Solvency: Paying Your Debts When Due

02 June 2008 Topics: Insolvency and restructuring

In the recent Qld Court of Appeal decision in Williams (as liquidator of Scholz Motor Group P/L (in liq) v Scholz & Anor (2008) QCA 94 the facts were uncontroversial but spectacular.

A newly formed company commenced business selling cars. It had no substantial capital assets and no working capital. From the beginning, the company did not trade profitably.

Trading for some 16 months the company accumulated a loss over $3m. The overdraft limit commencing at $200,000 increased to $1m but did not solve the company’s liquidity problems. During the last 5 months the company sold 19 motor vehicles at less than cost. During this final period a loss of over $500,000 was incurred on these transactions and company cheques totalling over $9m were dishonoured.

The liquidator obtained a judgment against the directors for insolvent trading.

On the appeal it was argued by the directors that the company was able to pay its debts as and when they fell due.

In the NSW decision at first instance of Lewis and Anor v Doran and Ors (2004) NSWSC 608 when considering the issue of company insolvency it was held that it was no longer necessary that the company be able to pay its debts ‘from its own moneys’.

In Scholz the directors argued that the company was not insolvent because the directors were capable of, and willing to, furnish the company with funds, by way of loan or share capital, to meet the debts of the company.
Crucially it was said in Lewis v Doran with respect to establishing prospective solvency that such willingness on the part of a third party would have to be cogently demonstrated, if not as a matter of legal obligation, then as a matter of commercial reality. Looking at solvency retrospectively the evidence of what actually occurred will be compelling.

In Scholz there was no evidence that the directors were able and willing to provide sufficient funds from their own resources to the company to enable it to discharge its debts.

Where was the provision of necessary financial support as $9m worth of cheques were dishonoured? Continuing to trade only by exceeding the overdraft limit so that cheques were dishonoured was powerful evidence of the absence of willingness and ability by the directors to fund the company to meet its debts as they fell due for payment.

Another argument made by the directors was that it might be inferred, as they had met their obligations under guarantees personally given to banks, that they were willing and able to make their own funds available to meet obligations of the company where they had not given guarantees.

It was held that the issue is not whether the directors were willing and able to meet their own legal obligations to the company’s creditors, but whether they were willing and able to assume the burden of discharging obligations of the company where they were not under a personal liability to creditors. Not surprisingly they failed to do so.

Although the evidence in Scholz was plainly insufficient the decision is consistent with the decision in Lewis v Doran that a company is not restricted to paying its debts ‘from its own moneys’. In such circumstances when seeking to retrospectively establish solvency you will need cogent evidence that the third party was capable of, and willing to, furnish the company with the necessary funds to pay its debts when they fall due. This is usually a difficult task where for example the directors in fact failed to provide the third party funding and the company ended in liquidation.

For more information regarding this article, please contact Graham Roberts 07 3231 2444.

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