Insolvency Series No 1 Proving Solvency

Introduction Discussions of solvency usually are nothing more than restatements of the same old statements of principle. These discussions rarely examine the evidentiary requirements necessary to satisfy the required standard of proof.

Why? Proving solvency becomes necessary in many ways, namely: -the rebuttal of the Section 459C presumption. -defence of a voidable transaction under Section 588FF. -opposition to the making of a sequestration order on the basis of solvency.

Statutory Definition Section 95A provides: “Solvency and Insolvency (1)A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable. (2)A person who is not solvent is insolvent.”

Classic Statement In Sandel v Porter, Barwick CJ observed: “The debtor’s own moneys are not limited to his cash resources immediately available. They extend to moneys which he can procure by realisation by sale or by mortgage or pledge of his assets within a relatively short time …

Classic Statement Cont’d The conclusion of insolvency ought to be clear from a consideration of the debtor’s financial position in its entirety and generally speaking ought not to be drawn simply from evidence of a temporary lack of liquidity. It is the debtor’s inability, utilising such cash resources as he has or can command through the use of his assets, to meet his debts as they fall due which indicates insolvency.”

Common Problem Balance sheet solvency is for the most part irrelevant to the definition. Accountants are trained to consider balance sheet solvency. However, balance sheet solvency can be useful in identifying the value of assets against which monies can be raised.

Onus In so far as the company seeks to rebut the section 459C presumption then: -the company bears the onus of proof; -the Court must be presented with the “fullest and best” evidence of the financial position of the company.

Onus Cont’d As Spiegleman CJ observed in Switz Pty Ltd v Glowbind Pty Ltd: “The process of proving solvency is not some kind of forensic game. Solvency is a matter peculiarly within the knowledge of the company. The primary source of information on the solvency of the company must be the company itself.” So if the Company fails to disclose something and gets caught then the Court can never be satisfied as to solvency.

Expert Report An external and independent expert should prepare a special purpose report as to solvency. It is not sufficient for the company to use: -its own internal accountants; -external accountants; -tax compliance accountants, to prepare the report.

Expert Reports Cont’d The expert must carry out their own audit to satisfy themselves of the business and reporting system of the company. Any report must bring liabilities to account at the day of hearing. Bold assertions of solvency arising from a general review of accounts (even by qualified accountants) are not sufficient.

Expert Reports Cont’d The expert report must be based on independent third party valuation of company assets. Any internal company document should be independently verified by external accountants or insolvency practitioners. Remember that the insolvency practitioner and any valuer providing valuation evidence will be cross-examined.

The Evidence Unaudited accounts are not ordinarily probative of solvency. Unverified claim of ownership should be disregarded. Unverified valuations of property are not ordinarily probative of solvency. The nature of company assets and ability to convert those assets into cash in a short time can be relevant.

The Evidence Cont’d Value of equity in leased assets should be regarded with suspicion. Loans treated as non current should be examined closely. Any gap in financial records must be explained. Loans to director or related entities should be examined to assess recoverability or be disregarded.

The Evidence Cont’d Failure to verify the acquisition costs of assets must be explained. Trade debtors are an unreliable source of funds and should generally be discounted. Financial accounts produced internally by well known software packages are unreliable.

Statutory Obligations In trying to demonstrate solvency, companies often forget or ignore debts which are not immediately due eg: -PAYG installments may not be due until 28 days after the end of the quarter however, deductions will have already been made from employee wages; -GST will often be collected but not yet due to be remitted.

Statutory Obligations Cont’d -Statutory obligations such as Workcover often will not be payable until after end of a quarter; -The issue of solvency cannot be addressed unless all statutory returns are lodged.

Practical Difficulty The statutory demand regime is now operating in a very robust manner so if the presumption arises the only defence is that under Section 459C and in turn Section 459S. A Company has 7 days after determination of a Section 459G Application to comply with a demand.

Practical Difficulty Con’td A creditor can apply for winding up and have a return date in under 2 weeks. A company is unlikely to gather evidence to prove solvency in 2 weeks The company needs to act quickly.

A Solvent Company In the event the Section 459C presumption is rebutted then the winding up application should be properly dismissed. A creditor can then sue in a court of competent jurisdiction to recover the debt.

Conclusion It may be argued that the burden placed on a company to demonstrate solvency is too onerous. However, the Company is in that position because it failed to satisfy or set aside a statutory demand and thus allowed the statutory presumption to arise.