Factors to consider when proving insolvency

In First Strategic Development Corporation Limited (in liq) and Anor v Chan and Ors [2014] QSC 60, an application was brought by the liquidators of First Strategic Development Corporation Limited (in liq) (FSD) against three former directors for insolvent trading.

In its decision, the Supreme Court of Queensland discussed the relevant factors to take into consideration when assessing the solvency of a company.  The Court also gave useful direction on assessing solvency in circumstances where the company had no assets or external line of credit, but a director who purported to be willing and able to finance the company’s activities at any one time.


In 2009, FSD struck an agreement with Macarthur Minerals Limited (MML) to, among other things, spend $2.5 million for exploration services on a MML project in return for the buy option for the purchase of a tenement.

On or around August 2010, a director of FSD expressed concerns about the agreement and requested that MML suspend exploration “with immediate effect until further notice” and send through an account for the work done to date.1  The amount outstanding at that time was $856,365.19.  At a meeting of creditors of FSD on 17 November 2010 a resolution was passed for FSD to be wound up and for liquidators to be appointed.2

Issues and legal analysis

Section 588G of the Corporations Act 2001 (Cth) (Corporations Act) imposes a statutory duty on a company’s directors to prevent insolvent trading.  Pursuant to section 95A of the Corporations Act, a person is solvent if the person is able to pay all the person’s debt, as and when they become due and payable.

Case law establishes that the court must have regard to “commercial reality” in assessing whether a company is able to pay its debts as they become payable.  In Lewis v Doran & Ors3the Court said:

In my opinion, s 95A requires the Court to decide whether the company is able, as at the alleged date of insolvency, to pay all its debts as they become payable by reference to the commercial realities. If the Court is satisfied that as a matter of commercial reality the company has a resource available to pay all its debts as they become payable then it will not matter that the resource is an unsecured borrowing or a voluntary extension of credit by another party.

The solvency of a company must be considered with regard to not only its:

legal rights and obligations but also other circumstances such as the relative likelihood that it will have funds available to it from sources with which it has no formalised agreement or understanding.4

Several recent decisions have confirmed that, when assessing solvency, the Court may have regard to finance being provided by a director or related entity where “evidence establishes that the directors are likely continue it”.5

In this instance, it was accepted that the director of FSD had some inclination to advance funds to the company (as it would stand to benefit him personally) but his preparedness to do so was qualified by too many contingencies.  As a result, the Court found that the first defendant was not a reliable source of funds and FSD was insolvent at all relevant times.  At paragraph 80, the Court said:

The degree of preparedness of the first defendant to pay the debts of the company as they fell due, was not such as to provide a sufficiently reliable source of funds by which the company became able to pay its debts as they fell due. The company was insolvent at all material times and each of the subject debts was incurred when the company was insolvent.6

Lavan Legal comment

When assessing the solvency of a company, the Court may have regard to ongoing financial accommodation provided by directors or related entities.  However, it must be shown that the director (who purports to provide the financial support) is not only able to pay debts on behalf of the company as and when they fall due, but must demonstrate a sufficiently certain and reliable source of funds.

1 First Strategic Development Corporation Limited (in liq) and Anor v Chan and Ors [2014] QSC 60 at [36].

2 Ibid, at [40].

3 (2004) 184 FLR 454 at 481.

4 Ibid, at [67].

5 International Cat Manufacturing (in liq) v Rodrick (2013) 97 ACSR 200 at 224.

6 First Strategic Development Corporation Limited (in liq) and Anor v Chan and Ors [2014] QSC 60 at [80].

Disclaimer – the information contained in this publication does not constitute legal advice and should not be relied upon as such. You should seek legal advice in relation to any particular matter you may have before relying or acting on this information. The Lavan team are here to assist.