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Metropolitan Fire Systems Pty Ltd v Raymond Wayne Miller & Ors [1997] FCA 399 (22 May 1997)

CORPORATIONS LAW - director's duty to prevent insolvent trading - creditor's right to sue - time when debt incurred - unsecured debt - retention of title clause - insolvency - reasonable grounds to suspect insolvency - defences - reasonable grounds to expect solvency - reliance on another director - positive duty of directors

Corporations Law ss 95A, 588G, 588J, 588M, 588R, 1317DA, 1317EB

Corporations Legislation Amendment Act 1994 (1994) Schedule 1

Companies Act (1991) s 303

Federal Court Rules Order 13 Rule 2

Companies Code s 556

Sodeman v R [1936] HCA 75; [1936] 55 CLR 192

Reifek & Anor v McElroy & Anor [1965] HCA 46; [1965] 112 CLR 517 at 521.

Queensland Bacon Pty Ltd -v- Rees [1966] HCA 21; [1966] 115 CLR 266

Sandell v Porter [1966] HCA 28; [1965-6] 115 CLR 666

Londish & Ors -v- Gulf Pacific Pty Limited [1993] FCA 470; [1993] 45 FCR 128 117 ALR 361

National Australia Bank -v- Nobile & Anor [1988] FCA 72; [1988] 100 ALR 227

3M Australia Pty Ltd v Kemish [1986] 10 ACLR 371

Group Four Industries Pty Ltd v Brosnon & Anor [1991] 9 ACLC 1181

Leigh Mardon Pty Ltd -v- Wawn & Ors [1995] HCA 48; [1995] 13 ACLC 1,244; 17 ACSR 741

Morley v Statewide Tobacco Services Limited [1990] 2 ACSR 405

Heide Pty Ltd v Lester & Anor [1990] 3 ACSR 159

Shepherd & Ors -v- Australian & New Zealand Banking Group Limited & Anor (1996) 20 ACSR 81

Dunn v Shapowloff [1978] 2 NSWLR 235

Expo International Pty Ltd (In Liquidation) v Chant [1979] 2 NSWLR 820

Hawkins & Ors -v- Bank of China (1992) 26 NSWLR 562

Standard Chartered Bank of Australia Ltd v Antico & Ors [Nos 1&2] [1995] NSWSC 31; [1995] 38 NSWLR 290; 131 ALR 1; 13 ACLC 1381

Hollis -v- Burton [1892] 3 Ch 226

METROPOLITAN FIRE SYSTEMS PTY LTD -v- RAYMOND WAYNE MILLER, PATRICIA MILLER & LEONARD EWINS

No. NG 3178 of 1995

EINFELD J

SYDNEY

22 MAY 1997

IN THE FEDERAL COURT OF AUSTRALIA )

NEW SOUTH WALES DISTRICT REGISTRY ) No. NG 3178 of 1995

GENERAL DIVISION )

Between: METROPOLITAN FIRE SYSTEMS PTY LIMITED

Applicant

And: RAYMOND WAYNE MILLER, PATRICIA MILLER AND LEONARD EWINS

Respondents

1. The Court declares that, in causing Raydar Electrics Pty Limited to incur a debt or debts to the applicant in the sum of $49,549, the respondents as directors of Raydar Electrics Pty Limited have breached the provisions of section 588G of the Corporations Law.

2. The respondents are to pay to the applicant compensation in the amount of $49,549 together with interest thereon in accordance with section 51A of the Federal Court Act from 3 February 1994 until the date of judgment.

3. The respondents will pay the applicant's costs of the proceedings.

Note: Settlement and entry of orders are dealt with in Order 36 of the Federal Court Rules.

EINFELD J

SYDNEY

22 MAY 1997IN THE FEDERAL COURT OF AUSTRALIA )

NEW SOUTH WALES DISTRICT REGISTRY ) No. NG 3178 of 1995

GENERAL DIVISION )

Between: METROPOLITAN FIRE SYSTEMS PTY LIMITED

Applicant

And: RAYMOND WAYNE MILLER, PATRICIA MILLER AND LEONARD EWINS

Respondents

EINFELD J

SYDNEY

22 MAY 1997

1. INTRODUCTION

By an application dated 19 April 1995 the applicant, Metropolitan Fire Systems Pty Limited (Metropolitan), sought a declaration that the respondents Raymond and Patricia Miller, and Leonard Ewins, who were directors of Raydar Electrics Pty Limited (Raydar), breached section 588G of the Corporations Law by causing that company to incur debts to Metropolitan in the sum of $49,549. Metropolitan claimed compensation for that sum plus interest and a declaration concerning a civil penalty order under section 1317DA of the Corporations Law.

2. FACTUAL BACKGROUND

Raydar was incorporated on 23 July 1974, and on 15 October 1987 the respondents became its directors. The company specialised in electrical contracting. In December 1993 it was engaged by a company called Reed Constructions Services Pty Limited (Reed) to perform all of the electrical, fire and 'EWIS' (Emergency Warning Intercom Systems) work in the construction of the Clancy Auditorium at the University of New South Wales. The contract was given on the understanding that this work was to be a `fast-track' job upon which everyone involved would be working over Christmas and New Year to meet the deadline of 28 February 1994. Reed was the head contractor for the job and had engaged Raydar as a sub-contractor on several previous projects. In the same month Metropolitan, which supplies and instals fire prevention equipment, was approached by Raymond Miller on behalf of Raydar and asked whether it would be interested in sub-contracting the installation of the fire systems aspect of the job.

On 22 December 1993 Metropolitan became the approved tenderer for this sub-contract and it commenced work on the site on the following day constructing throughout the Christmas and New Year period. On 24 February 1994 Metropolitan's employees worked until 10pm to meet the deadline. Metropolitan alleged that on that evening James Ross, one of its employees, had a conversation with Raymond Miller concerning the fact that it had not received any payment for the work done. Mr Miller is alleged to have said:

I assure you that money is not a problem. I am expecting money from Reed Constructions any day now.

Raydar is now in liquidation and to understand the nature of the claim brought by Metropolitan, reference must be made to the process by which this situation came about. In late 1993 Raydar owed $114,267.29 to John R. Turk & Sons Pty Limited (Turks), an electrical wholesaler which had since 1990 been one of its major suppliers. After repeated efforts to secure payment of this debt, Turks applied to the Supreme Court of New South Wales on 2 December 1993 to wind up Raydar.

On 25 February 1994 that Court wound up Raydar and appointed Kevin Shirlaw of Horwarth and Horwarth, Chartered Accountants, as the official liquidator of the company, with Brian Dunphy of the same firm responsible for the care and control of the liquidation. With the permission of the liquidator, Metropolitan thereafter commenced these proceedings against the directors of Raydar to recover the unsecured value of the goods and services supplied to and for the Clancy Auditorium.

3. THE LEGISLATIVE FRAMEWORK

This proceeding is brought under Part 5.7B of the Corporations Law, which came into effect on 23 June 1993. Until October 1995 the only courts with jurisdiction to deal with these provisions were the Federal Court of Australia and the Supreme Courts of the States and Territories. After the commencement of Schedule 1 of the Corporations Legislation Amendment Act, such matters could be instituted in courts of lesser jurisdiction. However, proceedings already instituted could not be transferred to such lower courts. Accordingly the existing matter, although involving a small sum, had to be continued where it had commenced.

The application is made under section 588G of the Corporations Law. This section is found in a division headed 'Division 3 - Directors' duty to prevent insolvent trading by company'. By subsection (1) the section applies if:

(a) a person is a director of a company at the time when the company incurs a debt; and

(b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and

(c) at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be; and

(d) that time is at or after the commencement of this Part.

Subsection (2) provides that by failing to prevent a company from incurring the debt, the director contravenes the section if:

(a) [the director] is aware at that time that there are such grounds for suspecting; or

(b) a reasonable person in a like position in a company in the company's circumstance would be so aware.

Pursuant to section 588M(1), a creditor has a right of recovery of compensation from a company director for losses arising from insolvent trading of the company if the creditor:

.....

(b) has suffered loss or damage in relation to the debt because of the company's insolvency; and

(c) the debt was wholly or partly unsecured when the loss or damage was suffered; and

(d) the company is being wound up;

whether or not:

(e) the director has been convicted of an offence in relation to the contravention; or

(f) a civil penalty order has been made against the director in relation to the contravention.

Section 588M(3) provides:

The creditor mayrecover from the director, as a debt due to the creditor, an amount equal to the amount of the loss or damage

By section 588R(1) a creditor needs the consent of the liquidator to sue for compensation for an unsecured debt:

A creditor of a company that is being wound up may, with the written consent of the company's liquidator, begin proceedings under section 588M in relation to the incurring by the company of a debt that is owed to the creditor.

In this case the permission of the liquidator was obtained by Metropolitan in June/July 1994.

4. INSOLVENCY

Insolvency is defined in section 95A of the Corporations Law. Pursuant to subsection (2), a company which is not solvent is insolvent. According to subsection (1):

(1) A [company] is solvent if, and only if, the [company] is able to pay all the [company's] debts as and when they become due and payable.

This test contrasts with the provisions of section 303(3) of the Companies Act 1991 , a criminal provision, in which liability was imposed on the basis that a person was knowingly a party to the contracting of a debt in circumstances in which no reasonable or probable ground of expectation that the company could pay the debt was available: Dunn v Shapowloff [1978] 2 NSWLR 235 at 243.

There is a necessity, therefore, to consider the whole of the company's resources, including its credit resources. In determining these resources, there is to be taken into account the time extended to the company to pay its creditors on the one hand and the times within which it will receive payment of its debts on the other: Heide Pty Ltd v Lester & Anor [1990] 3 ACSR 159 at 165; Sandell v Porter [1966] HCA 28; [1965-6] 115 CLR 666 at 670; Expo International Pty Ltd (In Liquidation) v Chant [1979] 2 NSWLR 820 at 837.

5. THE BASIS OF RELIEF

Part 5.7B of the Corporations Law effected a substantial change to the legislative regime. Under the previous insolvent trading section, section 592, it was necessary for a creditor to establish that the company had incurred a debt and that immediately before the time the debt was incurred, there were reasonable grounds to expect either that the company would not be able to pay that debt and all of its other debts as and when they became due, or that if the company incurred the debt, it would not be able to pay all of its debts as and when they became due. Under the previous legislative provisions, there was no "reasonable person" test and an expectation of insolvency was required as opposed to a suspicion of insolvency as under the current law.

6. REASONABLE GROUNDS TO SUSPECT

Under section 588G the new test requires that whatever is suspected must be based on reasonable grounds, thus importing into the test an objective test for the suspicion. It has been said that the actual state of mind or knowledge of a director will not be a relevant factor in determining whether reasonable grounds exist: Group Four Industries Pty Ltd v Brosnon & Anor [1991] 9 ACLC 1181 at 1184 in which Duggan J dealt with the predecessor of section 592 of the Corporations Law (section 556 of the Companies Code):

The words 'reasonable grounds' which appear in both sub-paragraphs of s556(1)(B) require a consideration of objective criteria and an assessment as to reasonableness. The state of knowledge of the particular defendant and any assessment he may have made as to the ability of the company to pay its debts are irrelevant considerations in so far as this subsection is concerned. It is for the court to make a judgement on the basis of the facts as they existed at the relevant time and without the benefit of hindsight.

A slightly different perspective was taken by Hodgson J of the New South Wales Supreme Court in Standard Chartered Bank of Australia Ltd v Antico & Ors [Nos 1&2] [1995] NSWSC 31; [1995] 38 NSWLR 290; 131 ALR 1; 13 ACLC 1381. His Honour was of the view that the facts to be taken into account when assessing whether there were reasonable grounds to expect that a company would not be able to pay its debts were not limited to facts which were reasonably capable of being known by a director, but extended to all facts actually known to the director. For example, if directors learned by some other means of circumstances constituting reasonable grounds to expect that the company would not be able to pay all its debts, the section would apply.

Irrespective of how the test is formulated, it is one of objectively reasonable grounds which must be judged by the standard appropriate to a director of ordinary competence: 3M Australia Pty Ltd v Kemish [1986] 10 ACLR 371 at 373. Questions of knowledge of and participation in the incurring of the relevant debt are now relegated to the status of factual matters which may arise should the director seek to establish one of the statutory defences afforded by the legislation. The establishment of liability is, therefore, not contingent on elements personal to the respondent.

With regard to onus of proof, it is clear that in cases such as this where the section is being used to establish a head of civil liability, Metropolitan must establish the ingredients prescribed by section 588G to the extent that its proof be:

clear and cogent such as to induce, on a balance of probabilities, an actual persuasion of the mind as to the existence of (the liability): Reifek & Anor v McElroy & Anor [1965] HCA 46; [1965] 112 CLR 517 at 521.

The defences to the section need also only be established on the balance of probabilities: Sodeman v R [1936] HCA 75; [1936] 55 CLR 192. The point of time at which the reasonable grounds are to be established is immediately before the incurring of the subject debt, thus eliminating all sense of hindsight. As Justice Foster stated in 3M Australia at 377-8:

Clearly, if some event occurred after the incurring of the subject debt, which produced the situation of the company's inability to pay all its debts, but which was, at the relevant time, beyond the limits of reasonable foreseeability, then such an event could not form part of the `Reasonable Grounds' envisaged by this section. Conversely, if the happening of such a future event were reasonably foreseeable at the relevant time, by a director or manager of reasonable competence, it would form part of the 'Reasonable Grounds'. Equally, the fact that a person can look back to the financial situation of the company at the time when the subject debt was incurred, and express the view that the relevant 'Reasonable Grounds' to expect then existed, does not mean that some impermissible operation of 'Hindsight' is taking place, provided that in expressing that view, the person is doing no more than evaluating facts which were or should have been known to the defendant at the time of the incurring of the debt. Consequently, the evidence of an appropriate expert reviewing the situation as it obtained at the time when the relevant debt was incurred, is both admissible and helpful in determining whether objectively 'Reasonable grounds' did or did not exist at that time.

7. APPLICATION TO THE FACTS

A number of conditions must be satisfied for a successful claim for contravention of section 588G to be brought by a creditor:

7.1 Liquidated Debt

The respondents sought to argue in their final submissions that Metropolitan's claim was for unliquidated damages rather than for a debt. However, during pleadings they admitted that Raydar had incurred debts to Metropolitan and leave was not sought to amend their defences.

A liquidated debt exists "whenever the amount to which the Plaintiff is entitled... can be ascertained by calculation or fixed by any scale of charges, or other positive data...":see a passage in Odgers: Pleadings and Practice, 5th ed, at page 41, approved by Knox CJ and Starke J Spain -v- Union Steamship Co. of New Zealand Ltd [1923] HCA 21; [1923] 32 CLR 138 at 142. I have no doubt that Metropolitan's claim is for a specific sum of money which is manifestly liquidated. It can be easily ascertained by reference to the agreed contract price of $59,950, the two progress claims of $44,962 and $3,663 invoiced to Raydar on 18 January 1994 and 13 May 1994 respectively for work done up to and including 24 February 1994, and the balance of $11,325 for the completed work which was settled with Reed for $10,000 after the completion of the project. Raydar had incurred a debt to Metropolitan to the value of $48,625 plus $924 owing for a small project at Liverpool Hospital completed in early 1994.

7.2 Unsecured Debt

According to section 588M(1)(c), the debt must be wholly or partly unsecured. In their pleadings the respondents admitted that the debt was unsecured but in their final submissions they argued that the principal contract with Metropolitan contained a Romalpa (or retention of title) clause which read:

It is an express condition of this offer that any equipment and materials supplied and installed in accordance with this quotation shall remain the property of this company until such time as payment in full has been received.

The respondents asserted that the Romalpa clause has the effect that if there was a debt, it was wholly secured at the time of any loss and damage. They argued that because the existence of this clause was raised in cross-examination, reliance on it by the respondents could not conceivably have taken Metropolitan by surprise. However, if necessary, they sought to amend their defence.

The Court may permit an admission to be withdrawn: Hollis -v- Burton [1892] 3 Ch 226. Furthermore, pursuant to Order 13 rule 2 of the Federal Court Rules, the Court may also permit the pleadings to be amended at the close of evidence if the circumstances are such that it would not be unjust to do so: National Australia Bank -v- Nobile & Anor [1988] FCA 72; [1988] 100 ALR 227. Although Metropolitan was made aware during cross-examination that the respondents intended to submit that the debt was secured, the respondents were solely responsible for the lateness of the application for leave to amend, a factor which must have some bearing on the exercise of the discretion involved: Londish & Ors -v- Gulf Pacific Pty Limited [1993] FCA 470; [1993] 45 FCR 128 117 ALR 361. Metropolitan submitted that it was not open to the respondents to now suggest that the debt was in some way secured.

In light of the actual work undertaken by Metropolitan on this job, it would seem that the goods it supplied -- electrical installations and an early warning fire detection system -- have long since physically merged with the Auditorium structure so as to become fixtures. These systems would, I assume, require significant wiring throughout the building and the installation of a variety of pieces of equipment, removal of which, at this time, would not be an easy or loss-free task.

Moreover, Metropolitan has made no claim under the retention of title clause. As it would provide no security to Metropolitan for this debt at all, I would dismiss this defence to the claim if it were allowed. It is therefore pointless to permit the amendment. In any event, having regard to the fundamental importance of security for the relevant debt under the statutory scheme, it is somewhat ironic, to say the least, that the respondents have argued in support of the amendment that Metropolitan knew or should have known about this claim long before it was formally sought. As a general principle, I do not believe that such a major defence as this should be allowed to be raised at so late a stage of the case.

There is some evidence to suggest that an informal understanding existed between Metropolitan and Raydar to the effect that it would not be required to pay Metropolitan for the Clancy Auditorium contract until it had received payment for the project from the head contractor Reed, that is, the debt may have been contingent. However, as has been established by a number of cases : Hawkins & Ors -v- Bank of China (1992) 26 NSWLR 562 at 572; Shepherd & Ors -v- Australian & New Zealand Banking Group Limited & Anor (1996) 20 ACSR 81 at 89, the fact that a debt may have been contingent by virtue of a supposed back-to-back payment arrangement does not render it outside the scope of the section.

7.3 Incurring of Debt

It is necessary to identify the date on which the debt was incurred because it is at this time that the solvency of the company is assessed. It was accepted in the pleadings that the debt was incurred at the time the contract was entered into, namely 22 December 1993.

7.4 Insolvency of Raydar on 22 December 1993

While the financial records available to Metropolitan and the Court were incomplete, it was obvious from the evidence that in December 1993 Raydar was in severe financial difficulties: its creditors were demanding their money, and its major assets were all locked in as security for two major debts. Moreover, although Raydar was owed substantial amounts of money, it was not foreseeable that this money would be realised in the near future to enable creditor demands to be satisfied.

The primary witness for Metropolitan on this subject was Brian Dunphy. He provided to the Court what must really be described, despite his assertions to the contrary, as a "balance sheet" analysis of Raydar's assets and liabilities as at 22 December 1993. His analysis concluded that Raydar had assets of $196,485.38 and liabilities of $326,720.76. In arriving at this figure, Mr Dunphy included as assets unrealised debts to the company including those under dispute, but excluded the value of work in progress. In calculating the liabilities, he took note of all the disputes Raydar had with creditors. He concluded that if these disputes were all resolved in Raydar's favour, the total figure for liabilities would be adjusted down by $42,221.96. It was on the basis of this assumption that Mr Dunphy calculated that the company had a deficiency of assets to liabilities of $88,013.42. The respondents disagreed with Mr Dunphy's inclusion or exclusion of a number of figures, but having considered their arguments, I do not believe on the available evidence that the figures should be significantly altered.

Nevertheless, while the assets and liabilities of a company at the time when the relevant debt is incurred are relevant, the essential issue is whether Raydar was in a position to pay all of its debts as and when they became due and payable. The evidence reveals that most of the debts listed by Mr Dunphy, and by Raymond Miller in Raydar's statement of affairs, were overdue on 22 December 1993, and many of the creditors were considering, or in the process of taking, legal action to recover their money. As earlier mentioned, Turks had issued a statutory demand for payment of its debt of over $114,000 and had already applied for a winding-up order. Another company, O'Donnell Griffin, issued a final notice of demand on 22 November 1993 threatening legal action if the amount of $11,191 owing since May 1993 was not paid within seven days.

Indeed, of the $326,720.76 owed by Raydar on 22 December 1993, $233,258.63 was sixty or more days overdue (this figure ignores the $43,344.70 owed to the Australian Taxation Office since early 1993 because arrangements had been made to pay that debt by instalments); creditors owed $129,810.29 of the latter amount were taking or intending to proceed to legal action if payment was not immediately forthcoming; and creditors owed a further $26,423 had given final notice on their debts. It can thus be seen that on 22 December, debts of $326,720.76 were due on paper, and $156,233.29 of these debts required immediate payment.

The respondents maintained that they were contesting $131,697.29 of the debt owed by Raydar and that these claims would be substantially resolved in their favour. The largest debt disputed by Raydar was the money owed to Turks. Raydar claimed it had a good and valid defence to this claim as a result of Turks' breach of an agreement with Raydar to supply the switchboard for installation in the Liverpool project. However, Raydar took no steps to pursue its stance in the matter, even after Reed, the head contractor for the Liverpool project also, informed Raydar that it would be imposing a liquidated damages penalty for losses incurred due to the late delivery of the switchboard. Subtracting the value of the alleged cross-claim against Turks from the portion of the debt Raydar claimed they were contesting, $138,803.29 still remains immediately owing. It should also be noted that in August 1993 Raydar ceased paying the instalments on the money owed to the Australian Taxation Office, and there was some evidence that because of this default, the whole amount became due and payable in late 1993.

The respondents sought to argue that Raydar's creditors were prepared to wait until it had received payment from the head contractor of its various projects. Moreover, they argued that Metropolitan had failed to establish whether any oral arrangements or understandings existed between Raydar and its various creditors to extend the times for payment which could alter the dates on which these debts were to fall due. While such understandings or business practices can alter the date on which a debt is considered due and payable: see 3M Australia at 378, given the strength of the demands made by some of Raydar's creditors, this argument can only have any value in respect to debts for which no final notice had been issued. Only the uncorroborated evidence of Raymond Miller and some entries of small payments by Raydar on some of the invoices support the argument that some creditors were reluctantly prepared to wait for their money. But with most of the invoices requiring payment within 30 days, and many creditors pressing in other ways, some quite threateningly for Raydar's survival, I cannot find that any arrangements or dealings existed in respect to the debts more than 60 days overdue that would have given Raydar the expectation of further periods of grace in which to pay these which were the majority of its debts. While originally there may have been some informal non-binding `back-to-back' payment arrangements between Raydar and some of its sub-contractors, commonsense indicates that the majority of creditors would not wait forever and would start to demand payment even if the head contractor failed to pay Raydar.

Against the $156,233.29 -- or $138,803.29 should Raydar succeed in its contested claims -- immediately owing on 22 December, Raydar claimed to have assets totalling $196,485.38 but most of them were not immediately realisable. $134,208 of this amount, also evidenced on the company's statement of affairs prepared by Raymond Miller, was for unrealised debts, $20,000 existed in the form of shares in Seven Hills Electrical Wholesalers Pty Ltd the value of which was contested, $12,667.38 was cash in the bank, and the remainder existed as office furniture, equipment, stock and motor vehicles owned by the company.

Although Raydar had considerable money owing to it, very little of it was immediately realisable to pay the company's debts. Some of these claims were for retention moneys for projects done which generally do not become payable for 12 months after completion. Consequently, at least $22,505 of its declared assets would not be payable in the near future. Raydar had been having significant problems with the slow payment of debts by creditors, especially with securing money from Reed which owed Raydar about $100,294 (excluding retention moneys) for various projects. For example, the previously mentioned project at Liverpool Hospital valued at $32,447.48 was completed in May 1993 and by December Raydar had received no payment for it. In fact, Reed was making a claim for liquidated damages against Raydar in respect of this project which they were assessing at $2,000 a day. There was little chance that Raydar would be paid what it was owed whilst this claim for damages remained outstanding, and it was possible that the company would end up owing Reed money. Raymond Miller also admitted that he had been having difficulties getting payments from Reed in respect of another substantial debt -- $62,502.38 for a project at Gosford Railway Station. While the project had been completed in late October/early November 1993, the money had been outstanding at that time for "approximately seven months" and any payment from Reed did not appear to be imminent in late December.

When asked about the money that was outstanding on various projects, Mr Miller admitted under cross-examination:

Q. You see, you had not been able to collect those moneys for many months, had you?

A. No.

Q. These sums had been outstanding, some for well over 90 days, had they not?

A. Yes.

Q. You had not been able to collect them?

A. No.

Q. You could not, I suggest to you, expect to collect them in the short term?

A. Not necessarily.

He went on to admit that he had been making phone calls to Reed about the money due to him since 1992 but to no avail (T164).

As at December 1993, it does not seem to me likely that Raydar was going to receive any of the money owing to it from Reed in the near future. Indeed, taking into account the retention moneys owing, Raydar could not have expected to receive more than $20,000 from outstanding accounts in the short term, and even this result would only occur if everyone other than Reed immediately paid their debts. With very little income available, Raydar would thus have had to be able to realise substantial funds from either company assets, new finance facilities, or personal support from the directors, if it was to be in a position to pay its debts including what it contracted to pay Metropolitan on 22 December 1993.

It is therefore necessary to have regard to moneys which could have been procured by sale, mortgage or pledge of assets within a relatively short time in the normal course of the company's business. The evidence suggests that the ability of the directors to support Raydar in this manner had already been exhausted. In August 1992 when Raymond Miller granted to Turks a mortgage over his one half share interest as tenant in common of a property in Seven Hills as security for Raydar's debt to Turks, his share of the factory unit was valued at $85,000. At that time Raydar owed approximately $90,000 to Turks, but by December 1993 this debt had risen to $114,267.29. Mr Miller had previously sought to sell the unit but Mr Powers, the other tenant in common, had refused to co-operate.

In April 1992 Australian Guarantee Corporation Limited had advanced $160,000 to Raydar under an overdraft facility. The loan was increased by $7,000 in October 1993 because of the slow payment for projects. Raymond and Patricia Miller secured this facility by personal guarantees and the granting of first and second registered mortgages over the family home. Mr Miller put forward the possibility of raising further finance on the home, but he had made no attempt to do so. Some attempt had been made to restructure the debt to Turks, but a proposal put to the Commonwealth Bank to refinance the debt had been rejected by Turks which had threatened to sell the factory unit. There were no remaining assets of meaningful value to allow the directors to provide further financial support. Furthermore, neither Raymond Miller nor his wife had drawn wages for 13 weeks; the number of employees had been reduced from 14 in June 1993 to 4 or 5 in December 1993; and Raydar had been unable to keep up with the instalment payments on the tax debt.

I have taken into consideration that many businesses operate on the basis that turnover will fund debts and that in due course imbalances on balance sheets somehow even out. However, having considered all of the resources available to Raydar, including additional personal support from the directors who undoubtedly knew the situation they were facing, I have concluded that in late December 1993, Raydar was not in a position to pay all its debts as and when they became due and payable. This conclusion has been confirmed by events subsequent to that date. Reed has not been forthcoming with money for the Clancy Auditorium project nor for any of the other projects for which Raydar maintains Reed owes it money.

7.5 Loss or damage

Section 588M(1)(b) requires Metropolitan to have suffered loss or damage in relation to the debt because of Raydar's insolvency. The loss suffered by and claimed by Metropolitan amounts to $49,549 -- the value of the agreed contract price for the Clancy Auditorium project excluding the amount settled with Reed, plus the small Liverpool Hospital project valued at $924.

It is unlikely that Metropolitan will be able to recover any of the debt in the winding up of Raydar, and it is equally unlikely that money could be recovered in proceedings against Reed. If not for Raydar's insolvency, Metropolitan could have sued Raydar for the whole debt regardless of any informal arrangements between the two companies for delaying payment until moneys were received from Reed.

8. PERSONAL LIABILITY OF THE RESPONDENTS AS DIRECTORS

Having established that Raydar was insolvent at the time it incurred the debt to Metropolitan, it remains to be determined whether at that time there were reasonable grounds to suspect the insolvency and whether the directors of Raydar were aware of the situation. Alternatively, it must be determined whether a reasonable director in a like position in a company in Raydar's circumstances would be so aware. The respondents asserted that there were no reasonable grounds for suspecting insolvency.

I have already found that Raymond Miller was aware of the difficulties Raydar was experiencing in obtaining money from its debtors. He was also aware that Raydar's and his own major assets were tied up as security for company debts. He admitted that should a major debt, such as that owed to Turks, have fallen due in December 1993 or soon after, Raydar would not have been able to pay it. When asked in cross-examination about the $43,344.70 owed to the Australian Taxation Office, he responded(T120):

Q. Were you in a position to pay the whole of that tax instalment in December 1993?

A. No.

In late 1992 Turks stopped supplying Raydar and were not prepared to extend it any further credit. In early 1993 they closed its account. Raymond Miller admitted that in July 1993, Turks told him that they would commence legal proceedings to recover their debt, and in September he received a letter in which Turks reiterated this threat. He said that he thereafter advised his accountants that any correspondence from Turks regarding legal action be forwarded straight to Ken Hickey, the company's solicitor. This may explain how Mr Miller could stoutly maintain throughout the hearing that it was not until late January 1994 that he learnt that in October 1993 Turks had served a statutory demand on Raydar and on 2 December had applied for its winding up.

In my view, Raymond Miller was fully aware in December 1993 that Raydar was not in a position to pay its major debts if they were to fall due and payable in the short term as they would, had and did. He was also aware that a significant proportion of its creditors were demanding immediate payment. Despite his hopes to the contrary, I have no doubt that reasonable grounds existed to suspect that the disputes he alleged with some of these creditors would have little or no impact on the strength of their demands. His cross-examination established quite clearly that he was aware that some creditors were considering or had commenced legal action to recover their debts.

The respondents argued that it was reasonable for Raymond Miller to take the view that there was a substantial cross claim which would more than offset Turks' debt, and that the $200,000 odd owed to the company would be received over a reasonable period of time. It is never easy in the course of a court hearing with reasonable time and human limits to prove or disprove the state of a person's knowledge or awareness of something like the solvency of a fully functioning company on a particular working day. Judging from professional experience, I do not doubt that many companies are or would be found to be insolvent on particular days or even for longer periods if a balance sheet were taken at a particularly difficult trading time. It is also easy in hindsight and in the remoteness of a courtroom many years later to be too artificial about the day to day running of a business in what I imagine was a highly competitive and "rough and tumble" entrepreneurial field.

But the law now imposes very severe tests for company directors to pass, especially in trading companies going through major and long term liquidity problems. Raymond Miller may in fact have held the views he expressed in evidence, but I cannot accept that a reasonable person in his position would have been so confident. Based on the financial and factual analysis earlier detailed, it seems to me that a reasonable company director in the position of the respondents would have or should have suspected, if not actually known, at the time immediately prior to the incurring of the debt to Metropolitan, that Raydar was already insolvent and was unlikely to be able to "trade out" of its problems in the foreseeable future.

While a large amount of money was owed to Raydar, there existed reasonable grounds to suspect that none or very little of this money would be paid to Raydar in the short or medium term, and there existed no other sources of large sums of money. A reasonable company director, aware of Turks' intentions to pursue legal proceedings against the company, and knowing the lack of commitment shown by the company in seeking to defend the proceedings, would have to suspect that such an action would succeed. Knowing also that successfully defending Turks' claim was critical to the financial survival of the company, I believe that a reasonable director of ordinary competence would have made him/herself aware that both a statutory demand for payment of debt and a winding up summons had been served on the company in late 1993. These facts, combined with the demands being made by other creditors, clearly amount to grounds that would create in the mind of a reasonable director of Raydar a real suspicion, indeed an actual apprehension or fear, that Raydar was insolvent at the time that it incurred the debt to Metropolitan.

The debt was incurred as part of the Clancy Auditorium project which was the only job that Raydar had at that time. Given the poor track record of Reed as a debtor, and the season of the year when this job was being done, no reasonable director could have reasonably expected to receive payment from Reed in time to satisfy the amount that was to become owing to Metropolitan shortly after. Consequently, by taking on the new project and incurring the further debt to Metropolitan, Raydar was sinking even more deeply into insolvency. It is clear that a reasonable director would have suspected that incurring this debt to Metropolitan would have compounded even further Raydar's by then quite chronic inability to pay its debts as and when they fell due.

9. DEFENCES

Section 588H provides several defences to an action under s588G:

(1)

(2) It is a defence if it is proved that, at the time when the debt was incurred, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.

(3) Without limiting the generality of subsection (2), it is a defence if it is proved that, at the time when the debt was incurred, the person:

(a) had reasonable grounds to believe and did believe:

(i) that a competent and reliable person ('the other person') was responsible for providing to the first-mentioned person adequate information about whether the company was solvent; and

(ii) that the person was fulfilling that respon-sibility; and

(b) expected, on the basis of information provided to the first-mentioned person by the other person, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.

(4) If the person was a director of the company at the time when the debt was incurred, it is a defence if it is proved that, because of illness or for some other good reason, he or she did not take part at that time in the management of the company.

(5) It is a defence if it is proved that the person took all reasonable steps to prevent the company from incurring the debt.

The onus of proof for these defences is on the director seeking to rely on them who must establish the elements of the defences on the balance of probabilities. The grounds on which the director forms the view as to the company's solvency or otherwise must be reasonable. This implies an objective consideration of the grounds viewed against all circumstances and not whether, when looked at from the point of view of the director in question, the grounds appear reasonable.

The defences under section 588H require that there be reasonable grounds to `expect', as opposed to `suspect', solvency as provided in section 588G. From the cases in which the meaning of these words has been considered, it would appear that to `suspect' something requires a lower threshold of knowledge or awareness than to `expect' it: see a discussion on `to suspect' by Kitto J in Queensland Bacon Pty Ltd -v- Rees [1966] HCA 21; [1966] 115 CLR 266 at 303; and 3M Australia at 192. The expectation must be differentiated from mere hope in order to satisfy this defence: Dunn -v- Shapowloff [1978] NSWLR 235. It implies a measure of confidence that the company is solvent. The directors must have reasonable grounds for regarding it as likely that the company would at the relevant date have been able to pay its debts as and when they fall due.

The respondents claimed under subsection (2) that at the time Raydar incurred the debt to Metropolitan, they had reasonable grounds to expect, and did expect, that the company was solvent and would remain solvent even if it incurred that particular debt. In light of the evidence, however, it cannot be said objectively that there were reasonable grounds to expect that this would be the case. There was no reason to believe that Reed would pay Raydar any money in the short term, and Raydar's creditors had already begun to take an ominous and aggressive attitude towards the company's persistent disputation of accounts. These factors, in addition to the situation brought about by the actions of Turks, and the unlikelihood that either the company or the directors could raise further significant funds, show that at the time Raydar incurred the debt to Metropolitan, there were no reasonable grounds to expect that Raydar would be able to pay this or any other debts as and when they fell due. Any optimism regarding the company's future was based on hope rather than reasonable expectations. Therefore, I reject the defence raised under section 588H(2) in respect to all three defendants.

The second and third respondents also raised defences under section 588H(3). It is now settled that directors have a positive duty to take an active part in the affairs of the company to the extent that they should be aware of what is going on in the company: Morley v Statewide Tobacco Services Limited [1990] 2 ACSR 405 at 431 where Ormiston J said at 448:

A director should not ... be entitled to hide behind ignorance of the company's affairs which is of his own making or, if not entirely of his own making, has been contributed to by his own failure to make further necessary inquiries.... What each director is expected to do is to take a diligent and intelligent interest in the information either available to him or which he might with fairness demand from the executives or other employees and agents of the company.

Patricia Miller and Leonard Ewins asserted that they had relied on Raymond Miller with respect to the running of Raydar's affairs, including informing them on the state of the company's finances. They said that he was responsible for the day to day running of the company and for providing them with all necessary information about its affairs. They asserted that, as far as they were aware, he was fulfilling those responsibilities and that, on the basis of the information he provided, they expected that the company would remain solvent if and when it incurred the debt to Metropolitan.

Patricia Miller, as well as being a director, was employed by the company as a full time casual clerk performing banking, some invoicing and general banking duties from home. She typed the invoices but claimed that she did not take in the details. Mrs Miller also sometimes made phone calls regarding debt collection, but she claimed not to be aware of the details of these debts or the difficulties being experienced in recovering them. She claimed to be unaware of the dispute with Turks or the company's liability to the Tax Office, although she was aware of the mortgages granted over the family home and the factory unit. Mrs Miller also admitted that she was aware that the company was reducing its staff although this apparently caused her no concern. More importantly, there is no evidence of her inquiring of her husband, the director of the company on whom she relied for information about the company, as to the state of the company's finances.

Contrary to her assertion, required for her defence to succeed, and to some of her own statements, the evidence leads to the conclusion that Mrs Miller's opinion that the company was trading profitably and was solvent was not based on information provided by her husband at all but on her own observations as part of her duties: she saw "plenty of banking and invoices going out". She may have believed that her husband would inform her if the company was in trouble but as a director she had a duty to take an interest in and demand information on the financial state of the company, especially as she undoubtedly knew that it was at best "in trouble". As a working director, she had a duty to observe and draw reasonable and obvious conclusions from facts coming to her attention.

I accept that Mrs Miller lacked detailed knowledge of the financial situation of Raydar, but I cannot find that there were and that she had reasonable grounds to believe that Mr Miller was fulfilling the responsibility of providing adequate information to his co-director. I therefore reject her defence raised under section 588H(3).

In respect to Leonard Ewins, the reasons for rejecting this defence are even stronger. In addition to being a director of Raydar, Leonard Ewins was employed as a full time electrician. He worked on various sites at which Raydar was engaged as a subcontractor and was involved in the ordering of goods and the preparation of quotes. In his statement Leonard Ewins said:

Whilst I had access to the books and records of the Company I did not regularly check those records and allowed Raymond Wayne Miller to manage the financial affairs of the Company.

He further stated that his belief that Raydar was trading profitably and was solvent was based on the fact that:

(t)he Company had traded for a number of years as an electrical contractor and because of the continued engagement of the Company by various builders and other contractors,..

not, I add, on any information provided by Raymond Miller. Leonard Ewins was not available for cross-examination.

As a person working on Raydar projects and having contact with suppliers, Mr Ewins could reasonably have been expected to know of the attitudes of some of the suppliers towards Raydar's slow payment of debts and also of the difficulties Raydar was having in obtaining payment for jobs. There did not exist reasonable grounds on which Mr Ewins could rely to support a belief that Raymond Miller was providing adequate information on Raydar's solvency at the time of the Metropolitan contract. As a director, he had an obligation to inquire as to the financial health of Raydar, yet so far as the evidence goes, he failed to make any demands for information at a time when his suspicions about the company's financial viability and survival should and would have been aroused. I therefore reject the defence raised by him under section 588H(3).

10. CONCLUSIONS

There is, in my view, no doubt that on 22 December 1993 when Raydar incurred the debt to Metropolitan, it was insolvent. It is my further opinion that on the same date reasonable grounds existed on which to base a suspicion, within the meaning of section 588G of the Corporations Law, that Raydar was insolvent, and that a reasonable director would have been aware of these grounds. I do not accept the defences on which the respondents relied. All other conditions precedent to an order as sought by Metropolitan pursuant to sections 588M and 588R have been satisfied. I therefore find that the respondents contravened section 588G and that Metropolitan has established its entitlement to recover the debt owed by Raydar from the respondents, being directors of the company, under section 588M.

11. CIVIL PENALTY APPLICATION

Metropolitan sought in terms:

[a] declaration that the said claim is a civil penalty provision under S1317DA of the Corporations Law.

I have never understood and, notwithstanding the end of the case, still do not understand what is meant or intended by this part of Metropolitan's application. No mention was made of it in its final submissions. If it is a request for a civil penalty order as provided by section 1317DA, it is not available in a case of this kind. Whilst section 588G(3) states that that section is a civil penalty provision as defined by section 1317DA, only the Australian Securities Commission, its delegate, or a person authorised by the Minister can, by section 1317EB, make an application for a civil penalty order. Consequently, it is not open to Metropolitan as a creditor of a company in liquidation to seek an order of this kind. I therefore reject the application for the declaration as pointless.

12. COSTS

Metropolitan's costs will be paid by the respondents.

For the applicant	John K. Chippindall instructed by Terry McCabe assisted by Richard Shakenovsky of McCabe Brown, Lawyers
For the respondents	Jonathan Simpkins instructed by David Michael Vaughan of Heaney Richardson & Nemes Solicitors
Dates of hearing	12 & 14 June 1996 and 2-4 July 1996
Written submissions completed	9 August 1996
Date of judgment	22 May 1997