retrenchments and redundancies for employees. A recent statement from the Australian Workers Union national secretary Paul Howes has likened the current crisis to the Great Depression.

Restoring sustained growth represents a significant challenge for the manufacturing industry and the government particularly during a time where there is continuing uncertainty both in the commercial and political environment.

For companies within the manufacturing industry, the writing is clearly on the wall. The companies that heed this warning by reviewing its operations with a view to boost business performance and improve profit margins might just survive the tough road ahead.

Suggestions for manufacturers to keep afloat

For manufacturers to stay competitive in the current market, they will need to look at new opportunities and solutions. Here are some key opportunities to consider;

Improve Cashflow - explore ways to create immediate liquidity through working capital managemement and cost reduction solutions

Business Performance Improvement - obtain external assistance that may add deep industry and functional experience to help the business improve its operations

Debt Restructuring -  renegotiate favourable terms with creditors to keep a healthy and sustainable cashflow for the business

At Hall Chadwick, we can assist in exploring the above opportunities through our senior personnel and utilizing our extensive national and international network to help manufacturers in Australia navigate through difficult waters.

1.       Understand why and where you are and where you want to go, and set targets to track your progress

A lot of businesses that fail have very poor accounting systems and records. Having up to date financial data is critical for a business in difficult times. Management needs to understand and rely on the most current position of their business, including understanding where and why any aspects of the business are underperforming, and be able to fix these areas and implement a plan for the future direction of the business.

Management accounting systems that provide current and reliable information on the following items are critical in order for a business to be able to adopt forward thinking solutions;

-          Current cash position and cash flow requirements;

-          Current liability position;

-          Accounts receivables position;

-          Sales figures;

-          Gross and net profit results

One of the most important functions that turnaround practitioners undertake when successfully restructuring a business is immediately creating liquidity through the business internally by way of working capital management. This is achieved by actively budgeting, planning and tracking cash flow forecasting. A business in tough conditions should follow this practice.

Proper cash flow forecasting will enable the prediction of the peaks and lows of the company’s cash balance which will result in the assistance with planning of meeting the debts and expenses of the business moving forward. It will also create cash resources. Cash is the oxygen of a business. Without cash, a company cannot survive. As such, there must be realistic visibility and mechanisms put in place for adequate weekly and daily management of cash inflows and outflows through proper cash forecasting.

Once systems for accurate and up to date management reports are implemented, it is also important to set clear and realistic targets so that the progress of the business turnaround can be accurately monitored and constantly improved.

2.        Look for long term rather than short term solutions

A lot of companies that are referred to us initially advise they do not require external help as they have better solutions. Unfortunately, many of these companies end up coming back to us after a few months with an even bigger problem.

The reason is that the majority of time the steps that are taken are merely a band-aid solution that does not deal with the cause of a problem and solve it.

There is no doubt that sometimes damage control is needed to stabilize a critical situation – however it is important that whilst a short term solution is found, management also immediately explores for solutions which are sustainable in the long term.

An example of a short term solution is a company entering into a payment arrangement with the Australian Taxation Office – this may be useful in the short term, however, if the business is continuing to make losses due to reasons such as delayed financial reports and poor budgeting, all the company is really doing is prolonging the inevitable to a later date. As such, entering into a payment arrangement is only part of the solution. Once a payment arrangement is secured, it is also important for a business to implement accurate and reliable accounting systems, look at ways at either reducing costs or increasing revenue, and properly forecast cash flow so that when the next tax bill arrives, it can be fully paid when it is due and payable without suffocating the businesses cash flow.

This same principle applies to companies that continually extend trading terms as part of their solution – this may assist in the short term, however suppliers may not be too happy continuing this arrangement, especially if the supplier has their own cash flow requirements.

3.       Address the problems

It is amazing how many business executives bury their head in the sand when the going gets tough, causing problems to fester until it is too late.  There could be many reasons for this however the most prevailing reasons we see in many instances is that business owners may feel that they have failed if they need to resolve to external assistance for a business which they have operated for many years.

The most successful restructures we have witnessed are those whereby Directors have identified the warning signs early, did not hide the fact that their business could be facing difficult challenges, and sought external assistance to address the issues early.

Directors and management should seek assistance of trusted and experienced professional advisers in this difficult area so that that they are provided with all the options available and equip themselves in order to execute the best strategy for their particular distressed situation.

This article explores this recent case and a general overview of the rights and benefits of Liquidators in assigning causes of action.

Facts

The Owners Corporation and a building company, BMP, entered into a contract (the contract) which provided that neither party was able to assign the contract or any payment under the contract, without the written approval of the other party, referred to as a “non-assignability” clause.

BMP was subsequently placed in voluntary liquidation and the liquidators entered into an agreement with another entity, CGS, purporting to assign all of BMP’s entitlements under the contract to CGS. BMP nor the liquidators obtained the written approval of the Owners Corporation, which was required by the contract. Subsequent to the assignment taking place, CGS commenced proceedings against the Owners Corporation seeking to recover the amount due to the builder.

Section 477 of the Corporation Act

A company’s rights of action are “property” of the company and can be sold to third parties. Assignments are normally made in return for a payment and/or a percentage or proceeds from successful litigation. This power for Liquidators is derived from section 477 of the Act.

Section 477(2)(c) of the Act provides that:

“Subject to this section, a liquidator of a company may:

 (c) sell or otherwise dispose of, in any manner, all or any part of the property of the company.”

The Decision by the Court of Appeal

In the first instance decision, Bryson JA determined that CGS had title to rights provided for under the contract as a result of BMP’s liquidator having made a valid sale or disposition pursuant to s 477(2)(c) of the Act.

The Owners Corporation appealed this decision on the basis that s 477(2)(c) should not be construed as authorising BMP’s liquidator to assign the rights under the contract without the consent of the Owners Corporation.

The Court of Appeal of NSW held that s 477(2)(c) of the Act was not broad enough to authorise the liquidator to transfer rights arising under contracts with “non-assignability” clauses, such as the entitlements arising under the contract between the Owners Corporation and BMP.

As such, where a company is party to a contract which includes a “non-assignability” clause, it is important to note that s 477(2)(c) of the Act will not operate to allow a liquidator to assign the rights of the company under the contract without consent of the relevant parties under the contract.

Key Principles Governing Assignment of Causes of Action

This case highlights that some actions may be non assignable by a Liquidator due to contractual prohibition. The following are other basic principles that should be considered by a Liquidator before assigning a cause of action;

• the sale or assignment must be a bona fide exercise of the liquidator’s power;
• an assignment should not open the defendant up to vexatious litigation;
• frivolous claims (ones unlikely to succeed) should not be assigned;
• liquidators are not required to assign a right of action where the only offer received is “pitiful”
• any agreement that involves the liquidator’s continued involvement in the litigation for more than three months requires approval under s 477(2B) of the Act;
• an assignment of a cause of action can include an assignment of the right to control the litigation;
• a liquidator’s assignment of a cause of action in accordance with s 477(2)(c) of the Act is not prohibited by the bar on champerty and maintenance — but any subsequent assignment by the assignee is
• a Liquidator should see that the claim has merit before assigning it and if it does have merit he/she should seek fair payment for the claim;

Benefits for Liquidators in Assigning Causes of Action

In some instances, assigning causes of action by a Liquidator may be the best option available. Some of the reasons for this are as follows;

1. It takes away the risk of litigation. In some cases, an upfront sum for the Liquidator may be better than conducting the litigation as it takes away the risk of an unsuccessful outcome
2. It may be cost effective. Litigation can become expensive. If a Liquidator conducts the litigation, the Liquidator’s costs in running the litigation to its full extent may diminish the return for creditors.
3. Some causes of action are complicated and may relate to events that arose years before the Liquidator became involved. As such the Liquidator would not have sufficient factual knowledge of the case to properly conduct the litigation efficiently.
4. Liquidators may be unfunded to conduct the litigation, which may also encourage a defendant to defend any proceedings vigorously with the intention to exhaust the Liquidator. However it is important to note that a Liquidator in this scenario could look at litigation funding options.
5. In some cases, assignees of causes of action are highly incentivised to conduct and obtain a successful outcome. For example, a Director may have the incentive of obtaining a successful outcome for the benefit of creditors as it may minimize their personal exposure under personal guarantees and insolvent trading claims.
6. Litigation can take time. In some cases, creditors may prefer to receive an immediate (and definite) sum of money, even if it is of a lesser amount that what could be expected from successful litigation, rather than wait for years for the litigation to run its full course.

There is no doubt the government will have to focus on collecting revenue in order to achieve its predicted budget figures. It is our opinion that there will be no more ‘leniency’ from the tax office for non payment of tax. We  are already seeing a tougher attitude from the tax office based on the enquiries we are receiving in our insolvency practice. In fact, the following is a section of the budget “Countering fraudulent phoenix activities by company directors” – Budget Paper No. 2 (pp 45-46), which emphasizes this point;

Countering Fraudulent Phoenix Activities by Company Directors

The Government will strengthen the tax law to counter fraudulent phoenix activity, which involves a company intentionally accumulating debts to improve cash flow or wealth and then liquidating to avoid paying the debt. The business is then continued as another corporate entity, controlled by the same person or group and free of their previous debts and liabilities.

With effect from 1 July 2011:

• the director penalty regime will be extended to superannuation guarantee amounts, making directors personally liable for their company’s failure to pay employee superannuation;
• the Australian Taxation Office (ATO) will be given the power to commence recovery against directors under the director penalty regime, without providing a 21 day grace period, for certain unpaid company liabilities that remain unreported after three months of becoming due; and
• in certain circumstances directors and associates of directors will be prevented from obtaining credits for withheld amounts in their individual tax returns where the company has failed to pay withheld amounts to the ATO.

The above changes are quite significant and have serious consequences for Directors. Firstly, Directors from 1 July 2011 may become personally liable for non payment of superannuation. Secondly, the ATO will be able to initiate recovery (including recovering unpaid super) against Directors personally without having to provide the required notice to Directors, in cases where companies do not report their unpaid tax liabilities after three months of becoming due.

The changes will impact many companies, in particular within the SME space. Until now, many companies have been managing cash flow by deferring payment of tax (including not reporting tax until a later date when cash flow improves and allows payment of tax). This will no longer be a viable option for Directors if they want to avoid personal liability. Directors will now have to report all tax liability on time regardless whether their cash flow can accommodate payment of the reported tax immediately.

In our opinion the above changes will cause an increase in companies entering into insolvency as Directors will not want to take on personal exposure for their company’s superannuation and tax liabilities.

We will provide further updates in respect to the above upon further developments.

However,  a  recent  case  has  shown  that  there may  be  circumstances  which  require  a  receiver and    manager    to    retain    their    appointment after  a   secured  lender   has   been   paid   in   full and/or   there   are   no  further   assets   to   realise.

In Bowesco v. Cronin (2008) WASC 296 (“Bowesco”) a   company   and   its   director   and   shareholder (“the plaintiff’s) lodged an application for the removal   of   a   receiver   and   manager   where the  secured  lender  had been  paid  out  in  full.

Facts

In summary the facts of the case were as follows: -

• The receivers had paid the debt owing to the secured lender in full;
• The receivers retained the sum of approximately$900,000;
• The receivers had been invited to retire but had declined to do so.

The decision not to retire by the receivers related to  a  sale  that  occurred  during  the  receivership that  gave  rise  to  a  capital  gains  liability.  The receivers received advice that their liability to the Commissioner of Taxation was in excess of $1 million.

The receiver is personally liable for this amount due to  Section  254(1)  of  the  Income  Tax  Assessment Act 1936, which provides that every agent and trustee  shall  be  responsible  for  taxation  amounts that come about as a result of his or her agency and  the  agent  or  trustee  is  entitled  to  retain such monies as are necessary to discharge the taxation amounts and are personally liable for the taxation amounts that should have been retained.

Decision

The Court held the following:

1.  “a receiver and manager’s decision as to whether or not to retire is not an act or omission for the purposes of Section 423(1)(b). It is not open to the plaintiff’s to rely on that subsection”.

The  application  brought  under  Section  423(1) (b)   of   the   Corporations   Act   2001   argued that   as   a   result   of   the   receiver’s   decision not  to  retire,  this  constituted  an  “omission” in  relation  to  the  performance  and  exercise of    the    receiver’s    functions    and    powers.

A receiver is therefore, entitled to retain sufficient surplus funds in order to protect their position, particularly where personal liability may result.

Mortgagor’s should take note of this case as threats of litigation from stakeholders against a receiver may dissipate any surplus’ that may otherwise be available and returned from the receivership process.

For further information please contact:

Blair Pleash
Partner, Sydney
Phone: +61 2 9263 2600
Email: bpleash@hallchadwick.com.au

Director Penalty Notices

The Tax Laws Amendment (Transfer of Provisions) Act 2010 commenced operation on 1 July 2010 which makes some important changes to the director penalty notices (DPN) regime.

In essence, the DPN is typically served on a director in circumstances where the company has fallen behind in payment of its tax withholding obligations. Failure to comply with the DPN has serious consequences for directors in that they will become personally liable for the company’s outstanding tax and any penalties if the DPN expires without the director complying with one of the prescribed options in which the DPN can be satisfied.

The key amendments are as follows;

• A DPN now takes effect 21 days from the date that it is posted to a director (and not the date in which it is received), rather than 14 days from the date that it is received as was previously the case. It is crucial that directors do
  not leave it until the end of the 21 day period to seek advice on a DPN in order to avoid personal liability;
• The ATO is entitled to rely on ASIC records to obtain a director’s address, the onus therefore being on directors to ensure that ASIC records are kept up to date.
• There is now only 3 ways in which directors can be discharged of their obligations under a DPN, being as follows:

• by the company paying the outstanding tax obligation;
• by appointing a voluntary administrator to the company; or
• by commencing a winding up of the company.

• The company by entering into a payment arrangement with the ATO will no longer constitute an end to a director’s obligations under a DPN. However, the ATO cannot commence or take any further steps in existing proceedings against the director whilst a payment arrangement is in force and being complied with.

• There are variations in relation to the defense that is currently available to directors on the basis that the director “was not taking part in the management of the company as a result of illness or some other good reason”. Under the new law, a director must now also establish that such illness or other good reason “meant that it would have been unreasonable” in those circumstances to expect the director to take part in the management of the company.

Directors’ Indemnities

A recent decision in Young & Anor v Commissioner of Taxation [2010]NSWSC 288 is a timely example of another way (in addition to the DPN regime) in which the ATO can ‘lift the corporate veil’ and make directors liable for debts owed by their company to the ATO. In this decision, a personal liability of the Director under Section 588FGA of the Corporations Act 2001 (the “Act”) was identified.

Section 588FGA

Pursuant to Section 588FGA(2) of the Act, if a Liquidator of a company recovers an unfair preference from the ATO, the ATO has the right to pursue directors of the company for certain amounts for which the ATO is liable to repay the liquidator.

The four elements of a preference claim a Liquidator must establish against the ATO are as follows;

1. The company was insolvent when each transaction was entered into or became insolvent as a result of entering into each transaction;
2. The ATO and the company were parties to each transaction;
3. The transaction resulted in the ATO receiving more than it would have if the transaction were set aside and the ATO proved for the debt in the winding up of the company;
4. The transaction was entered into during the six months ending on the relation-back day, or if after that day, on or before the day on which the winding up began.

Legal Proceedings Required to Trigger Personal Liability

The indemnity of Directors under Section 588FGA of the Act requires a court order under Section 588FF of the Act. As such, the ATO can only recover from Directors payments it makes back to a Liquidator upon legal proceedings having been commenced by the Liquidator and a court making an order under Section 588FF of the Act.

Orders are allowed to be made by consent without the necessity to make a finding after the examination of all the evidence. This however in my view questions the fairness to Directors as orders by consent could have significant consequences by automatically triggering an action for the ATO against the Directors personally under Section 588FGA of the Act. In the matter Crosbie, re Trollope Silverwood & Beck Pty Ltd (in liq) v Commissioner of Taxation (2003) 21 ACLC 1,659;  [2003] FCA 922, Finkelstein J considered whether a mere consent judgment against the Commissioner satisfied the criteria for the Director’s indemnity, and decided it did not. However Finkelstein’s approach was rejected in Wanted World Wide (Australia) Ltd v FC of T (2004) 22 ACLC 1,284, where the court concluded that s 588FF allows orders to be made by consent without the necessity to make a finding after examination of all the evidence. The court considered the practical advantages of enabling an order to be made on the admissions of the parties before the court, in order to avoid a waste of time, effort, resources and expense. The same approach was followed in Dean-Willcocks v Commissioner of Taxation (No. 2) (2004) 22 ACLC 1,034, where the Court again determined not to follow Crosbie.

The Extent of the Indemnity

Section 588FGA(2) states that:

“Each person who was a director of the company when the payment was made is liable to indemnify the Commissioner in respect of any loss or damage resulting from the order”

An order in favour of the Commissioner under Section 588FGA in respect of “any loss or damage” resulting from a court order under Section 588FF can include the costs ordered to be paid by the Commissioner to the liquidator unless it can be shown that the costs were incurred in consequence of unreasonable conduct by the Commissioner in defending the claim: Commissioner of Taxation v Sims [2008] NSWCA 298.

However there is uncertainty as to whether the indemnity extends to covering the costs of the ATO in defending the preference proceedings.  In the matter Deemah Marble & Granite Pty Ltd (In Liq) v Deputy Commissioner of Taxation [2003] NSWSC 1126; (2004) 22 ACLC 81, the Director was ordered to pay the Commissioner’s costs of defending the preference proceedings. However, this was questioned in Sims v Deputy Commissioner of Taxation [2006] NSWSC 305

Conclusion

Directors when entering into a payment arrangement subsequent to the receipt of a DPN need to be satisfied that the payment arrangement will be adhered to, as the payment arrangement with the ATO will no longer constitute an end to a director’s obligations under a DPN.

Directors also need to be cautious when entering into a payment arrangement without a DPN being issued, as they may become personally liable if the payments they make under the payment arrangement are subsequently found to be preferential payments by a Liquidator.

Hence Directors can find themselves stuck between a rock and a hard place when deciding as to whether to enter into a payment arrangement, as the payment arrangement may be crucial in sustaining the company’s cash flow (and existence) in the short term – however may also be a financial catastrophe for the Directors personally if the company is Liquidated in the future.

It is important for Directors to consider the solvency of their company when entering into a payment arrangement. The question they will need to ask is whether the payment arrangement will co-exist with the long term viability of the company or whether it is simply a ‘quick fix’, which only serves the purpose of prolonging the inevitable.

If Directors have any doubts or questions when entering into a payment arrangement, they can speak to the Hall Chadwick insolvency and reconstruction team.