The importance of being cautiously aware of contractual terms relating to insolvency termination events

In the matter of Carna Group Pty Ltd v The Griffin Coal Mining Company (No 6) [2021] FCA 1214, the Court held that Griffin Coal Mining Company (Griffin) was insolvent, without having to prove so under the section 95A Corporations Act 2001 (Cth) (Corporations Act). This was in accordance with a contractual provision where it provided specific circumstances where insolvency could be proven and as such a breach had occurred and the contract could be terminated. It was proven as at the relevant period Griffin could not pay all its debts when they fell due without parent support and, that parent support could not be relied upon.

It demonstrates while the authorities under section 95A are relevant, the words of the contract must be given their own plain meaning in context and it is relevant, among other things, to consider what a ‘reasonable person’ would have understood the clause to mean.

Background

Mckerracher J considered a contract between Carna Group Ltd Pty (Carna), a family-owned company providing earth moving and mining services and Griffin, a long-standing coal mining company in Western Australia. In March 2014, a contract was entered into between the parties which presented a substantial opportunity for Carna to continue and consolidate its expansion into the area of mining services.

In May – September 2014 almost all invoices due to be payable by Griffin were late, resulting in between $5 million to $11 million of debts owing to Carna. On 3 December 2014, Carna issued a notice of termination due to Griffin’s ‘Insolvency Default’, and on this basis, Carna claimed, that it was entitled to a payment for early termination.

This matter centred on two contractual issues:

• whether or not Griffin committed an ‘Insolvency Default’ as defined under the contract; and
• whether Griffin failed to establish a ‘Payment Account’ as required under the contract, for payment of invoices to Carna.

Within the contractual period, Griffin suffered serious financial strain with respect to its ability to repay the debts. Its financial liquidity was crucially dependent on:

• funding from its parent company which had difficulty providing payment on time; and
• an invoice factoring facility it had set up to pay its creditors, which required repayment with a substantial interest rate.

Griffin acknowledged that it was under serious financial strain throughout 2013 and 2014. However, the root of its contention is that as Griffin continued to trade, there is no basis upon which its troubles could be characterised as anything other than a temporary liquidity problem.

Contract

The contract broadly defines the term ‘Insolvent’ by setting out seven specific circumstances where it will be present. The relevant circumstances for this dispute are within subparagraphs (a) and (g):

Insolvent means, in respect of a party, that it:

• (a) is (or states that it is) insolvent (as defined in the Corporations Act);
• (g) is otherwise unable to pay its debts when they fall due.

 The appropriate interpretation and meaning of subparagraph (g) is contested.

Carna contended that Griffin was ‘Insolvent’ as per subparagraph (g) by 3 December 2014, being the date on which Carna claimed to terminate the contract with immediate effect. Carna disputed that it was not necessary to satisfy subparagraph (a) to fall within subparagraph (g) and all that was necessary is a factual finding that Griffin was unable to pay its debts when they were due at the relevant deadline. Whereas Griffin argued that subparagraph (g) should not be read more broadly than subparagraph (a), while subparagraph (g) seeks to cement that definition by effectively setting it out. Griffin argued, the clause is intended to pick up the well-understood concept of insolvency as per the Corporations Act and adopting the natural and ordinary meaning of the words used.

The Court found that Carna’s interpretation was to be preferred as there was no reason to confine and read down subparagraph (g) by reference to subparagraph (a). It was held that each subparagraph should be construed as providing independent ways of demonstrating that a party to the contract could be said to be ‘Insolvent’ within the meaning of the contract.

Was Griffin able to pay its debts when they fell due?

The central question to consider is whether Griffin’s incapacity make payments on time was temporary or whether it had enough inconsistency and duration to fall within the definition of insolvent in subparagraph (g). It was found that for the duration of the contract, Griffin was entirely dependent on funding from its parent company to pay its creditors. However, it was rejected that the parent company support kept them solvent as although a company can rely on financial support even from a company that cannot be legally compelled, there does need to be a degree of assuredness, which was not present in this case.

Although, the Court accepted that temporary liquidity problems are not conclusive in proving whether a company can pay its debts when they fall due, the Court found that Griffin’s liquidity problems were not temporary and its reliance on parent company support was crucial. Carna relied upon the indicia in Australian Securities and Investments Commission’s Information Sheet 42, including continuing losses, insufficient cash flow, creditors being paid outside the usual terms and overdue taxes to support a finding that Griffin was insolvent within the meaning of subparagraph (g).

His Honour rejected Griffin’s argument that, as creditors were eventually paid, insolvency was not present. There was not sufficient evidence to show that the creditors were paid on time, and it was said to be fundamental that the debts can be paid when due. The Court rejected the assertion that as Griffin continued to trade, the financial problems were temporary. It was also found that the mere fact that some companies do trade out of trouble does not mean that this is either the norm or acceptable and the basis underpinning insolvent trading prohibitions is to prevent creditors being put at risk.

The Court concluded that Griffin was insolvent at the relevant time, however it made clear that this finding was in relation to the contractual term and was not a finding of insolvency under the Act.

Key takeaway

1. When entering contractual agreements, be mindful of the flow on effects from termination clauses referring to insolvency if the definition is independent of s95A of the Corporations Act.
2. When using a definition different to the legislation, the Court will generally examine whether the ordinary meaning of the words in the clause have been satisfied as a matter of fact.
3. To find insolvency, the mere fact the company continues to trade for a long period of time, does not necessarily inhibit a finding that it was insolvent from that earlier date.

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Authored by:

Guy Edgecombe, Partner
Sophia Leembruggen, Graduate