Phoenix activity: Don’t forget about accessorial liability and potential access to PI policies; Do consider how to quantify the loss.

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By Kirsten Farmer, Partner and Barbara Dimovska, Lawyer

In a recent decision of the Supreme Court of New South Wales In the matter of IW4U Pty Limited (in liq),[1] the liquidators of IW4U sought to recover compensation from the company’s accountant for alleged accessorial liability with respect to breaches of directors’ duties by the sole director of IW4U.[2]

This case is interesting for a number of reasons, including the relatively small number of cases involving the pursuit of professional advisers involved in illegal phoenix activity since the decision in 2009 in ASIC v Somerville,[3] but also the reasons why the liquidators failed to recover compensation.

Background

IW4U was incorporated in 2011 and operated a labour hire business, supplying staff to work in its clients’ warehouses and sourced its casual labour force from two related subcontracting entities. IW4U’s primary clients were Fantastic Furniture Pty Ltd and Plush-Think Sofas Pty Ltd, with which it had arrangements on an informal, handshake basis.

In about 2015, the Company was under financial stress and owed approximately $220,000 to the ATO. In evidence given at a public examination, the director had stated that the accountant informed him in mid-2015 that IW4U was trading whilst insolvent and should cease trading.

This evidence was consistent with the incorporation of a new company, Employment Services Pty Limited, on 12 May 2015, with the accountant appointed as its sole director, secretary and sole shareholder.

In about August 2015, IW4U’s business and assets were “transferred” to Employment Services for nil consideration. That transfer was not recorded in a written sale agreement between IW4U and Employment Services.

On 9 June 2017, IW4U was wound up by order of the Federal Court of Australia.

The director of IW4U died in September 2019 and the liquidators brought proceedings against the accountant pursuant to s 79 of the Corporations Act for accessorial liability based on the allegation that the director had breached his statutory duties under s 181(1) of that Act in transferring the business and assets of IW4U for nil consideration. The liquidators also pleaded a claim based on the “knowing assistance” second limb in Barnes v Addy,[4] but this was not pressed at the hearing.

The quantum of the claim was $482,000, which was based on expert evidence  from a chartered accountant and company director as to the value of the business of IW4U.

Decision

The Court had no difficulty in finding the director had breached s181(1)[5] of the Corporations Act, by allowing Employment Services to “take over” the Company’s business for no consideration.

The Court also found that the accountant had actual knowledge of the elements constituting the director’s contravention. In coming to this finding, the Court was persuaded by the following acts:

  • the accountant registered the new company and the new ABN on instructions from the director;
  • the accountant was the initial sole director, secretary and shareholder of the new company from May 2015 to July 2016;
  • the accountant acted as a “watch dog” of the new company controlling the overheads and invoices were sent to his office; and
  • the accountant controlled the bank account of the new company for a period of time from August 2015 until March 2016.

The Court concluded that these acts meant the accountant had “aided and abetted” and been directly or indirectly “knowingly concerned in or party to” the contravention by the director of s 181(1), because those acts facilitated and permitted Employment Services to take over the business of IW4U.

Having established liability, the case advanced by the liquidators was that the damage suffered by IW4U was the value of the business “transferred” to Employment Services. The expert valued the business of IW4U on a realisation of future maintainable earnings at $482,000.

The Court raised whether the expert had addressed the appropriate counterfactual given IW4U’s insolvency or near insolvency when it transferred its business to Employment Services and the likelihood of some form of external administration if the transfer had not occurred. The Court considered the following circumstances were relevant to the counterfactual:

  • IW4U was insolvent or near insolvent in mid-2015;
  • IW4U’s contracts with its clients were informal, being based on a handshake; and
  • the director had not been subject to any restraint of trade obligations in favour of IW4U preventing him from competing against IW4U if it entered external administration.

The Court inferred that the most likely counterfactual was that IW4U would have entered some form of external administration and that “it is entirely unrealistic to suggest as the liquidators do…that a “knowledgeable, willing but not anxious buyer” of the business would have paid a substantial amount, if any, to acquire the benefit of IW4U’s informal contracts…”

Accordingly, the Court gave no weight to the expert’s opinion of the damage suffered by the Company.

The liquidators also claimed against Employment Services alleging that the transfer of the business was an unreasonable director related transaction.[6] Again, the liquidators were successful as to liability but failed to persuade the Court that Employment Services received benefits of $482,000.

In the concluding paragraphs of the judgment, the Court posited that the benefits received by Employment Services might have been better quantified by reference to the amount of profit, if any, earned by Employment Services since the transfer in August 2015. However, this alternative was not submitted by the liquidators and therefore not necessary for the Court to address the issue.

Takeaways

  • accessorial liability under s 79 of the Corporations Act for a director’s breach of duties can ground an order for compensation under 1317H, provided that the loss and damage is properly quantified by evidence.
  • an expert report as to the value of a company’s business, even when the expert is not challenged as to his or her methodology, ought to consider the appropriate counterfactuals to justify the conclusion reached.
  • in appropriate cases, liquidators and their expert witnesses should consider an alternative business valuation by reference to the amount of profit, if any, received by the transferee of a company’s business.

[1] [2021] NSWSC 40.

[2] This case pre-dates the introduction of s588GAC of the Corporations Act which was introduced by the Treasury Laws Amendment (Combatting Illegal Phoenixing) Act 2020 (Cth).

[3] (2009) 77 NSWLR 110.

[4] (1874) LR 9 Ch App 244.

[5] A director or other officer of a corporation must exercise their powers and discharge their duties in good faith and for a proper purpose.

[6] S588FDA Corporations Act

Click here for the link to decision. 

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