In Australia, s 436A of the Corporations Act 2001 (Cth) (Act) provides for the circumstances in which a company may appoint a voluntary administrator. This provision requires the company’s board to resolve that: (a) in the opinion of the directors voting for the resolution, the company is insolvent, or is likely to become insolvent at some future time; and (b) an administrator of the company should be appointed.
This article considers the requisite opinion regarding the company’s solvency which must have been held by the appointing directors at the time of passing the resolution. This is an important issue. The appointment of an administrator can be challenged by various stakeholders – including creditors and shareholders. If the appointing directors did not hold the requisite opinion, the resolution could be invalidated with the consequence that the court terminates the administration. This in turn could lead to instability of the company (and a loss of value) and claims being made against the appointing directors for loss caused to the company (and potentially to third parties).
The directors’ opinion
Where an application is brought which seeks to impugn the opinion of the appointing directors, the court will consider whether there is any suggestion of a lack of bona fides on the part of the directors in making the appointment and whether there was an apparent basis for the opinion in the circumstances (see for example: Jack James as Administrator of ZYL Ltd, Re  WASC 57 at ; Hayes v Doran (No. 2)  WASC 486).
The test for ‘opinion’ in s 436A of the Act
The test for the requisite opinion in s 436A of the Act was summarised by Weinberg J in Downey v Crawford  FCA 1264 at  as follows:
However, the question whether the company was insolvent as at 4 August 1999 in one sense presents a red herring. The real issue is whether the defendants, or either of them, acted in breach of duty when they proceeded to put the company into administration. The answer to that question depends largely upon whether they genuinely believed, on reasonable grounds, that the company was insolvent or likely to become so in the future, and not upon whether that was the company’s actual position. The reasonableness of any such belief in turn depends, at least in part, upon the adequacy of the steps that they took to satisfy themselves that the preconditions for the appointment of an administrator had been met [emphasis added.]
Is the test subjective or objective?
Clearly, determining whether an opinion as to likely insolvency has been genuinely formed involves both subjective and objective elements. The subjective element requires that the Court be satisfied that the requisite opinion is actually held by the director. The objective element requires that the Court be satisfied that a competent director in the position of the director concerned could reasonably have formed the opinion on the facts known to that director.
Who bears the onus of proof?
As to onus, it is uncontroversial that a person challenging the reasonableness of a director’s belief bears the onus to show that the belief was not objectively reasonable in the circumstances (see: Re Condor Blanco Mines Ltd  NSWSC 1196 at ; Re ACN 607 358 887 (fka Carzapp Pty Ltd)  NSWSC 1561 at -).
What relevance does the actual financial state of the company have?
The actual financial state of the company at the time the directors passed the resolution appointing an administrator, is not determinative as to whether the resolution was validly passed (see for example: Re Windows  VSC 880 at ).
This said, evidence of the actual financial state of the company at the time of the appointment can inform the validity of the appointing directors’ opinion. For example, if the actual financial state of the company was such that the company was patently cashflow solvent at the time the resolution was passed, such evidence could be used to undermine the genuineness of the directors’ belief.
What should directors do to satisfy themselves of the financial state of the company?
There can be a tension between needing to act quickly if the company is insolvent or likely to become insolvent (for example to minimise the risk of personal liability for insolent trading), and undertaking detailed analysis to understand the actual financial state of the company.
While directors may form the necessary opinion as to the company’s solvency notwithstanding that they do not possess complete and up-to-date information (ASIC v Sino Australia Oil and Gas Limited (prov liq apptd)  FCA 42 at ), they will be required to take steps to satisfy themselves that an administrator can be appointed. As it was put in Downey v Crawford  FCA 1264 at :
[T]he question is not whether, as at that date, the company was actually insolvent, or likely to become so at some future time. It is rather whether the directors genuinely believed that this was so, and whether that belief was reasonable in the circumstances. That in turn will depend largely upon whether they took adequate steps to satisfy themselves that the statutory requirements were met before resolving to appoint… [an] administrator [emphasis added.]
Therefore, before appointing an administrator, directors should (non-exhaustively):
- carefully consider the company’s available financial information to assess solvency (consider the indicators of insolvency below);
- consult with any internal or external accountants who have insight into the company’s financials and who could potentially provide a more ‘expert’ opinion as to solvency;
- consider whether there are any alternatives to voluntary administration;
- discuss the company’s financial position with an insolvency practitioner; and
- document their decision-making process, and reasons for appointing an administrator – set out the basis for their opinion as to the company’s solvency. This said, directors should bear in mind that such documents could be discoverable in any future proceeding – for this reason, directors may wish to take legal advice (benefiting from privilege) before creating such documents.
When is a company insolvent?
In Australia, solvency is determined using the cashflow test – that is, can the company pay all of its debts as and when they become due and payable (s 95A of the Act).
When considering whether the company is ‘cashflow insolvent’, regard should be had to the non-exhaustive list of indicators of insolvency which were set out in ASIC v Plymin, Elliott & Harrison  VSC 123. Those indicators include:
- Continuing losses
- Liquidity ratio below 1
- Overdue Commonwealth and State taxes
- A poor relationship with the company’s present bank, including an inability to borrow further funds
- No have access to alternative finance
- Inability to raise further equity capital
- Suppliers requiring cash on delivery, 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.”
While in most cases the appointment of a voluntary administrator will be uncontroversial, directors should ensure that the decision to appoint an administrator has been carefully thought through and the requisite opinion as to the company’s solvency was properly formed.
Directors should bear in mind that third parties can seek orders of the court invalidating the resolution to appoint an administrator on the basis that the requisite opinion was not genuinely held on reasonable grounds. For this reason, directors may wish to take advice from an insolvency practitioner and or insolvency lawyer before appointing an administrator.
For more information about appointing an administrator, voluntary administration and insolvency generally, please contact:
Trevor Withane: firstname.lastname@example.org, tel +61 (0)418 717 001
Blackwattle Legal’s communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication.