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Franchise agreements: When is a debt incurred in the context of insolvent trading law?

  • In the case of Re Overgold the Supreme Court of Victoria held that franchise fees were incurred when the franchise agreement was made, before the company became insolvent.
  • This case offers valuable guidance on the threshold question of when a debt is incurred in the context of insolvent trading law affecting franchisees.
  • The use of the statutory defence in s 588H(2) of the Corporations Act 2001 by the sole director of the franchisee failed, due to temporal limitations applied when assessing whether corporate assets available can be realised within a realistic timeframe.

As an essential prerequisite for director liability under the insolvent trading law in s 588G of the Corporations Act 2001, the liquidator (or creditor) must prove that the debts were incurred by the company while insolvent. The Act, however, does not prescribe precisely when a debt is incurred for the purposes of s 588G. Judicial authorities show it will vary and depend on the nature of the transaction and that it is necessary to analyse the contractual context in each case.1

The determination of when a debt is incurred is necessary for several reasons, including for the purpose of calculating the total amount of debt incurred during insolvent trading, as well as to show that the defendant director had, or ought to have had, the requisite awareness that there were reasonable grounds for suspecting insolvency at that time.

In this context, the recent decision in Re Overgold Pty Ltd [2019] VSC 624 is noteworthy. The Supreme Court of Victoria considered a novel question arising from the collapse of an insolvent franchise business:2 whether a debt in relation to franchise fees and other charges under the franchise agreement that was the subject of this case (totalling $132,446.03) were incurred at the time of entry into the franchise agreement, or at some other time.

Recognising that the answer will ultimately depend on the terms of the franchise agreement under consideration, the court held (at 134) that the franchise fees and other charges were incurred at the time of entry into the franchise agreement, before the company was shown to be insolvent. Given the nature of the franchise agreement, where the contract provided for a prospective liability for periodical payments, the court reasoned by analogy and reached its conclusion by drawing upon the leading authority dealing with obligations incurred under a lease of land, Russell Halpern.3 In Russell Halpern, liability for rent under a lease was regarded as being incurred (in the context of insolvent trading) at the time that the lease was entered into.

The disallowance of the franchise fees and related charges had a significant impact on the original amount of payment claimed by the liquidator ($242,782.74), resulting in the court ordering the director to pay a reduced amount of $120,408.39 to the company for the other claims successfully made in relation to insolvent trading. In this respect, the decision in Re Overgold is also noteworthy for the director’s unsuccessful reliance on the statutory defence in s 588H(2), discussed below. 


Mr Appel was the sole director of Overgold Pty Ltd (‘Overgold’) from its incorporation in January 2005 to its liquidation in February 2013. Overgold entered into a franchise agreement and a licence agreement with Nando’s Australia Pty Ltd (‘Nando’s’) on 27 April 2010 to operate a Nando’s store at Hampton, Victoria for a five-year term. The franchise agreement allowed for Nando’s to close the franchised business under certain circumstances and to continue to operate the franchised business for its own account.

Overgold did not lease the business premises, but instead occupied it under the terms of the licence agreement. Overgold was obliged to pay all of the rent and outgoings (expenses) incurred by Nando’s under a lease of the premises entered into by Nando’s as tenant with a third party as landlord. Such expenses were due to be paid to Nando’s within seven days of the date on which these expenses were payable under the lease.

In April 2010, Nando’s invoiced Overgold for $602,788 to construct a fit-out at the premises. In May 2010, Overgold drew down an ANZ bank loan of $274,724 to Overgold, secured by a charge over the company’s assets and a personal guarantee given by Mr Appel. Overgold applied the proceeds of the ANZ bank loan, together with $300,000 provided by Mr Appel’s father, to meet the cost of the fit-out. The advance of the father was described in Overgold’s balance sheet as ‘owner/shareholder capital’.

Overgold operated the Nando’s store from March 2010 to 30 June 2012, when it ceased trading and departed the premises.

On 4 July 2010, Nando’s terminated the franchise agreement and the licence agreement and thereafter exercised its contractual right to carry on operating the business under a new franchise. In October 2012, the ANZ bank loan went into default and, in March 2013, the bank obtained a default judgment against Mr Appel for failure to honour the personal guarantee. On 25 February 2013, ANZ bank was appointed controller. On 14 March 2013, the bank sold the fit-out to Nando’s for $23,996 on the basis of a forced sale for plant and equipment that were second-hand.

On the basis of its review of the books and records of Overgold, the liquidator considered that Overgold was insolvent throughout the period 30 June 2010 to the date it was wound up on 20 February 2013, a finding that was upheld by the judge. In the context of s 588G(2), the liquidator contended that there were reasonable grounds for suspecting that Overgold was insolvent, or would become insolvent, during that period and that Mr Appel was aware (or a reasonable person in his position would have been aware) that there were reasonable grounds for suspecting insolvency. In support of this, the liquidator submitted that Mr Appel knew, or ought to have known, the following (which was subsequently upheld by the judge):

  • Overgold had suffered operating losses in each of the financial years for 2010, 2011 and 2012
  • Overgold had a net deficiency of assets in each of those years. Mr Appel knew, or ought to have known, that the value of Overgold’s business as recorded in the balance sheet was significantly overvalued
  • Overgold failed to lodge income tax returns from 2008 onwards, and failed to lodge business activity statements (BAS) after 30 September 2011
  • From at least May 2011, Overgold had a debt owing to the Australian Taxation Office (ATO), which it could not pay
  • From at least 1 April 2011, Overgold had outstanding superannuation guarantee charges (SGC) to the ATO, which it could not pay
  • Overgold owed debts to various creditors (totalling $120,408.39), which it could not pay.

Mr Appel denied that Overgold was insolvent when the debts were incurred. He argued that he had reasonable grounds to expect that the company was solvent, because the company could readily liquidate its assets and the cost of the fit-out ($602,788) meant that the money received from the sale of the company’s plant and equipment would be sufficient to pay its creditors. This argument was rejected by the court, for the reasons outlined below.


In establishing personal liability for insolvent trading, the court was satisfied that all the essential elements in s 588G were satisfied on the facts. Mr Appel was a director of Overgold at a time when each of the relevant debts (identified above) were incurred and that the company was insolvent (as defined in s 95A) at that time.

It was held that there was ‘abundant evidence’ to support the liquidator’s claim that there were reasonable grounds for suspecting that Overgold was insolvent, or would become insolvent, as a result of incurring debts (s 588G(1)(c)). The conclusion that the company had no demonstrable financial resources to meet its debts was supported by the failure to lodge BAS, to settle the running balance account deficit owing to the ATO and to remit amounts for SGC to the ATO.

In accepting the liquidator’s evidence that the company’s books grossly overvalued the value of the fit-out, the court made the following observations (at 132):

While to a lay person the very dramatic difference in the expenditure involved in the fit-out and what was realised on its sale a comparatively short time afterwards is hard to fathom, the evidence is that this is the reality of the situation… ANZ had a vested interest in getting the best possible price for the business… and… an experienced bank manager with over 40 years’ experience, indicated that the sale price was the best that could be obtained.

The court concluded (at 137) that as a sole director of Overgold, the director must have been aware that the company never made a profit and indeed, had operating losses for the whole of its trading life.


The court rejected the director’s reliance on s 588H(2), which provides a defence of reasonable grounds to expect that Overgold was solvent at the time the debt was incurred, for the following reasons (at 139):

… a reasonable director in Mr Appel’s position, armed with the knowledge he had of the affairs of Overgold (or what a reasonable director in his position would have known)… could not, on the basis of his knowledge of the financial position of Overgold (or the knowledge he should have had), have reasonably expected that Overgold could pay its debts.

The court observed (at 32) that the legislative schemes of ss 588G and 588H are cast in terms such that a director can, at one and the same time, have a ‘suspicion’ of insolvency and also an ‘expectation’ of solvency.

The legislative schemes of ss 588G and 588H are cast in terms such that a director can, at one and the same time, have a ‘suspicion’ of insolvency and also an ‘expectation’ of solvency.

The court, however, affirmed authorities that state that the reasonable grounds for ‘suspecting’ insolvency do not require the same degree of satisfaction as is required to determine if a director has reasonable grounds ‘to expect’ solvency. Approving the distinction discussed in Tour Print International Pty Ltd v Bott,4 the court in Re Overgold also held that ‘expectation’ (as required in s 588H(2)), means a higher degree of certainty than ‘mere hope or possibility’, or ‘suspecting.’

In this context, the court stated that the director’s defence in s 588H(2) also failed for these reasons (at 130):

The evidence in this case is that [the director] had the business on the market for a year and was not able to attract a purchaser for it despite his unique connections [in his former role as the National Property and Development Manager of Nando’s] with the other Nando’s franchisees. He was a person who, on his own admission, was well acquainted with the Nando’s franchise business model. I cannot accept that it was reasonable for him to regard the value of the fit-out as being a nest egg, with the [grossly] inflated value he attributed to it, as a basis for maintaining that Overgold was solvent.

Furthermore, it was held (at 130) that the director’s defence ignored the fact that the law uses a cashflow test to determine solvency, which also has a temporal limitation. Drawing upon Hall v Poolman,5 the court in Re Overgold affirmed that realisable property can only be taken into account in assessing solvency if that property can be realised in time to meet the indebtedness as the claims mature. The court (at 33) endorsed the observations of Palmer J in Hall v Poolman:6

There comes a point where the reasonable director must inform himself or herself as fully as possible of all relevant acts and then ask himself or herself and the other directors: “How sure are we that this asset can be turned into cash to pay all our debts, present and to be incurred, within 3 months? Is that outcome certain, probable, more likely than not, possible, possible with a bit of luck, possible with a lot of luck, remote or is there no real way of knowing?”… directors must face up to the issue of insolvent trading directly and with brutal honesty: they must not shirk from asking themselves the hard questions and from acting resolutely in accordance with the honest answers to those questions.

Failure by the director of Overgold to engage in such a reflective exercise when struggling to pay debts, particularly in the face of hard realities and the failure to find a buyer when he had the business on the market for a year, negated the prospect of a successful defence under s 588H(2).

The court… affirmed that realisable property can only be taken into account in assessing solvency if that property can be realised in time to meet the indebtedness as the claims mature.


The decision in Re Overgold is valuable for the guidance it provides on the threshold question of when a debt is incurred in the context of insolvent trading law. Significantly, for the purposes of this litigation, the sums disallowed by the court were the debts to the franchisor in respect of franchise fees ($115,706.17) and for rent and outgoings in respect of the premises for a certain period ($16,639,63). These liabilities were held to have been incurred prior to the date that insolvency had been established.

Drawing upon the logic used by the Full Court of the Supreme Court in Russell Halpern ­– that a company incurs a debt when it first enters into the lease ­– the interpretation provided by the court in Re Overgold helps ensure that the civil and criminal consequences for directors who act in contravention of s 588G(2) are used discriminately when addressing the threshold question posed in this case.

  1. Hawkins v Bank of China (1992) 26 NSWLR 562; Standard Chartered Bank v Antico (1995) NSWSC 31.
  2. The defendant was self-represented. The judge noted, relying upon the liquidator’s counsel for research, that there are apparently no authorities that deal directly with franchise agreement obligations in the context of this case
  3. Russell Halpern Nominees Pty Ltd v Martin (1986) 10 ACLR 539.
  4. Tour Print International Pty Ltd v Bott [1999] NSWSC 581. See also Hall v Poolman [2007] NSWSC 1330.
  5. Hall v Poolman [2007] NSWSC 1330.
  6. Ibid.

Anil Hargovan can be contacted on (02) 9385 3577 or by email at

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