Bell Group Limited Decision

• Q. How much hindsight may be used to retrospectively assess solvency as at a particular date. 
• A. The issue of solvency is a question of fact to be determined in light of all the circumstances as they were known or ought to have been known at the relevant time. The Court first determines the prevailing circumstances of  the relevant time having regard to any relevant event or fact (both before or after the relevant date), if it helps to determine the actual state of affairs.  Having determined the prevailing circumstances, the Court then considers whether or not at the relevant date and under the circumstances found, the company had the alibility to pay its debts.  This involves balancing existing  debts with available assets and resources over a period of time. Facts that were not in existence or not properly knowable at the relevant date are not relevant to a retrospective assessment of a company’s solvency.  However, a Court can take into account facts available in hindsight (that is, after the determinative date of solvency), if the facts help determine which version of conflicting accounts  concerning the state of affairs is more likely. The fact that an event actually took place may weigh in favour of the alleged expectation being a commercial reality. However, that fact alone is not determinative. It is one only of a host of matters that may intrude into the decision making process. 
• Q. What is the appropriate test of insolvency? The cash flow test or the balance sheet test?
• A. In Australia, the cash flow test of insolvency (which focuses on an entity’s income sources and expenditure obligations) is generally viewed as the more appropriate mechanism for assessing solvency   than the balance sheet test (which concentrates on the value of assets and liabilities reflected in the entity’s books). However, the balance sheet test continues to have relevance in some circumstances. In this case, in assessing the Group’s solvency at the relevant date, the primary focus was on the cash flow test. However, the balance sheet test was used to determine some contentious issues.

Obligations on financiers

•  Banks cannot enter into a transaction which enhances their existing security position and, in effect, provides them with priority to the claims of creditors and future creditors of the group or individual companies in the group. Such an act would be construed as prejudicial to the individual company, its creditors and shareholders and may have ramifications; 
• A bank which obtains further security from a group of companies when it is aware that the company is insolvent or may be insolvent shortly after the security is obtained may be held accountable as being privy to the directors breaching their fiduciary duty to an individual company in the group, its shareholders and creditors; 
• A bank should not take further security from an individual company or group when they suspect that the directors may have breached their fiduciary duty to an individual member of the group. If a bank proceeds in this manner it will be held to hold any such property subject to the further security on trust for the group as it arose from a breach of the directors’ fiduciary duty (the first limb of Barnes v Addey);
   
• The mere fact that a transaction document states that the directors have considered the corporate benefit and entered into a transaction does not by itself mean that directors have applied their minds to the corporate benefit for the individual company and a bank cannot rely solely on this statement;
• If further facilities are provided the banks should consider the cash flow situation of individual companies and satisfy themselves that there is a real and substantial benefit to each corporate entity;
• It is not good practice in a transaction document to waive compliance with obligations under the document in an attempt to avoid defaults that may trigger the liquidation of the company within the six months preference period. This will normally be construed as a sham;
• A bank cannot raise by way of defence that it was not aware that a director was breaching his fiduciary duty to an individual company, shareholders and creditors if there is no plan existing prior to the further security being taken to restructure the company or the group
• A bank could be held to be acting inequitably or unconsciously where a Court was to find that there was an inequitable or unconscionable bargain because the directors of an individual company or group were not as commercially astute or were not receiving competent legal advice;
• For a case of equitable fraud to be made out against a bank, the directors would have had to engage in dishonest and fraudulent conduct and the bank would have known that the directors were so acting. 

Director’s Obligations

In respect of companies which are insolvent or are likely to be insolvent, the directors of the company owe the following duties:

• If the group is either insolvent or possibly insolvent, by providing existing lenders with further security from individual companies in the group, the directors have breached their fiduciary duties owed to the individual company,  if they have not considered the benefit of any such transaction to the individual company;
• By acting in this manner, the directors would be acting for an improper purpose if they provided further security to a secured lender to prevent that lender putting the group into liquidation. Such an act will be construed as acting in the interests of the bank rather than acting in the interest of the group of companies and their creditors;
• The company cannot enter into a transaction even if the transaction is in the best interests of the group as a whole unless the transaction is also in the best interests of the company individually and the interests of its creditors and shareholders;
• For a director to procure companies individually to provide further security to a financier to remove the threat of one company in the group and the group globally going into liquidation without properly considering the interests of the company individually, including shareholders and creditors, is an improper exercise of a director’s power and the act will be construed as acting for an improper purpose.

Conclusion

The above legal findings impose heavier duties on directors and banks than had been originally envisaged. Importantly, it exposes a bank which obtains further security to the real risk that their security will be declared invalid and the proceeds of realisation of the security will be returned to the company, its shareholders and creditors.  Importantly, it will make informal workouts subject to unexpected risks particularly where a financier proposes to provide further working capital or obtain further security.  In this context, a financier may be better placed appointing a receiver to a company or a group of companies, to protect its position. The findings of Owen J apply both to syndicated and non-syndicated loans where there is a group of companies. Many of the complex legal issues raised by this case will probably ultimately be appealed and more than likely, be reviewed by the High Court of Australia.