Executive Summary
- During an insolvent trade claim by a liquidator, AS Advisory operated on behalf of the defendants.
- The defence concentrated on establishing the liquidator relied on incorrect and inaccurate financial information.
- To establish that the liquidator did rely on information from the wrong accounting file, AS Advisory integrated the company’s accounting system to confirm the liquidator’s error.
Background
A father and son operated a long-standing industrial supply business. The business ran through a trust structure and its beneficiaries were corporate entities.
Over time the trust had made several unpaid distributions to the corporate beneficiaries. Since there was a change in 2010 by the ATO regarding how it treated Unpaid Present Entitlements (UPE) between a trust and a corporate entity, these were now considered Division 7A Loans under the Income Tax Act.
Their financial accounts contained several UPE loans that the directors were servicing, regardless of the change in the legislative procedure, it still harmed the ability to meet these obligations.
The directors sought advice from their accountants and decided that the new legislative approach did not apply to loans between companies and that they would sell the business from the trust to a new corporate structure.
Business Re-Structure
The directors had a dormant company they planned to use as the new operating entity. An appraisal was conducted on the existing business, and a sale agreement was prepared that transferred the assets and trading liabilities from the existing trust structure to the dormant company.
The dormant company had a different name to the business trading name, but it continued to operate under the trading name. From an outsider’s perspective, it would appear to have no changes to the business operations, notwithstanding the business now operates through a different structure with different ABNs.
Following the sale, the directors engaged external consultants to create a new MYOB file for the new business. To maintain specific data the MYOB file operated by the business under the previous trust structure was copied to the new MYOB file. Subsequently, the MYOB file for both the old and new entity were the same.
For some unknown reason, the new company decided to continue operating through the old company’s MYOB file resulting in the old file being re-named the new file (i.e. the Company) and the new file being renamed the old entity (i.e. the trust).
To enable documentation to display the new entity name and ABN the external consultants added a checkbox to amend the name to the new entity. This created some problems as it enabled the new entity to issue invoices and or purchase orders that contained the old trust details (i.e. staff failed to tick the box at creation) but had the right trading name and processed within the correct MYOB file.
As a result of the above and in particular, when looking at transactions and reports relating to periods before the sale it was difficult to determine which database you were extracting records from and further, it was difficult to identify which documents related to which entity as this may not be clear on the documentation.
Insolvency
Around the same time as the re-structure, the business became entangled in litigation concerning a franchise arrangement it had established. The litigation was ultimately successful and a damages claim was awarded against the trust entity.
This claim accompanying the trading issues ultimately led to the liquidation of the initial trust entity and the new company entity.
Following the liquidator’s investigations which included conducting public examinations into the company’s affairs, the liquidators issued proceedings in the Federal Court against the directors for Insolvent Trading and Breaches of Directors Duties.
AS Advisory's Role
The director’s lawyers retained AS Advisory to assist with the defence of the claim. In particular, AS Advisory were instructed to provide an expert report which responded to the Insolvency Report prepared by the Plaintiffs and comment on whether certain transactions that formed the basis of the liquidator’s claims related to the old entity or the new entity.
With the assistance of a computer specialist, AS Advisory was able to interrogate the databases that had been backed up and reviewed by the liquidators to show that the liquidators were extracting data from the wrong entity MYOB file.
Furthermore, AS Advisory investigated the transactions on which the liquidators relied as the insolvent transaction allowing our team to prove that these transactions occurred after the date of sale and related to the operations of the new Company and not the old.
The actions of AS Advisory showed that notwithstanding what may first appear to be the case as reported within the financial accounts and on documentation may not be the case. An appreciation of how the transactions occurred, and how they were ultimately reported along with knowledge of the history of the data structure was ultimately required to determine the position.