TGIF 6 August 2021 – When are third party funding sources relevant in assessing solvency? Victorian Supreme Court of Appeal weighs in

The recent Victorian Supreme Court of Appeal case of Quin v Vlahos [2021] VCSA 205 has clarified when third party funds, such as a sole director’s personal bank account, can be taken into account in determining a company’s solvency.

Key Takeaways

• Funding that is available to a company from a third party can be taken into account in assessing solvency where the relevant company has a sufficient degree of assurance that the external funds will be made available to pay its debts.
  
  
• The assessment is objectively made from the company’s perspective based on the company’s ability to call on and rely on that third party funding, rather than the intentions of the external funder.
  
  
• The burden of proof falls on whichever party is arguing the funds were available and the company was in fact solvent. A liquidator is not required to prove that the funds were not available to the company in question.

The recent Victorian Supreme Court of Appeal case of Quin v Vlahos [2021] VCSA 205 has clarified when third party funds, such as a sole director’s personal bank account, can be taken into account in determining a company’s solvency.

Mr David Quin was the liquidator of Roderick Group Pty Ltd (in liquidation). The company operated a business that sold discounted textbooks to university students. It had two physical stores – one in Melbourne and one in Adelaide – and an online store. It entered into liquidation in August 2014.

Mr David Vlahos was its sole director. The director had a personal offset account in his own name from which he regularly paid some of the company’s debts throughout 2013 and 2014.

The liquidator alleged that the director had breached his duties under section 588G of the Corporations Act 2001 (the Act) to prevent the company from trading while insolvent and was therefore personally liable for the substantial debts incurred by the company while insolvent.

At first instance, the Associate Justice dismissed the proceeding, partly because his Honour found that the company was not insolvent as there were funds available in the director’s personal offset account which were available to pay the company’s debts. The liquidator appealed that decision.

The Court of Appeal (the Court) allowed the appeal, concluding that the company was, in fact, insolvent at the relevant time.

The Court ultimately relied on its analysis that on the date it considered relevant for assessing solvency, whether the third party funds were available to the company was a moot point because at the date, the total combined balance was still insufficient to meet the debts of the company.

However, the Court went a step further and still considered whether the director’s personal funds would have been available to the company in the event an alternative date was deemed relevant to the solvency assessment.

Contrary to the Associate Justice, the Court of Appeal considered that the director’s personal funds were not available to meet the company’s debts and ordered the director to pay $705,387.35 in compensation for losses resulting from the insolvent trading pursuant to section 588M of the Act.

The Court’s consideration of third party payments

The Court outlined the following relevant factors to the assessment of solvency where third party funding is available:

• the critical question is whether the relevant company has a degree of assurance that the funds of a third-party will be made available to it to pay the company’s debts;
  
  
• the Court must assess the availability of third party funds from an objective standpoint and from the perspective of the relevant company rather than from the perspective of the third party funder;
  
  
• strong evidence must be present to enable the Court to conclude that there is such a degree of assurance, however, it does not require absolute certainty;
  
  
• in the case of a director, the level of assurance and commitment is ‘such that it can be said that at any point of time it was likely’ the financial support provided by the director would continue;
  
  
• where support from a director is qualified, this will likely be insufficient to establish that the relevant level of assuredness was present. It is also essential to consider whether the company could compel the director to pay the money; and
  
  
• the burden of proof falls on the third party funder to establish that the funds were available for a company to discharge its debts. A liquidator is not required to establish that those funds were not available.

Why did the Court not permit the director’s personal account to be factored into the solvency assessment?

In the present case, the Court was not satisfied that the company had the necessary degree of assurance that the funds in the director’s personal account would be made available to it as and when needed.

It was found the director exercised an unfettered discretion as to when and if any funds in his personal account would be made available to the company. Despite the director swearing in an affidavit that the funds in the personal account were always available to the company, the Court found that he did not always exercise this discretion to the benefit of the company.

The Court pointed to the fact that the director had not accessed his personal account to satisfy the company’s statutory liabilities in respect of tax and superannuation when they were due and payable, and the director eventually conceded that he decided what debts would be paid from his personal account.

The Court also relied on the fact that there was no formal or informal agreement that entitled the company to access funds in the personal account. Even if there was, it was made clear that this alone is not enough to establish that a third party fund is available if the circumstances mean that the controlling mind(s) of a company were unlikely to compel payment from the third party fund.

The Court also made findings that the presumption of insolvency arose due to the company’s failure to maintain proper books and records.