The taxman concedes

By Karen O'Flynn.

Key Points:
Directors of failed companies will be given the opportunity to contest settlements between a liquidator and the taxman.

My, my, I tried to hold you back but you were stronger
Oh yeah, and now it seems my only chance is giving up the fight
And how could I ever refuse
I feel like I win when I lose.

The Tax Commissioner must hum ABBA's "Waterloo" under his breath every time he's faced with a company liquidator's application to claw back tax payments.

The reason, of course, is that whatever the Commissioner refunds to the liquidator can be claimed back from the company's directors, under the statutory indemnity in section 588FGA of the Corporations Act.

That doesn't mean that the Commissioner throws in the towel every time a liquidator launches an action. However, the prospect of that indemnity must make him a little bit more inclined to consider the benefits of reaching a negotiated settlement with the liquidator.

As some recent cases show, this prospect raises some practical issues for a court which is asked to approve such a settlement.

Satisfaction

Interestingly, although the legislation has been in place for a decade, it is only recently that this has emerged as a live issue.

For example, the idea that a court could make consent orders under section 588FF appeared to draw no comment in Cadima Express v DC of T (1999) 33 ACSR 527 and SJP Formwork (Aust) Pty Ltd (in liq) v DC of T (2000) 34 ACSR 604. It was not until Justice Finkelstein's judgment in last year's Crosbie v FC of T (2003) 21 ACLC 1,659 that questions were first raised.

Justice Finkelstein pointed out that section 588FF only allows the court to make a clawback order if it is "satisfied" that the relevant transaction is voidable under section 588FE. In his view, a court couldn't be satisfied that a transaction was a voidable transaction "unless it has before it the facts which will establish that conclusion". An agreement between the Commissioner and a liquidator didn't constitute such a set of facts. If he wanted to prove his case, the liquidator had to prove all the relevant facts.

The practical implications of this issue are important for directors. The court can order the Commissioner to repay a tax payment if (among other things) it is "satisfied" that the company was insolvent when it made the payment. Having made the repayment, the Commissioner can then claim an indemnity from the company's directors. Directors have only a limited range of defences against such a claim. Importantly, they may not be able to dispute that the company was insolvent when it made the payment (because that has already been decided by the court case between the liquidator and the Commissioner).

Hence the importance of whether the Commissioner should be allowed to consent to a liquidator's clawback action: a consent judgment might effectively deem the company to have been insolvent, without the matter ever being tested in court.

The expense

Two more recent cases have disputed Justice Finkelstein's interpretation of the law: Dean-Willcocks v Commissioner of Taxation (No 2) [2004] NSWSC 286 (Justice Austin) and Wanted World Wide (Australia) Limited v Commissioner of Taxation [2004] FCA 1063 (Justice Lander).

In these cases, the courts were faced with situations in which the Commissioner was content to concede that the company was insolvent when the tax payments were made. However, Justice Finkelstein's judgment in Crosbie stood in the way of such a concession.

Justices Austin and Lander declined to follow Justice Finkelstein. They essentially broke the issue down into three parts:

• does the court always have to grant a consent judgment?
• what practical benefit is there in the law's requiring a liquidator to go to the expense of proving insolvency?
• what protections could the court use to safeguard directors against unfairness?

On the first point, it was emphasised thatjudges do not leave their critical faculties at the entrance to the courtroom. While a consent judgment may be efficient, judges don't grant them automatically:

"In my opinion there is no general principle preventing a court from being 'satisfied' of the matters that it is required by statute to address before making orders, where there is an admission between parties; nor is there any principle requiring a court in those circumstances to undertake its own factual inquiry when the parties invite it to do no more than act upon their consent. That is not to say that the court should simply act on consent orders without any independent thought. There being no jurisdictional bar to acting on admissions under s 588FF, it is up to the court to consider, in the circumstances of the instant case, whether admissions are sufficient to warrant its being 'satisfied'." (Justice Austin)

At a more practical level, there was the expense involved in proving insolvency. If a defendant to a clawback action couldn't concede that a company was insolvent, the liquidator would have the expense of preparing an insolvency report. Someone would have to bear that cost:

• the unsecured creditors; and/or
• the defendant, who could be hit with a costs order despite not disputing the solvency point.

These practical points support the argument that a clawback defendant should be allowed to concede the issue of insolvency. The flow-on effect on directors only becomes an issue when the defendant happens to be the Tax Commissioner. Ruling out consent judgments completely, just because of that special situation, would be a case of the tail wagging the dog.

Protections

That left the problem of the effect of "conceded insolvency" on the Commissioner's indemnity against the directors.

Justice Austin thought that the answer might lie in ensuring that the directors got notice of the Commissioner's proposed concession. In fact, he thought that it might be necessary to give directors notice of any clawback action against the Commissioner, regardless of whether or not the Commissioner intended to defend it:

"Crosbie is authority for the proposition that if the directors apply for leave to be joined to the recovery proceeding, s 588FGA gives them an interest sufficient to warrant the making of an order in their favour. It leaves open the question whether, if the directors do not seek any such relief, the court should ensure that they have been duly notified before making any orders under s 588FF. This question arises whenever the preference recovery action is against the Commissioner in respect of any of the tax liabilities mentioned in s 588FGA(1), regardless of whether the orders are to be made by consent, or upon an admission of insolvency, or after a full contest."

Some of Justice Lander's comments were along the same lines as Justin Austin's, but he also looked at the possibility of the court's critically evaluating the Commissioner's admissions:

"[49] … Because of the effect of s 588FGA, it would be relevant, if it were the Commissioner who was offering the concession or admission, to have regard to the interests of the persons who might be affected by that concession or admission. Ordinarily, they would be the persons who would be affected by the statutory indemnity which would be created by the orders made under s 588FF.

[50] Also, the court would have regard to the provisions of s 588E(8) of the Act which raises a statutory presumption in relation to subsequent proceedings. The court might insist that the liquidator give notice to persons who might be affected under s 588FGA, s 588FGB or s 588E, before the court was so prepared to act.

[51] The court would also have regard to the information which had been considered by the party offering the concession or admission and the extent of that party’s inquiries to satisfy itself that the concession or admission should be made and acted upon by the court.

[52] It might not be appropriate, having regard to the interests of other parties affected by the admission, to simply act upon that admission. It might, in some cases, be appropriate to require the liquidator to prove strictly the matters necessary to establish the prerequisites to the exercise of the power under s 588FF."

Conclusion

Although Justices Austin and Lander disagreed with his reading of the statute, their conclusions show that the issue raised by Justice Finkelstein is one that the courts, the Commissioner and liquidators need to be cognisant of.

The Commissioner will now presumably feel free to make concessions when he considers it appropriate. However, those concessions will be subject to procedural fairness protections.

In some cases, the directors will simply not bother taking up the cudgels. Even then, the potential for unfairness may cause the court to apply some critical analysis to the case before it. In that situation, the Commissioner would have to show that his concession was the result of a serious examination of the available evidence, rather than just a matter of convenience.

For further information, please contact Karen O'Flynn.