Related entities and failure to prevent insolvent trading – go to the back of the line

The West Australian Court of Appeal (Martin CJ, Mitchell and Beech JJA) recently delivered its reasons for decision in Perrine v Carrello¹ (click here for the decision), an appeal from the decision of Chaney J in the Supreme Court of Western Australia in Giovanni Maurizio Carrello as liquidator of Perrinepod Pty Ltd (in liq) v Perrine Architecture Pty Ltd² (click here for the decision).

Background

The appellants, Mr and Mrs Perrine, were directors and shareholders of Perrine Architecture Pty Ltd (Perrine Architecture).

Perrine Architecture owned approximately 79% of the shares in Perrinepod Pty Ltd (Perrinepod), of which the appellants were also directors.

The respondent liquidator, Mr Carrello (Liquidator) was appointed as liquidator of Perrinepod on 1 March 2012.

Perrine Architecture charged Perrinepod for office equipment facilities and staff at ordinary commercial rates on a running account basis from the early stages of Perrinepod’s existence.

The payment arrangement was flexible, payments on the running account were only made by Perrinepod as and when it had the funds to make a payment however Perrinepod remained an outstanding debtor until payment was made.

Failure to prevent insolvent trading

Section 588G of the Corporations Act 2001 (Cth) (Act) states that a director contravenes the section if at the time a company incurs a debt there were reasonable grounds for suspecting that the company is, or would become, insolvent and the director is aware that there were such grounds, or a reasonable person in a like position would be so aware.

Section 588M of the Act states that where a director has contravened section 588G in relation to the incurring of a debt by a company and the person to whom the debt is owed (the creditor) has suffered loss or damage, the company’s liquidator may recover from the director as a debt due to the company, an amount equal to the loss or damage suffered by the creditor.

First instance decision

At first instance, His Honour Chaney J found (amongst other things) that:

• Perrinepod was insolvent as and from 16 July 2010;
• there were reasonable grounds for suspecting as at that date that Perrinepod was insolvent;
• Mr and Mrs Perrine were aware that there were grounds to suspect that Perrinepod was insolvent and did not have reasonable grounds to expect, and did not expect, that Perrinepod was solvent at that time and would remain solvent even if it incurred further debts;
• that position did not change at any time up until the appointment of the liquidator; and
• therefore Mr and Mrs Perrine were liable to pay to the liquidator the amount of any losses suffered by creditors to whom debts were incurred whilst Perrinepod was insolvent.

The appeal

Mr and Mrs Perrine proceeded with a single ground of appeal, after abandoning their second ground of appeal, being that the primary judge erred in law in:

• holding that amounts recorded in the accounts of Perrinepod as loans from, or amounts invoiced by, Perrine Architecture were loss or damage suffered by Perrine Architecture in relation to a debt because of the insolvency of Perrinepod; and
• failing to hold that the respondent had not proved that Perrine Architecture had suffered loss or damage in that the debts were subject to agreed terms regarding repayment.

Mr and Mrs Perrine made submissions that, amongst other things, the primary judge had held that Perrinepod would not pay unless it had the funds to pay and therefore there was no “debt”.

The Court of Appeal (Martin CJ, Mitchell and Beech JJA) disagreed with Mr and Mrs Perrine’s submissions above and dismissed the appeal, finding that Perrinepod would make payments to Perrine Architecture “as and when” not “if and when” it had funds to do so.

Their Honours noted that there was no challenge by the appellants to the statement of principles set out by the primary judge with respect to the incurring of a debt, being:

The weight of authority shows that a debt can be incurred when the contract giving rise to the debt is entered into, even if contingencies affect the debt or the debt is a future debt.

[T]he focus must be on the conduct and choice of the alleged insolvent company.³

Their Honours upheld the primary judge’s order that, as the entities were related, the amounts paid by the appellants would not be available to pay the debts of Perrinepod to Perrine Architecture unless and until all other unsecured debts of Perrinepod were first paid out in full.

Lavan comment

This decision provides useful guidance for liquidators attempting to recover amounts from the directors of the insolvent company for failing to prevent insolvent trading, particularly in circumstances where the creditor company is a related entity.

“Unusual” or “flexible” payment arrangements between the related entities may still meet the requirements of incurring a “debt” and result in an order for the director to repay the amount incurred by the insolvent company, for the benefit of unsecured creditors.

Furthermore, this decision demonstrates the Court of Appeal’s approval of a liquidator moving a related entity unsecured creditor to the “bottom of the list” when proceeding against a director for these types of claims.