Presumption of insolvency - 7 years bad luck

The decision of Rees J in the New South Wales Supreme Court in In the matter of Substance Technologies Pty Ltd [2019] NSWSC 612 deals with the presumption of insolvency under section 588E(4) of the Corporations Act¹ due to a company failing to keep financial records under section 286 of the Act. 

Background

Substance Technologies Pty Limited (Company) operated a scrap metal business and yard.

The Company’s former sole director was appointed on 8 September 2004 and resigned on 3 January 2015, and his successor was appointed on 2 January 2015 (together, the Directors).

The Company was wound up pursuant to an application by one of its creditors on 27 June 2016.

The liquidator of the Company requested the Company’s books and records (Financial Records) under section 530A of the Act,² but the then current director refused to provide them.  No clear reason was provided for this refusal.

It is important to note that section 588E(4) of the Act provides that a presumption of insolvency arises where section 286 has been contravened, and the Company is presumed to have been insolvent throughout the period of the contravention.

The liquidator then informed the Directors that:

• he considered that the Company had not complied with its obligations to keep written financial records for a period of 7 years under section 286 of the Act;³ 
• this gave rise to a presumption of insolvency under section 588E(4)⁴ for the 7 years prior to the Company being placed into liquidation; and
• the Directors were therefore potentially liable for insolvent trading for that entire 7 year period. 

Defence and decision

The Directors took the position that the Company had complied with section 286 and that the Financial Records were in fact located in a storage unit, but that they were entitled to refuse the liquidator’s request under section 530A of the Act pursuant to their claim for privilege against self-incrimination.⁵

The Directors then went on to submit that they were also entitled to not tender any evidence of the Financial Records in the insolvent trading proceedings, and that the Court should infer that the Financial Records exist (thereby defeating the presumption of insolvency) from other business records of the Company.

Justice Rees noted that:

• the privilege against self-incrimination had not previously been considered in the context of sections 286 or 588E;
• however, the question before the Court was whether there was sufficient evidence to infer that the Financial Records exist;
• where a party relies upon the privilege against self-incrimination it is not appropriate to draw an adverse inference as a consequence of invoking the privilege;
• nonetheless, it is open to the Court to draw an inference about the existence or otherwise of the Financial Records from the evidence put before the Court.  The relevant standard is whether the Court can be satisfied on the balance of probabilities; and
• the only relevance of the privilege against self-incrimination is that the Court cannot gain extra assistance by drawing a negative inference from the fact that the party claiming the privilege has failed to advance relevant evidence that could have assisted their case.⁶

Justice Rees found that the Company had entirely failed to comply with its obligation to maintain the Financial Records for the 7 years prior to the Company being placed into liquidation, and that the presumption of insolvency arose for the entire 7 year period for which records ought to have still been in the Company’s possession when it went into liquidation.

Lavan comment

This case highlights the following key points:

• it is critical to check whether proper financial records have been kept and handed over by the directors of a company in liquidation; and
• the lack of, or refusal to hand over, financial records may give rise to a presumption of insolvency, allowing liquidators to assume the company was insolvent up to 7 prior to the company being wound up.