Proving Insolvency

A liquidator or bankruptcy trustee will commonly be faced with the need to establish that, at a particular point in time, a debtor company or individual was "insolvent" or "unable to pay their debts as and when they fall due".

The typical response to that obligation is a decision to prepare a Solvency Report and seek to tender that Report as evidence at trial. In a number of recent cases, however, the Courts have rejected either part or all of these reports – leaving the insolvency practitioner’s case decidedly shaky.

The question of whether or not a debtor, be it a company or an individual, is insolvent is one of fact. Proving “insolvency” is a matter of establishing those facts which lead to the conclusion that debts are not being, and cannot be, paid at a particular point in time. Expert opinion evidence about “insolvency” will only be necessary where:

1.
a conclusion about solvency cannot be drawn only from a review of those underlying facts, so that the Court is asked to draw an inference that the debtor is insolvent. Expert opinion on that issue will be relevant and admissible; or
2.
where the underlying facts are extremely voluminous or complicated a Solvency Report which analyses or interprets those facts may be of some assistance to the Court and, therefore, admissible.

In very many, if not the majority of cases, however, insolvency will be established not by tendering a Solvency Report but by proving the existence of those facts which demonstrate insolvency (the usual “indicia” of insolvency) in just the same way that facts in issue in the case are proven. That is by tendering primary accounting records or company documents or correspondence and by testimony from persons with first hand experience in dealing with the company at the relevant time. Interpretative analysis of these facts should, for the most part, be left for Submissions rather than tendered under the guise of some “expert” opinion.

What evidence then, either as part of a Solvency Report or otherwise, should be gathered and led at trial? Time and again the Courts have emphasised that whether or not a company is solvent or not is a question of fact to be determined in light of the commercial realities that existed at the time of the events in question. Sophisticated working capital ratio figures or industry risk formulas will almost never be of any use in this exercise. In my experience, the best approach, albeit one that usually involves hours of review of contemporaneous records, is to gather those primary accounting records which go to the following factual matters:

1.
those debts actually in existence at the relevant time including evidence as to when those debts were due for payment; ie, terms of trade, monthly statements, credit applications, creditors’ ledger, legal files.
2.
those assets which were actually, and readily, available for paying those due debts and, where the assets are other than cash, evidence about their value and liquidity; bank files and statements, stocktake reports, land valuations, insurance documents.
3.
(in respect of a trading entity) the profitability of the business insofar as such would enable the Court to assess the weight of any claim that existing debts (and past losses) can be paid from future profits; sales and purchases ledger, general journal, contracts, files or work in progress reports.
4.
the likelihood of third parties providing funds which would enable the company to meet presently owing debts from longer term loans or additional capital.

(This summary is taken from the Federal Court decision of Quick v Stoland 29 ACSR 130.)

Each of these matters would generally be proven by the tender of the primary accounting records. If a Solvency Report or even a Solvency Affidavit is thought to be necessary it is well advised to concentrate on these four issues as central pillars of the practitioner’s case on solvency.

For any questions on this or other insolvency related topics, please contact Stephen Mullette of our Insolvency Team.