Insolvency Alert: The case of the disappearing accountant failure to maintain financial records and proof of insolvency - 14 June 2011

Liquidators frequently seek to rely upon the presumption that arises under section 588E(4) of the Corporations Act 2001 (Act) that a company is insolvent for the period during which it fails to keep or retain financial records. In a decision of the New South Wales Supreme Court this year, a mysterious disappearing accountant thwarted a Liquidator's attempts to rely upon that presumption.

Key points from this case

  • The case emphasises the importance for Liquidators of properly considering the question of solvency before commencing proceedings, particularly as insolvency is generally the cornerstone of the cause of action
  • Presumptions of insolvency can be somewhat fragile and should only be used an alternative or last resort. Actual evidence of insolvency is always preferable (although not always possible)
  • If possible, alternative grounds of claim should be pleaded

Fisher -v- Devine Homes Pty Ltd; Allen -v- Harb

The Liquidator of Devine Homes brought proceedings against Mr Harb, the sole director and shareholder, seeking to recover payments made by him to himself, family members and various other parties. The Liquidator claimed those monies on two distinct bases:

  • That they were voidable transactions in accordance with section 588FE(1) and (4) of the Act (Voidable Transaction claim);
  • Alternatively, that the payments were in breach of section 598(2) of the Act, which allows the Court to make Orders in circumstances where the person is guilty of, amongst other things, breach of duty in relation to the company (Misfeasance Claim).

A critical element of the Voidable Transaction Claim was that Devine Homes was insolvent at the time that the payments were made. The Liquidator relied solely upon the presumption that arose by virtue of section 588FE(4) to prove that the company was insolvent. This appeared reasonable, particularly as:

  • Mr Harb was prosecuted and convicted for offences under the Act arising from his failure to deliver books and records of Devine Homes to the Liquidator;
  • In response to a Summons requiring him to produce books to the Court, he produced limited documents - that were actually generated after the making of the Winding Up Order; and
  • Mr Harb conceded that the company had not prepared income tax returns, business activity statements, balance sheets or profit and loss accounts for any period since its incorporation, nor had it made any lodgements with ASIC.

Notwithstanding these matters, the Court found that the Liquidator was not entitled to rely upon the presumption of insolvency.

Mr Harb gave evidence that he delivered documents to a mysterious accountant named "Shafeel" of a firm called "Stamford Accountants" with a view to Shafeel to providing certain services to assist Mr Harb in co-operating with the Liquidator. Those documents were said to have been delivered after the making of the Winding Up Order. Mr Harb gave evidence that Shafeel then simply disappeared, leaving his office unoccupied and that the papers Mr Harb had given him were then lost, in that Mr Harb did not know where they were and could not retrieve them.

Mr Harb did not specifically identify the documents delivered to Shafeel, but described them as, "All my files, all my receipts, everything so I can finalise it for the Liquidator," and, "Everything like invoices that I've paid, all my documents for my properties, all my loan documents."

The Court referred to the broad definition of "Financial Records" in section 9 of the Act, and concluded that the fact that no income tax returns, business activity statements, balance sheets or profit and loss statements was prepared did not mean that "financial records" for that period were not kept. The Court stated that for the presumption to arise it must be proved either that:

  • No document whatsoever within the definition of "financial records" was kept; or
  • The documents that were kept were deficient, in the sense that they did not correctly record and explain the company's transactions and financial position or would not enable true and fair financial statements to be prepared and audited.

The Court considered that where there was Mr Harb's evidence that certain documents did exist in relation to the Company's activities, the presumption will not be available unless the Liquidator could show that those documents were deficient.

Perhaps unsurprisingly (as the documents had disappeared, with their contents unknown), the Liquidator was unable to show any such deficiencies. Accordingly, the Liquidator was unable to rely upon the presumption on this ground.

The court also considered that Devine Homes had not failed to "retain" financial records for seven years as required by section 286(2) of the Act. The Court referred to Mr Harb's evidence again, and concluded that until the point that he delivered the documents to Shafeel, Devine Homes had retained financial records. Because the documents had been lost after the Liquidation, the failure to retain them was no longer an act of Devine Homes, as control of it had vested in the Liquidator. In view of this, the Court concluded that it was not possible to identify any "failure" of Devine Homes to retain documents by reason of Mr Harb's delivery to the accountant.

In view of the above matters, the voidable transaction claim fell at the first hurdle.

The Court then went on to consider the misfeasance claim. The majority of those claims were successful, as the payments related to payments made for Mr Harb's expenses or to family members and were clearly made in breach of his duties to the company.

Implications of this case

This decision emphasises that Liquidators must carefully consider proof of insolvency in bringing voidable transaction claims. Had it not been for the alternative misfeasance claims, the Liquidators would have been wholly unsuccessful. That would have potentially had adverse cost consequences for them.

It also appears from the Court's judgment that the presumption of insolvency that may arise from a failure to keep financial records is in fact quite limited and fragile. There were no adverse findings made on Mr Harb's credibility, nor was there any suggestion that he had fabricated his evidence regarding delivery to Shafeel. Nonetheless, situations can be envisaged where missing documents would prevent a proper assessment of the company's affairs, but also prevent a Liquidator from relying upon the presumption of insolvency. That would seem to be contrary to the intention and spirit of the Act.

For more information about this case, please contact HopgoodGanim's Insolvency practice.