ensuring adequacy of company financial records

The fifth edition of The aVoidable Issue considered a recent case in which a liquidator attempted to rely upon a company’s failure to keep adequate financial records to presume that the company was insolvent (the liquidator was pursuing a creditor for an unfair preference payment). The Court disallowed this, because of the operation of s588E(7) of the Corporations Act 2001 (Cth) (the Act), which provides that such a presumption cannot arise where the claim is an unfair preference payment against an unrelated third party.

This article is a follow-on from that article, and is an attempt to explore what is required to demonstrate non-compliance with s 286 of the Act (s286).

 

Keeping adequate records

Directors have positive obligations to keep adequate financial records for 7 years that:[1]

  • “correctly record and explain its transactions and financial position and performance; and
  • would enable true and fair financial statements to be prepared and audited.”

A failure to comply with s286 is a ‘strict liability’ offense and may cause the Australian Securities and Investments Commission (ASIC) to investigate and prosecute the company and its directors.

The meaning of s286 can be quite difficult to discern from the Act, as, practically speaking, it is rare that Insolvency Practitioners receive all of the information, books and records that they may want so as to piece together the company’s financial position/performance.

Fortunately for Practitioners, Black J recently considered this issue at the end of last year, in Re Swan Services Pty Limited (in liquidation) [2] (the Swan Services case).

 

The Swan Services case

  • On 22 May 2013 Mr Anthony Elkerton was appointed Administrator of Swan Services Pty Limited (in Liquidation) (the Company) and then on 30 September 2013 as Liquidator.
  • In commencing proceedings against Mr and Mrs Swan for insolvent trading, the Liquidator sought to prove insolvency for the period 1 November 2012 to 22 May 2013 (the relevant period) by relying upon s286 and the presumption of insolvency found in s 588E(4) of the Act,[3] based on the following:
  • signed copies of financial statements appeared to be limited to 30 June 2003;
  • financial statements had not been finalised beyond 30 June 2008;
  • the last management accounts available had been prepared as at October 2012; and
  • there were material discrepancies between the Company’s 2011 tax return and 2011 unsigned financial statements.
  • An expert witness for the Liquidator, Mr Lombe, expressed the view that the financial records of the Company were poorly maintained.

Black J, in considering all the evidence, concluded that the presumption in s 588E(4) of the Act did apply to the Company throughout the relevant period as the Company breached s286. His Honour established that:

  • it must be separately and distinctly proved that during the period no documents described as ‘financial records’ were kept, [4] but if such ‘financial records’ were kept then they must be deficient in content; and
  • s286 does not necessarily arise merely because of a failure to prepare certain financial documents (eg income tax returns, financial statements or business activity statements),[5] but rather that failure must result in an inability to determine the financial position of the Company at any given time; and
  • the Liquidator must use all evidence available to attempt to determine the financial position of the Company during the relevant period. For more information on what other information the Liquidator could obtain, we recommend reviewing the table found in the fifth edition of The aVoidable Issue.

Therefore, the test of compliance with s286 may properly be described as: upon a review of all of the evidence, whether as a matter of fact the company had any records (at all) that meet the definition of ‘financial records’ in s 9 of the Act, such that:

  • if they did not, then the company would be in breach of s286; or
  • if they did, whether it is possible to produce accurate financial records (that explain the transactions, financial position and performance of the company) and ultimately enable true and fair financial statements to be prepared and audited.[6]

 

Takeaway

It can be difficult to work out whether a company has failed to keep adequate financial records, such that s286 is enlivened, thereby, allowing the Liquidator to possibly rely upon the presumption of insolvency: per s 588E(4) of the Act. In our view, the Swan Services case makes it just that little bit easier for stakeholders to know when s286 could/will apply.

In light of this case, directors are encouraged to work with their advisors to double-check the accuracy and substance of their financial records. Please call our Expert Advisers at SV Voidables should you require any assistance with this.

 

[1] Section 286 of the Act.

[2] [2016] NSWSC 1724.

[3] More information on this presumption can be found in our previous article, which can be found here.

[4] The term financial records is defined in s 9 of the Act to include: invoices, receipts, cheques, document of prime entry, working papers that explain the method by which financial statements are made up or adjusted.

[5] See also Fisher v Divine Homes Pty Ltd [2011] NSWSC 8, 23-24.

[6] See also Woodgate v Fawcett [2008] NSWSC 868; Re SSET Constructions Pty Ltd (In Liq) – Sims v Khattar [2010] NSWSC 102; Fisher v Divine Homes Pty Ltd [2011] NSWSC 8, 24.

Article written by Anna Claessens and Matthew Hudson of SV Voidables 

 

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