Third party funds and a company’s solvency


Third party funds and a company’s solvency

Introduction

In Quin v Vlahos [2021] VSCA 205, the Victorian Supreme Court of Appeal recently considered the interesting question of when third party funds can be taken into account in determining a company’s solvency.  The Court also considered the circumstances in which a liquidator can rely on “unreconciled” financial accounts to prove insolvency.

Background

Prior to its liquidation in August 2014, Roderick Group Pty Ltd (in liq) (“the Company”) operated a business which sold discounted text books to students.  From time to time in 2013 and 2014, the Company’s debts were paid from funds held in the personal accounts of Mr Vlahos and his wife.

The liquidator alleged Mr Vlahos had failed to prevent the Company from trading while insolvent, and that certain payments made to Mr Vlahos were voidable transactions.  In dismissing the proceeding at first instance, the Associate Judge rejected the liquidator’s contention that the Company was insolvent at the relevant times on the basis that:-

  1. There were funds available to pay the Company’s debts in the accounts held by Mr Vlahos and his wife.
  2. The MYOB accounts relied on by the liquidator were “unreconciled” with other available accounting information, and therefore could not be relied on to prove insolvency.

The liquidator appealed.

The third party funds

In considering the circumstances in which third party funds can be taken into account when assessing solvency, the Court of Appeal usefully set out the following principles:-

  • The key question is whether the relevant company has a sufficient degree of assurance that the third party funds will be made available to it as and when required.
  • The position must be considered objectively from the perspective of the relevant company, rather than the third party funder.
  • While the liquidator bears the onus of proving insolvency, a party seeking to rely on the availability of third party funds bears the onus of proving that issue.
  • To discharge the onus, there must be “cogent evidence” that the third party funds will be made available at the given time.

Ultimately, it was not necessary for the Court to decide the issue, given the funds held in Mr Vlahos’ account were insufficient to pay the Company’s debts.  Nevertheless, the Court found the Company did not have sufficient assurance that the funds would be made available to it in any event.  While Mr Vlahos had previously paid the Company’s debts from funds held in his account, this was “wholly dependent on a favourable exercise of Mr Vlahos’ unfettered discretion.”  In particular, there was no formal or informal agreement between the Company and Mr Vlahos in relation to the funds, nor were the funds identified as an alternate source of finance in the Director’s Questionnaire completed by Mr Vlahos.

The “unreconciled” financial statements

Contrary to the position taken at first instance, the Court of Appeal confirmed that there is no requirement for a liquidator to reconcile a company’s accounts with other available accounting evidence in order to rely on those accounts to prove insolvency.  Rather, the critical question is whether the relevant accounts are “sufficiently reliable,” when considered with the other evidence, to enable the Court to determine the company’s solvency.

The starting point in the relevant analysis is s.1305 of the Corporations Act 2001 (Cth)(“Act”).  Pursuant to that section, the tendering of a company’s accounts is proof of the matters recorded therein, unless other evidence satisfies the court, on the balance of probabilities, to the contrary.

While the Court accepted there were inconsistencies in the MYOB accounts relied on by the liquidator, they were not sufficiently serious to displace the prima facie position established by s.1305.  Accordingly, the liquidator was able to rely on the accounts, along with other indicators of insolvency, to prove the Company’s insolvency at the relevant time.

Outcome

Ultimately, the liquidator’s appeal was successful and Mr Vlahos was ordered to pay the Company $705,387.53 pursuant to s 588M of the Act and $553,966.06 pursuant to s 588FF of the Act.

Take-Aways

Liquidators are required to consider a company’s access to external funding in determining its solvency. Where a liquidator is satisfied that a company has sufficient assurance that third party funds are available to pay debts as and when they fell due, this may well weigh against a conclusion that the company was insolvent based upon its own resources.

However, self-serving assurances from a director about access to funds is not enough.  There must be objective evidence to substantiate the claim, such as a funding agreement or an established course of conduct in which funds have been made available as and when required.

Finally, while liquidators are often faced with incomplete and inconsistent financial records, this is not necessarily fatal to proving insolvency.


~ by Helen Hodgins, Lawyer