Termination of winding up order: 2015 in review (part 1)

None of the decisions handed down in 2015 represented major changes to the policy or principles that were considered and applied by the Court in determining a Termination Application. However, the decisions do serve the purpose of:

1. Affirming and emphasising the matters and evidence that the Court will require to grant the Termination Application;
2. Providing practical guidance as to the specific evidence that is required to be brought before the Court (and what ought to be included in a solvency report to be relied upon at any hearing); and
3. Providing practical guidance as to what arrangements made with creditors will be acceptable and supported by the Court.

The matters discussed in this article will be particularly relevant to:

• Insolvency practitioners who have been appointed as liquidators of the company that is the subject of the Termination Application (Company);
• Insolvency practitioners who are assisting directors/shareholders in gathering the necessary solvency evidence for the purpose of marking a Termination Application; and
• Creditors of the Company who may be approached for their consent in respect of the Termination Application.

In Part 1 of this article we:

1. Set out the legislative framework by which the Court determines an application to terminate the winding up of a Company;
2. Set out the general principles that are applied by the Court in considering an application to terminate the winding up of a Company; and
3. Provide a summary of the principles and matters that can be derived from the decisions handed down last year.

In Part 2 of this article you will find the case notes of the various judgments handed down last year.

Legislative Framework

Section 482 of the Corporations Act 2001 (Cth) sets out the legislative framework to terminate or stay a winding up of a Company. For the purpose of this article, it is relevant to note that the provision says, among other things, that:

• At any time during the winding up of a Company, the Court may, on application, make an order staying or terminating the winding up of the Company (section 482(1)); and
• A Termination Application may be made by the liquidator, a creditor of the Company, or a contributory (e.g. a shareholder), of the Company (section 482(1A)(a)).

General Principles

For the most part, a substantial majority of the decisions handed down in 2015 relied upon the principles set out In the matter of Glass Recycling Pty Ltd (ACN 001 332 654)[2014] NSWSC 439 and/or Re Warbler Pty Ltd (1982) 6 ACLR 526. The principles derived from the cases can be summarised as follows:

1. The granting of a Termination Application is a discretionary matter, and there is a clear onus on the applicant to make out a positive case;
2. The Termination Application must be served on all creditors and contributories;
3. The Court will take the following into consideration in determining a Termination Application:
   1. the attitude and interests of the creditors, including future creditors whose interests might be prejudiced if the Company were released from winding up;
   2. the interests of the liquidator, particularly with regard to remuneration;
   3. the interests of contributories, so that a stay or termination will not generally be granted unless each member either consents to it or is bound not to object to it, or his or her rights are properly secured;
   4. the public interest, including matters of commercial morality, and whether all the Company’s debts have been discharged;
   5. the Company’s trading position and general solvency, particularly when the Company was wound up on the grounds of insolvency (being a matter that “is usually the most significant consideration“);
   6. any explanation for any non-compliance with statutory duties and of the circumstances leading to the winding up;
   7. the nature and extent of the creditors of the Company, and whether or not all debts have been or will be discharged;
   8. the current trading position and general solvency of the Company;
   9. whether there has been non-compliance by directors with their statutory duties as to the giving of information or furnishing a statement of affairs;
   10. the general background and circumstances which led to the winding up order;
   11. the nature of the business carried on by the Company, and whether or not the conduct of the Company was in any way contrary to “commercial morality“ or the “public interest“; and
   12. whether the state of affairs that required that the Company be wound up no longer exists.
4. The matters set out in paragraph 3 are not exhaustive; and
5. Ultimately what the applicant must do is satisfy the Court that, among other things:
   1. “the state of affairs that originally required winding up no longer exists”, which in the case of a winding up in insolvency (as is usually the case), would be proof that the Company is now solvent; and
   2. “it would be reasonable to entrust the affairs of the Company, once again, to the directors, under whose management it previously failed”.

Summary of Matters/Issues Arising From Cases in 2015

The various practical and legal matters and issues that arise from the judgments handed down in 2015 in respect of a termination of the winding up of a Company can be summarised as follows:

1. When the winding up of the Company has arisen as a result of a winding up order being made (as opposed to the shareholders or creditors of the Company resolving to wind up the Company), the applicant will need to show an adequate and sufficient reason why the Company did not respond;¹
2. Whilst the Court may be prepared to accept reasons such as an error in the treatment of mail as an explanation for the purpose of the winding up application, the Court has emphasised that those reasons are generally not legal excuses for failing to respond to a winding up application;²
3. It is important to demonstrate to the Court, to the extent possible, that the cause of the Company being wound up was not as a result of any inherent commercial inadequacy of the business of the Company, or any questionable activities in the way it which it was managed;³
4. The Court must be shown that the cause of the Company being wound up has now been addressed. For example, where the winding up of the Company arose:
   1. as a result of a breakdown of interpersonal relationships, then the Court will consider what has been done to resolve that breakdown (such as by the removal of a party from the involvement of the Company);⁴ or
   2. due to some deficiency in the management of the Company, the Court will take into account any steps that have been implemented to address those deficiencies (such as implementation of new policies or hiring a bookkeeper);⁵
5. The Courts need to be shown how the liquidator’s remuneration will be met. Where those costs have not been paid in full, this may be satisfied by depositing monies into trust.⁶ We note that no cases in 2015 involved a circumstance where an application was being made to terminate the winding up without provision being made for the liquidator’s fees. However, given that reference is made to the remuneration of the liquidator in almost all cases, in the absence of a legitimate reason (e.g. a bona fidedispute in respect of the amount claimed), a failure to do so is likely to be a significant factor weighing against the granting of the winding up;
6. Evidence should be given as to what the Company proposes to do once it comes out of liquidation. This may be relevant in showing that there is a public benefit (such as if the Company was going to go on to develop residences), which will be a factor in favour of granting the Termination Application.⁷ This will also be relevant for the Court in considering the utility of the Termination Application.⁸ The mere fact that the Termination Application was a condition of an agreement between the Company and a creditor is unlikely, by itself, to be a sufficient and adequate explanation;⁹
7. The Court will try and give effect to an agreement reached between the Company and its creditors where possible.¹⁰ However, the mere fact that the Company has reached an agreement is not determinative and the Court still needs to be satisfied of the matters discussed above;¹¹
8. Parties may satisfy the Court that there is no substantial risk of the Company becoming insolvent by giving an undertaking to the Court that certain third party funds will be utilised and provided for the repayment of the Company’s debts (at least in the short term),¹² or by depositing monies into trust to cover those short term costs;¹³
9. The Court will place significant weight on a liquidator’s evidence concerning the solvency of the Company.¹⁴ However, this does not mean that the Court will automatically accept the liquidator’s evidence. Any evidence given regarding solvency needs to be substantially corroborated and the Court must be satisfied that the liquidator has given a considered opinion (which can include, for example, being satisfied that the liquidator had access to all the Company’s books and records);¹⁵
10. Where the debts of the Company are to be paid from funds advanced by third parties, the Court needs to be satisfied as to the nature of those funds (for example, whether it is a gift or a loan, and if it is a loan, who the borrower of that loan is).¹⁶ To the extent that the third party funds represent a loan to the Company, it will be necessary to satisfy the Court that the Company will be able to meet its obligations pursuant to that loan;¹⁷
11. Where evidence is being given that certain liabilities to the Company no longer exist, specific evidence needs to be given to satisfy the Court that, as a matter of law, those debts have been paid, compromised or extinguished.¹⁸ This may include, for example, an arrangement whereby a creditor of a debt has agreed to accept share capital in the Company in lieu of payment.¹⁹ However, the mere fact that a creditor has withdrawn a proof of debt in the liquidation is not sufficient evidence;²⁰
12. To the extent that evidence is to be put before the Court by way of financial reports of the Company, the Court needs to be satisfied that the matters set out in the reports are substantiated and it may be necessary for an appropriate person to give an explanation of matters in the report by way of affidavit (such as, for example, where there is a bare note indicating that a debt no longer exists);²¹
13. Where a balance sheet or financial report put before the Court shows that a Company has no assets, the Court needs to be satisfied that any liabilities incurred after the termination will not immediately result in the Company becoming insolvent;²²
14. For the purpose of proving solvency, parties should seriously consider engaging an expert to prepare a solvency report that:²³
    1. adequately sets out the matters and books and records he/she considered;
    2. gives evidence as to the timing of when the Company has been solvent;
    3. sets out whether the means available to the Company would ensure it remained solvent in the future;
    4. gives an opinion on the Company’s history in the payment of creditors (including whether the Company has generally paid its debts in a timely manner); and
    5. the extent to which the Company will be dependent on third parties to remain solvent, or in other words, to what extent the Company is financially independent in remaining solvent;
15. The mere fact that the liquidator had conducted some investigations and identified potential voidable transactions (which will necessarily end upon the winding up being terminated) does not necessarily mean that the Court will not grant the Termination Application. This is because those investigations may not achieve a practical result other than to substantially increase the costs of the windings up for no commercial benefit or return to the parties who have real interests in the activities of the companies. However, this will be a matter relevant to considering the “commercial morality” of the Company;²⁴
16. In addition, in considering the “commercial morality” of the Company, the Court will have regard to matters such as whether there is evidence that the Company was seriously delinquent in meeting its obligations (including tax obligations);²⁵ and
17. Where the continued winding up of the Company would result in the Company and/or its shareholders being derived of a substantial tax benefit, then that will be a matter that favours the termination of the winding up (provided that all other matters are satisfied).²⁶

The relevance of the matters set out above, and the extent that those matters will need to be proved mustbe considered on a case by case basis. However, it provides a useful guide as to how the Court is likely to approach a Termination Application.

This article was written by Jonathan Kramersh, Partner and Matthew Youssef, Solicitor.

¹ See for example In the matter of Xiang Rong (Australia) Construction Group Pty Limited [2015] NSWSC 971 (Rong).
² See In the matter of R & S Trading Company Pty Limited (in liquidation) [2015] NSWSC 1712  (R & S Trading).
³ See for example Isacson v Riad Tayeh & David Solomons as liquidators of Isacson Pty Ltd (In Liquidation) [2015] NSWSC 1394 (Isacson); cf In the matter of Avenue Investment Capital Pty Ltd (In Liquidation) [2015] NSWSC 1919 (Avenue Investments). A case note of the Avenue Investments case forms part of this edition of the insolvency quarterly.
⁴ See Isacson.
⁵ See R & S Trading.
⁶ See for example Doolan, in the matter of MIH Company Pty Ltd (in liq) v MIH Company Pty Ltd (in liq) [2015] FCA 1130.
⁷ Isacson.
⁸ Avenue Investments.
⁹ Avenue Investments.
¹⁰ Isacson.
¹¹ Avenue Investments.
¹² Isacson.
¹³ In the matter of Kadzielski Soto Holdings Pty Ltd (in liquidation) [2015] NSWSC 1734 (Kadzielski).
¹⁴ Kadzielski.
¹⁵ Avenue Investments. See also comments made by the Court in R & S Trading (but ultimately in that case it was not fatal to the Termination Application).
¹⁶ Kadzielski.
¹⁷ Kadzielski.
¹⁸ Avenue Investments.
¹⁹ Isacson.
²⁰ Avenue Investments.
²¹ Avenue Investments.
_²² Avenue Investments.
²³ See for example Isacson and R & S Trading.
²⁴ Avenue Investments.
²⁵ Avenue Investments.
²⁶ Judson, in the matter of Maneroo Pty Ltd (in liq) [2015] FCA 783.