In the matter of Rainbow Carlingford One Pty Limited (in liquidation) (ACN 604 122 054)

1. [1]

   HER HONOUR: This is an application to terminate the winding up of a company, Rainbow Carlingford One Pty Limited (in liquidation) (the company), not on the basis that the company is solvent but on the basis that, if the winding up is terminated, related companies will provide sufficient funds to ensure that it is. The application is brought by Rainbowforce Pty Limited, which owns all of the shares of the company. The funding required to ensure that the company is solvent, on what the liquidator describes as the “pessimistic scenario”, is some $56 million. Given the size of this number, this application warrants careful review.

2. [2]

   In 2000, Rainbowforce was incorporated with issued share capital of $5. Rainbowforce owned land in Carlingford, New South Wales. In 2011, Rainbowforce obtained development approval to construct 450 apartments on the land. In 2015, as part of a corporate reorganisation, the company was incorporated with issued share capital of $100. Joseph Khattar and Sam Fayad were appointed as directors and secretaries of the company. The company purchased the Carlingford land from Rainbowforce for some $15 million.

3. [3]

   In July 2016, the company entered into a joint venture with related companies to consolidate the Carlingford land with adjoining land and develop the consolidated site. A related company, Dyldam Developments Pty Limited (Dyldam), was appointed to assist in the development of the project. A plan for consolidation was lodged and a consolidated folio created: the company has a two-thirds’ interest in the consolidated Carlingford land. The company hopes, with its joint venturers, to have the consolidated Carlingford land re-zoned and to obtain development approval for a far greater number of apartments which, if things go to plan, will result in the completion of construction and sale of the apartments in 2028.

4. [4]

   In April 2018, Joseph Khattar ceased to be a director of the company. The company obtained a valuation of the consolidated Carlingford land. The residential market overview, which formed part of the valuation report, noted a downward trend in prices, sales volumes and capital growth.

5. [5]

   The company has two external financiers:

Events leading to appointment of liquidator

1. [6]

   In May 2017, Dyldam retained a solicitor to negotiate with the Chief Commissioner of State Revenue (OSR) in respect of outstanding obligations to pay land tax by what were described as “Dyldam entities” and “Sam Fayad entities”, including the company.

2. [7]

   In November 2017, Sam Fayad resigned as a director and secretary of the company and Chahida Khattar and Fayad Lee Fayad were appointed directors.

3. [8]

   In February 2018, the OSR issued a 2018 land tax assessment to the company for some $960,000. In June 2018, the company made a part-payment of some $125,000 and, in August 2018, proposed a payment plan for the balance. Dyldam’s solicitor explained that the substantial increase in the taxable value of the land had increased land tax dramatically over the last two years, noting:

4. [9]

   The company defaulted on the instalment plan, as did other companies within the Dyldam group. Mr Fayad explained:

5. [10]

   On 14 January 2019, the OSR served a statutory demand on the company for the remaining 2018 land tax in the sum of $900,068.56. On 21 January 2019, the company’s in-house solicitor put forward a payment plan of $150,000 per month to the OSR, which was rejected later that day as follows: (emphasis added)

6. [11]

   The statutory demand was not complied with and, on 14 February 2019, the OSR filed an Originating Process seeking to appoint a liquidator to the company. On 21 and 22 February 2019, without prejudice correspondence passed between the OSR and the company’s in-house solicitor, which did not result in a resolution of the matter.

7. [12]

   On 27 February 2019, the Originating Process came before the Court and the company did not appear. An order was made to wind up the company and David Mansfield of Deloittes was appointed as liquidator. In respect of the company’s non-appearance, the company’s in-house solicitor said that no external legal representation had been appointed at the time; the company was seeking to negotiate with the OSR with the genuine intention of agreeing a payment plan; and, he was instructed to continue those negotiations. He said:

8. [13]

   Mr Fayad accepts that this was an error of judgment for which he apologises. Mr Fayad says he did not understand the significance of the first return date of the winding up application and mistakenly thought there would be further opportunities to negotiate a payment plan. I find this evidence surprising and concerning given the apparent size of the company’s assets and liabilities and given that Mr Fayad is also a director of the four proposed related party funders, which are companies of similar size. I am concerned by the cavalier attitude of the company when dealing with its most significant trade creditor and an Originating Process to appoint a liquidator to the company.

Steps to terminate the winding up

1. [14]

   A liquidator having been appointed, the company’s solicitors promptly wrote to the liquidator advising that they intended to apply to terminate the winding up. On 5 March 2019, the Australian Taxation Office lodged a proof of debt for some $1.6 million for income tax in respect of a consolidated tax group of which the company forms part. This tax has since been paid. On 6 March 2019, the company’s solicitor wrote to the liquidator advising that the OSR would be paid and requesting that the liquidator prepare a solvency report. On 7 March 2019, these proceedings were commenced by Rainbowforce. There is no doubt that, since a liquidator has been appointed, steps have been taken promptly to terminate the winding up.

2. [15]

   On 1 April 2019, two related party debtors of the company, Dyldam and Celex Pty Ltd, sent letters saying,

3. [16]

   On 2 May 2019, the liquidator obtained a valuation of the consolidated Carlingford land which indicated a 13% drop in value since the valuation obtained by the company in April 2018. The valuer noted that the Carlingford residential home unit market has “seen a large downward shift in demand and prices” over the last nine to twelve months with financiers becoming “much more stringent in their lending requirements making finance for both developers and pre-sale unit purchasers difficult”.

4. [17]

   On 29 May 2019, Mr Mansfield completed his solvency report. I will consider this report in more detail shortly. Suffice to note that Mr Mansfield concluded that the company was insolvent with a net asset deficiency of $56 million in a “pessimistic scenario”.

5. [18]

   On 27 June 2019, Dyldam obtained a “Residential Development Estimate Report” from a valuer on the proposed development at Carlingford on the assumption that the consolidated land was re-zoned and development approval was obtained for 1,320 units at the site. The company’s portion of the estimate of such a development was $120 million. The report is brief (5 pages), does not purport to be a valuation or an independent expert report, was obtained by a related party after commencement of these proceedings, and is in respect of a development which may be completed in 2028. It does not assist me greatly in my current task. The valuer does, however, note that the market has experienced a downturn since late 2017 in the order of 10 to 12% which is expected to continue well into 2019 and possibly beyond. This drop in value is consistent with that evidenced by the company’s valuation of the land in April 2018 and the valuation obtained by the liquidator 13 months later.

6. [19]

   On 24 July 2019, 16 minutes of meeting were signed by related companies agreeing not to call on repayment of debts owed by the company nor to charge any interest on the debt for 12 months, and to consent to the termination of the winding up.

7. [20]

   On 25 July 2019, the company’s solicitor caused sufficient funds to be transferred to the liquidator’s solicitors to pay outstanding land tax for 2018 and 2019 totalling some $2 million together with the liquidator’s fees and costs. A deed poll has been executed to permit those monies to be paid, on termination of the winding up, to the OSR and the liquidator.

8. [21]

   On 29 July 2019, the application was heard. The two external loans are due to be repaid later this month.

Financial position of the company

1. [22]

   According the company’s management accounts as at 27 February 2019, the company has net assets of $47.5 million and a liquidity ratio of 20.8. However, Mr Mansfield’s analysis indicates that there was a net asset deficiency of $57 million and a liquidity ratio of 0.13. In reaching this conclusion, Mr Mansfield made several adjustments to the management accounts, including:

2. [23]

   It is of some concern that the management accounts of a company of this size present a financial picture which, according to the liquidator’s analysis, is substantially and materially inaccurate.

3. [24]

   Applying the cash flow test, the balance sheet test and the profit and loss statement test, Mr Mansfield considered that the company was insolvent. When adjusted, the company’s liquidity ratio has been below one since 30 June 2017 and the company does not appear to hold sufficient assets to meet its current liabilities. The profit and loss statement test indicates that the company has been incurring trading losses since 30 June 2016 and its other income is not supported by any formal agreement nor expected to continue in the long term.

4. [25]

   In what Mr Mansfield calls the “pessimistic scenario”, there is a deficiency of assets over liabilities of $56,315,966. This scenario involves the following components:

5. [26]

   On an “optimistic scenario”, where the land sells for the valuer’s higher figure and the related party loans are fully recoverable, then there will be a deficiency of assets over liabilities of $1.7 million. The cash deficit over the next 12 months will be $653,610.

6. [27]

   Obviously, if Beijing Capital Land Limited extends its loan for two years then the position of the company will be improved. So to if Banner Capital Management secures refinance and so to if the company re-zones the land and obtains development approval to construct additional units.

Position of external financiers

1. [28]

   On 3 April 2019, Banner Asset Management advised that it would consider extending the term of the loan agreement due to expire on 23 August 2019,

2. [29]

   On 17 July 2019, Beijing Capital Land wrote to Dyldam, “subject to contract”, noting it was supportive of the company’s rezoning of the consolidated Carlingford land and:

3. [30]

   The liquidator regarded these letters as indicating that there may be continuing relationships with these financiers. I agree. Neither of the external lenders to the company oppose termination of the winding up, nor have they taken steps to appoint a receiver since the company went into liquidation.

Related party funders

1. [31]

   Mr Fayad says that if the winding up is terminated and the external lenders are unwilling to extend the terms of their loans, then the company intends to seek alternative finance from third parties. In the event that third party finance is not secured, then four related companies propose to provide $59.89 million funding to the company, being an amount sufficient to cover the “pessimistic scenario”. It is proposed that the related party funders will make these funds available as requested by the company at any time within 12 months of the date of the agreement. The company would repay the funds in two years’ time. It is proposed that the other related companies who own part of the consolidated Carlingford land will guarantee the company’s performance of the funding agreement, including repayment of the loan with interest and by providing a charge over the land. Ms Khattar and Mr Fayad, the directors of the company, have given an undertaking to the court on behalf of the company and, by Mr Fayad, on behalf of each of the proposed related party funders, to enter into the funding agreement within seven days of termination of a winding up. The proposed related party funders have also resolved to enter into the funding agreement.

2. [32]

   Mr Fayad suggested that, in his view, the related party funders should be able to provide further funding up to a total aggregate value in excess of $90 million if required. Mr Fayad says that if, at the end of the two year period, the company is unable to refinance the funding provided by the related party funders, then the related party funders intend to enter a further funding agreement in equivalent terms for a further 24 months. Mr Fayad deposed:

3. [33]

   Mr Fayad explains that, where necessary, the related party funders propose to obtain a mortgage in order to meet any request for a draw down under the funding proposal. This would be sourced through external financiers should it be necessary to do so. Such a mortgage would be obtained during the 30-day drawdown notice period under the funding agreement.

4. [34]

   The financial position of each of the related party funders needs to be considered to determine whether the funding which each proposes to provide is realistic, particularly where the related party funders propose to fund their obligations by obtaining external mortgage finance during the 30-day drawdown notice period under the funding agreement. In considering the financial position of each company, I encountered some of the same issues with their management accounts as Mr Mansfield did when examining the management accounts of the company. I have endeavoured to analyse the balance sheets of the proposed related party funders in the way which I understand Mr Mansfield approached the company’s balance sheet.

5. [35]

   Marrace Pty Ltd has agreed to fund $8.34 million. Marrace was incorporated in 1996 and has $100 issued share capital. Marrace’s balance sheet as of May 2019, which appears to come from Marrace’s management accounts, reports net equity of $9,935,086. Having reviewed the balance sheet and accompanying documents, it appears that:

6. [36]

   Special Gold Pty Ltd has agreed to fund $20,820,000. Special Gold was incorporated in 1997 and has issued share capital of $5,000. Special Gold’s balance sheet as of June 2019, which appears to come from Special Gold’s management accounts, reports net equity of $51,278,933. Having reviewed the balance sheet and accompanying documents, it appears that:

7. [37]

   Golden Mile 1888 Pty Ltd has agreed to fund $10,160,000. Golden Mile 1888 was incorporated in 1999 and has issued share capital of $3. Golden Mile 1888’s balance sheet as of May 2019, which appears to come from Golden Mile 1888’s management accounts, reports net equity of $13,919,486. Having reviewed the balance sheet and accompanying documents, it appears that:

8. [38]

   Finally, Sterling House 88 Pty Ltd has agreed to fund $20.57 million. Sterling House 88 was incorporated in 2002 and has issued share capital of $3. Sterling House 88’s balance sheet as of May 2019, which appears to come from Sterling House 88’s management accounts, reports net equity of $24,442,519. Having reviewed the balance sheet and accompanying documents, it appears that:

9. [39]

   Mr Mansfield has also considered the ability of the proposed related party funders to provide funds under the funding agreement having regard to the same documents in evidence before me. Mr Mansfield also assumed that the recoverability of loans owed by related parties was nil as he had not been provided with financial information relating to those entities. In contrast to my approach, Mr Mansfield accepted the higher figures in the “Commercial Estimate Report” obtained by Dyldam in respect of each of the properties, but I am not prepared to do so: a mortgage lender would be unlikely to lend on the basis of such a report and thus I do not think it is a realistic basis to assess the funds which the company can raise against the security of their land. Mr Mansfield concluded:

10. [40]

    Mr Mansfield considered that Special Gold would only have the capacity to lend $20.8 million, reducing the amount available to be lent under the proposed funding agreement to $59.87 million, but still greater than the amount of the deficiency of funds for the company over the next 12 months on a pessimistic scenario. On that basis, but subject to Mr Mansfield’s reservation about the related party funders’ ability to raise the funds required, Mr Mansfield considered that the company would have more than sufficient monies to cover the deficiency if the proposed funding agreement were entered into.

11. [41]

    I share Mr Mansfield’s concern as to whether the related party funders will be able to raise the additional mortgage finance should a drawdown notice be issued under the funding agreement, and within the 30 days of the notice. Overall, it seems to me that the proposed funding agreement is insufficient. To put it simply, the company has to pay $105 million within one month to repay finance over land presently worth some $63 million. There is a gap of about $42 million which needs to be filled by either paying down debt or making a further capital contribution to the company so that its books ‘stack up’ and so that the company has sufficient working capital to meet its debts in the near future, the most substantial of which is land tax of about $1 million a year.

12. [42]

    Section 482 of the Corporations Act 2001 (Cth) provides:

13. [43]

    The relevant legal principles are summarised by Black J in In the matter of MWM Sydney Pty Ltd (in liquidation) [2016] NSWSC 688 at [16]–[21]. In exercising its discretion on such applications, the Court traditionally turns to the principles set out by Master Lee QC in Re Warbler Pty Limited (1982) 6 ACLR 526 at 533; (1982) 1 ACLC 323 at 328, being:

14. [44]

    While there is no hierarchy of importance to such factors, it is well accepted that usually the most important factor is the solvency of the company. In In the matter of SNL Group Pty Ltd (in liq); Su v SNL Group Pty Ltd (in liq) [2010] NSWSC 797, Bergin CJ in Eq described the position as follows at [24]:

15. [45]

    As Brereton J put the matter in In the matter of Recycling Glass Pty Limited (ACN 001 332 654) [2014] NSWSC 439 at [18]: (citations omitted)

16. [46]

    His Honour also noted (at [19]–[22]) that the interests of future creditors was also relevant, that is, the court seeks some comfort that such a state of affairs is not likely to recur in the foreseeable future. The court requires evidence that demonstrates not only that the company is, but also that it is likely to remain, solvent. In Re Pine Forests of Australia (Canberra) Pty Ltd [2010] NSWSC 1127, Barrett J noted, at [3] :

17. [47]

    Rainbowforce submits that:

18. [48]

    Rainbowforce submitted that each of the related party funders owns substantial real estate totalling approximately $125 million against loans of approximately $49 million, and thus have total equity in excess of $75 million. This submission is based upon accepting the “Commercial Estimate Report” obtained by Dyldam in respect of the properties and the balance sheets on their face. For the reasons given, I do not think that approaching the matter in this way gives a realistic assessment of the ability of each of the proposed related party funders to obtain external mortgage finance within 30 days to satisfy a drawdown notice issued by the company in the event that it issues one. It may well be that a revised funding proposal can be put forward, or further information provided to Mr Mansfield or the Court to support some of the balance sheet items which I have put to one side in this judgment.

Commercial morality

1. [49]

   In In the matter of Modena Imports Pty Ltd (in liq) [2010] NSWSC 739, Palmer J noted that the court is vigilant to protect the public interest in an application such as this: at [8]. As to what that means, an oft-cited passages is that of Buckley J in In re Telescriptor Syndicate Limited [1903] 2 Ch 174 at 180:

2. [50]

   I repeat my concerns in relation to the company’s interaction with its sole trading creditor and to service of an Originating Process to appoint a liquidator to the company. Whilst, in a ‘mum and dad’ company, one might understand why the significance of these matters might escape the recipient, I am concerned that the director of an apparently substantial company proceeded in the way that he did. However, I do not regard this as determinative of this application.

3. [51]

   Both Mrs Khattar and Mr Fayad consent to continue as directors of the company if the winding up is terminated. Mr Mansfield said that the directors of the company have cooperated and assisted him by providing information and records of the company as requested and at all times indicated that they intend to pay in full the unsecured unrelated creditor claims in the liquidation of the company. I accept this.

4. [52]

   Mr Mansfield considered that the company’s records appeared to be adequately maintained. Based on his review of the company’s management accounting file, the financial information appeared accurate and the company was able to produce it in a timely fashion. Whilst he had seen financial statements prepared by an external accountant for the financial years ended 30 June 2016 and 2017, financial statements had not yet been prepared for the financial year ended 30 June 2018. The financial year ended 30 June 2019 has since closed. I found Mr Mansfield’s observation somewhat at odds with the wide disparity between the company’s management accounts and the more accurate financial position as ascertained by Mr Mansfield in his solvency report. However, I do not regard this as determinative of this application.

5. [53]

   Mr Mansfield points out that the company has never previously been placed into external administration and it appears that the company’s records with the Australian Securities and Investments Commission (ASIC) are up to date. He is not aware of any breaches of duty by the directors nor of any matters that would concern the Court in respect of the conduct of the company’s affairs or that would be against the public interest in terminating the winding up. I accept this.

6. [54]

   Mr Mansfield also points to the consequences which may result if the liquidation continues, including that the assets of the company are likely to be insufficient to satisfy the claims of all creditors, depending on the sale price obtained for the consolidated Carlingford land and the recoverability of related party debts. It may take some time to properly market and sell the consolidated Carlingford land and there may be an adverse effect on the viability of other related entities of the company as the land is held jointly. The joint venturers may see no funds returned to them which, presumably, would have an adverse effect on them. The OSR would be required to wait a further period of time before it sees a payment of the debt owing to it. The liquidator considers that the best prospect of maximising the value of the consolidated Carlingford land for the existing owners, including the company, is by developing the land which may assist in creating jobs and developing land in the local community of Carlingford.

7. [55]

   I can do little with a suggestion that, if the liquidation continues, the community will lose the benefit to be derived if the land is developed in accordance with the company’s plans. One would imagine that the consolidated Carlingford land, with the benefit of a development application to construct 450 units, will likely be developed by someone else and thus the community will not lose the benefits referred to by the liquidator. Rainbowforce’s senior counsel fairly concedes that, if I am not satisfied in respect of the company’s proposed return to solvency, such a consideration is irrelevant.

8. [56]

   Counsel for the liquidator submitted that the liquidation should be terminated because the liquidator had done his analysis on a conservative basis; the company has “learnt its lesson”; and, given that the secured creditors did not oppose the termination of the liquidation nor appoint receivers nor call for repayment, it may not be necessary to call upon the related party funders. I hope the liquidator did his analysis on a conservative basis: so have I. When a company is in liquidation because it has failed to pay its only trading creditor, then the Court should approach this exercise with caution. In a liquidation scenario, the ‘blue sky’ should be eschewed. Nor do I think it is sensible to approach this exercise on the basis that the external financiers will extend their loans and thus the ‘fall back’ position of related party funding, which appears inadequate, and may never need to be called upon.

9. [57]

   For these reasons, I am not prepared to make the orders sought. I am prepared, however, to give Rainbowforce an opportunity to put forward further and better information to support its application. I note in passing that Rainbowforce has not notified ASIC of this application, which it is obliged to use under rule 2.8 of the Supreme Court (Corporations) Rules 1999 (NSW). If Rainbowforce wishes to renew its application, it should attend to this.

10. [58]

    There may also be other ways of going about it than what is presently proposed. In some cases, the Court has granted leave to directors under section 198G(3) of the Corporations Act to take steps to make contributions to be a company before terminating a winding up (In the matter of CNL Transport Pty Ltd (in liq); Hunt v Smith [2017] NSWSC 291 per Gleeson JA) or made termination of a winding up conditional on the payment of outstanding creditors (Benedict v Olde; in the matter of ATS (Asia Pacific) Pty Ltd [2011] FCA 1008 per Jacobson J).

11. [59]

    I am in the hands of the parties as to how they wish to proceed from here. I note also that some of the evidence relied on by Rainbowforce was said to be confidential. I did not rule on those claims. I will give Rainbowforce a short opportunity to review these reasons and identify any material which it contends is confidential before publishing my reasons.

Notation to published reasons

1. [60]

   On handing down my reasons to the parties on 1 August 2019, I invited them to address the Court on whether any part of the judgment was contrary to the claims for confidentiality made during the course of the hearing. On 2 August 2019, I acceded to the liquidator’s request to revise paragraphs [4], [16] and [25] so as not to disclose the amount of the valuation it had obtained for the Carlingford land, to protect his ability to sell the land at the highest possible price in the interests of creditors, should that become necessary in the future. These are those revised reasons.