What is insolvency?
The case of ASIC v Plymin is significant for lawyers because it sets out a list of indicators that can help us understand when a company will be found to be insolvent. The general rule in law is that company insolvency is proven by a cash-flow test not a balance sheet test (can you pay all your debts as they fall due and payable?). Beyond this, a significant amount of case law has developed over time and a throw-away line by lawyers is that insolvency is decided “case-by-case”. This obviously isn’t helpful for company directors if they face illiquidity and want to make sure they aren’t liable for insolvent trading.
The case is also noteworthy because it involved the former corporate high-flyer John Elliott being found to have breached his director’s duties and he was ordered to pay compensation of $1.4 million and he was banned from managing corporations for four years.
The case is also known as the Water Wheel case.
What is ASIC v Plymin about?
The summary of the players and the business is:
- Name of business: The Waterwheel Group
- Dates: Entered rice industry in 1997 and was placed in voluntary administration in February 2000
- Companies: Water Wheel Mills Pty Ltd and Water Wheel Holdings Limited
- Business: Milling rice
- Business issue causing insolvency: Milling rice at 40% capacity due to NSW Rice Growers monopoly
- Defendants: Elliott (non-executive director), Plymin (Managing Director) & Harrison (Chairman)
- Plaintiff: Australian Securities and Investments Commission (ASIC)
- Date of insolvency: Found by Court to be 14 September 1999
The Court found that the companies traded insolvent from at least 14 September 1999 up until a voluntary administrator was appointed in February 2000. The directors were liable to compensate creditors for debts incurred (in breach of their duties as directors) during that period.
What are the indicators of insolvency?
The ASIC v Plymin case is relied upon to guide potential defendants (i.e. company directors) and their professional advisers about indicators of corporate insolvency. No single indicator is determinative of a finding of insolvency but in the Water Wheel case, the Court found that all the indicators of insolvency were proven by the Plaintiff (ASIC) to have occurred.
The indicators of insolvency are:
- Continuing losses
- Liquidity ratios below 1
- Overdue Commonwealth and State taxes
- Poor relationship with present Bank, including inability to borrow further funds
- No access to alternative finance
- Inability to raise further equity capital
- Suppliers placing [company] on COD, or otherwise demanding special payments before resuming supply
- Creditors unpaid outside trading terms
- Issuing of post-dated cheques
- Dishonoured cheques
- Special arrangements with selected creditors
- Solicitors’ letters, summons[es], judgments or warrants issued against the company
- Payments to creditors of rounded sums which are not reconcilable to specific invoices
- Inability to produce timely and accurate financial information to display the company’s trading performance and financial position, and make reliable forecasts.
The fourteen indicators of insolvency have withstood the test of time and it is the standard list of indicators that liquidators use to justify assertions of insolvency.
The bad news is that Courts still make findings of insolvency “on the facts” of each case and so these indicators are just that: indicators. This also means that the liquidators don’t have a ready-made template to prove insolvency and they need to explain the circumstances of the company to support an allegation of insolvent trading.
Breach of directors duties
Mr Elliot was a non-executive director and the case found that he still had director’s duties to keep himself appraised of the financial position of the companies.
Regarding the duties of non-executive directors, Justice Mandie said:
“A non-executive director is expected to take steps to put himself in a position to monitor the company and to exercise and form an independent judgment and to take a diligent and intelligent interest in the information either available to him or which he might with fairness demand from the executives or other employees and agents of the company.
This basically means that turning a blind eye is not a defence even if you are non-executive director and the company isn’t very forthright with giving you up-to-date financial information.”
Don’t forget there is now a safe harbour from insolvent trading
The new safe harbour from insolvent trading became law in September 2017 and it can be used to protect directors from insolvent trading allegations. The test is that the company starts to develop a plan that is likely to deliver a greater return than voluntary administration or liquidation. This means that a company (if it is in the safe harbour) can legally continue to trade whilst insolvent.
Contact Sewell & Kettle if you are concerned about insolvent trading.
The difference with Sewell & Kettle Insolvency Consultants is that the firm is adaptive and knowledgeable.
- There are few pre-insolvency advisers with our depth of experience in insolvency law and restructuring methodology
- We specialise in helping SMEs and entrepreneurs (whereas our competitors would prefer to work for banks and financiers)
- We are one of very few law and consulting firms that specialises in offering pre-pack insolvency arrangements
- We can help directors to take advantage of the new safe harbour defence to insolvent trading as both lawyers and consultants
- We charge fixed fees and also offer contingent pricing
First instance decision by Justice Mandie: ASIC v Plymin, Elliott & Harrison  VSC 123 (5 May 2003)
Victorian Court of Appeal decision after an appeal was made by Mr Elliot: Elliott v ASIC  VSCA 54
ASIC v Plymin – SUPREME COURT OF VICTORIA  VSC 123 (5 May 2003)