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Non party costs order against company director upheld on appeal

A recent Court of Appeal decision has upheld the decision of a District Court judge to impose a costs order against the director of a company that had been placed into liquidation five days after the close of evidence of a trial.

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The facts

At all material times Geoffrey Murphy was the sole director and ‘controlling mind’ of the defendant Collhart Investments Pty Ltd, formerly known as JM Kelly (Project Builders) Pty Ltd in civil proceedings in the District Court. The Plaintiff in that civil action was Mackay Labour Hire Pty Ltd, and it was suing for $288,242.54 for labour hire provided under various contracts. The defendant had also countersued for moneys it said had been paid to the plaintiff under a mistake of law.

The trial commenced on 13 June 2016 and when the evidence closed on 15 June 2016 the primary judge adjourned for submissions. On 20 June 2016, only 5 days later, Murphy placed the defendant into voluntary administration. After learning of this in a Rockhampton newspaper, the plaintiff brought an application for costs against Murphy personally.

Eventually, after the plaintiff was invited to provide evidence of the defendant’s insolvency and Murphy filed an affidavit, the primary judge on 2 May 2017 ordered costs incurred from 17 March 2016 (the date the defendant ceased trading) against Murphy on the standard basis. Behind that decision were various findings by the primary judge, including that “the defendant was insolvent for a significant time before the trial”, and that Murphy had failed to notify the plaintiff of this. Murphy appealed the costs decision.

Relevant law

By way of background, a company is a legal entity which is separate from its owners and directors, who are normally personally protected from the company’s liabilities:  see Salomon v A Salomon & Co Ltd [1896] UKHL 1, [1897] AC 22.

Courts are traditionally vested with an unfettered discretion as to the award of costs including costs against a non-party: see for instance Bischof v Adams [1992] VicRp 61; [1992] 2 VR 198 at 203. However, the decision to make an order for costs against a nonparty is rare. In Knight v FP Special Assets Ltd (1992) 174 CLR 178, a High Court case, Mason CJ and Deane J wrote that:

“For our part, we consider it appropriate to recognize a general category of case in which an order for costs should be made against a non-party… That category of case consists of circumstances where the party to the litigation is an insolvent person or man of straw, where the non-party has played an active part in the conduct of the litigation and where the non-party, or some person on whose behalf he or she is acting or by whom he or she has been appointed, has an interest in the subject of the litigation. Where the circumstances of a case fall within that category, an order for costs should be made against the non-party if the interests of justice require that it be made.”

The presumption of continuance is an evidentiary legal principle that holds that a state of affairs has not substantially changed from one time to another unless there is evidence to the contrary. It has been described as “no more than a convenient way of describing a process of logical reasoning involving the drawing of inferences from established facts” in R v Noonan [2002] NSWCCA 46 (28 February 2002).

Court of Appeal decision

There were numerous arguments and grounds of appeal. Philippides JA wrote the leading judgment and Fraser JA and Boddice J concurred.

Murphy argued that the statutory demand issued on the defendant in May 2016 without evidence of whether it had been paid could not be used to make a finding that the defendant was insolvent. However, Philippides JA said that this was not how the primary judge used the statutory demand in her reasons.

A challenge was made on the primary judge’s reliance on a form 509 listing the defendant’s assets and liabilities and their worth. The Court of Appeal rejected an argument that this form did not show that the defendant’s liabilities well exceeded its assets.

Murphy argued against the primary judge’s finding that various deeds had the effect of “transferring the productive resources and contracts of the defendant to a related company”. The Court of Appeal held that Murphy had failed to raise any evidence before the primary judge rebutting such a conclusion.

Murphy argued that the primary judge had erred by employing a “balance sheet” insolvency approach before concluding that the defendant was “hopelessly insolvent”, and failed to also consider the “cash flow test”, which considers the viability of a company’s business, such as meeting its present demands and debts as a going concern.  The Court of Appeal held that this argument may have had some force if evidence in support of it had been filed in the District Court. The Court of Appeal further observed that the form 509 “indicated a deeply unsustainable situation” and contradicted Murphy’s submission that there was nothing to suggest the defendant’s business was suffering.

Murphy also attacked the primary judge’s use of the presumption of continuance to conclude that the defendant had been insolvent for months prior to its being placed into liquidation, contending that the defendant’s position had changed in the days leading up to its liquidation. The Court of Appeal rejected this submission, concluding that the primary judge “had sufficient evidence to support a finding of insolvency as at 20 June 2016 and for a period of up to three months before the defendant ceased trading on 17 March 2016”.

Murphy argued that the primary judge had misapplied the test in Knight (supra) as she failed to address Murphy’s interest and involvement in the litigation. However, the Court of Appeal noted there was significant evidence of Murphy’s involvement in the matter as the defendant’s sole director, and held that it was open for the primary judge to find that Murphy had allowed the litigation and trial to go on.

As a result, it was held that it was open for the primary judge to make the findings and decision she did and so the appeal was unanimously dismissed with costs.

Conclusion

There are a number of lessons to be drawn from this case.

Firstly, directors of insolvent or heavily indebted corporations should not pursue litigation through their companies and then expect that the subsequent liquidation of the company will absolve them of further concerns. This case shows that there is recourse against the directors of companies for parties that incur legal costs as a result of the pursuit of such litigation.

Second, if a company is suing or being (or about to be) sued and may be insolvent, it would be prudent to disclose its financial position at the outset so that the other party is aware of the position and does not incur additional costs it would otherwise choose not to. In this case, it is quite possible the defendant would never have been sued if the plaintiff had known of its financial position.

Third, as any insolvency lawyer would know, the decision to wind up a company is one that should not be taken lightly, as there can be a number of unintended consequences that arise from such a decision.  Legal advice should be sought before placing a company in liquidation.

Finally, it is always important to put all the evidence in support in the first instance, as an appeals court is unlikely to admit further evidence that could have been adduced at first instance.  Some of Murphy’s arguments centred on evidence that could have assisted if produced in the District Court.

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