A warning to Liquidators: comply with your disclosure obligations or face dismissal of your unfair preference proceedings

29 April 2020
Robert Hinton, Partner, Melbourne James Roland, Partner, Sydney

In Clifton (Liquidator) v Kerry J Investment Pty Ltd trading as Clenergy [2020] FCAFC 5, the Full Court of the Federal Court of Australia found that:

    1. where the Liquidators failed to comply with their discovery obligations and the Court could not be satisfied regarding the existence of documents which might be deployed by innocent parties to meet the defaulting party’s claims, the Liquidators’ appeal should not be considered as to do so would be to consider it on a hypothetical and potentially false basis; and
    2. separately, despite Solar Shop and the Commissioner of Taxation (the Commissioner) entering into a payment arrangement pursuant to section 255-15 of the Taxation Administration Act 1953 (Cth) (the TAA), Solar Shop’s GST, PAYG and FBT liabilities remain due and payable.

In the first instance proceedings, the Liquidators sought recovery of unfair preferences paid to each of the Respondents. Ultimately, the primary judge found that the Liquidators had failed to establish that Solar Shop was insolvent on any of the alternate dates proposed by the Liquidators. The Liquidators sought to challenge the primary decision.

The business day before the appeal hearing, it came to light that the Liquidators had failed to comply with their discovery obligations. The Liquidators eventually conceded that their discovery was inadequate, but contended that the failure was minor, inadvertent and did not affect the result of the relief sought by the Respondents.

The Liquidators confirmed that there were three different sources of documents which they held, namely:

    1. 194 archive boxes containing hard copy documents, which had been reviewed three times by the Liquidators prior to the hearing of the proceedings at first instances;
    2. electronic images of Solar Shop’s file server and computers (including some emails) (the Electronic Documents), which had been reviewed by key word searches that were supposed to flag relevant documents (which had been conducted prior to the close of pleadings) and the complete email records of Solar Shop which were stored in the cloud (the Cloud Documents), which the Liquidators had never reviewed due to access and cost issues; and
    3. productions made by third parties in answer to a number of orders for production, which had been reviewed once after the close of pleadings.

The Liquidators put on further evidence that they had failed to disclose 9 documents relevant to the issue of solvency and a further 1,050 documents which were not directly relevant to the issue of solvency, but ought to have been discovered in one of the proceedings.

The fatal consequences of inadequate discovery

The Full Court determined that the Liquidators’ failure to comply with their discovery obligations was not minimal and that the Liquidators’ evidence did not provide a sufficient basis for the Court to conclude that they undertook a reasonable search of the documents in their control as:

    1. in respect of the Cloud Documents:
      1. they had never been interrogated;
      2. the Liquidators had put on no evidence to establish the number of documents in the cloud, the ease and cost of retrieving said documents, the significance of any documents that might be located or whether they might be able to be located from other sources; and
      3. the Liquidators failed to bring the existence of the cloud as a repository of material to the attention of the Court or the Respondents; and
    2. in respect of the Electronic Documents:
      1. the images were searched using key word searches, but a number of relevant search terms were excluded; and
      2. the images were searched prior to the close of pleadings, and as such the issues were not yet defined and any such search could not be adequate.

Given that the Liquidators had failed to establish the absence of a realistic possibility of the existence of documents which might be deployed by the innocent parties to meet the defaulting party’s claims, the Court held that the Liquidators’ appeal should be dismissed, as any consideration of the appeal would be built on a “hypothetical and potentially false basis”.

Solar Shop’s debt to the Commissioner is due and payable despite payment plan

As a separate issue, the Full Court upheld the primary judge’s decision that the Liquidators established that the payment arrangements between the Commissioner and Solar Shop did not vary the time at which the company’s liabilities to the Commissioner were due and payable as:

    1. the payment arrangements were made under s 255-15 of the TAA, which reflects “a deliberate legislative policy that regardless of entry into an arrangement, the debt remains due and payable”;
    2. sections 255-10 and 255-20 of the TAA expressly grant the Commissioner the discretion to defer the date when payment becomes due accordingly, there can be no suggestion that an instalment arrangement under s 255-15 should be taken to be a deferral in the absence of an express grant of deferral within the TAA and written evidence from the Commissioner that the payment arrangement should be taken as a deferral; and
    3. in any event, the payment arrangements did not constitute a waiver by the Commissioner of Solar Shop’s obligation to pay a tax debt.
Key Takeaway

The discovery obligations of a party to a proceeding are strict and comprehensive. A serious failure to comply with those obligations can result in the failure of an unfair preference claim, despite the merits of the claim.

A liquidator should promptly inform the Court and the other parties about any difficulties in accessing or reviewing documents, so that the Court can make appropriate directions regarding the scope of discovery (or confining it where the liquidator can show that the documents will not provide probative evidence).

Separately, without positive evidence to the contrary, payment arrangements with the Commissioner under s 255-15 of the TAA will not alter the fact that the debt owing to the Commissioner is due and payable. This may make it challenging for the Commissioner to establish the ‘good faith’ defence pursuant to section 588FG(2) of the Corporations Act 2001 (Cth).


Authored by:

Kimberley Arden, Partner
Rachel Zagorskis, Associate

This update does not constitute legal advice and should not be relied upon as such. It is intended only to provide a summary and general overview on matters of interest and it is not intended to be comprehensive. You should seek legal or other professional advice before acting or relying on any of the content.

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