Law & Practice

In this topic, we will try to find out about insolvent trading and how it is happened and while Company becomes insolvent what are the duties for directors in order to save unsecured creditors. We will also find out how directors become liable for their action in regard to insolvent trading and if they breach any law for insolvent trading what are the consequences they have to suffer and also law has given some defences for insolvent trading for directors in order to avoid penalty. S9 defines a director of a company- a person who is appointed to the position of a director or alternate director regardless of the name given to their position. Managing director is responsible for overall daily business. Non executive directors have part time involvement with the company.

They participate board meeting or meeting of board committees. They monitor the activities of the management team bringing an independent view often an outside or broad perspective to the board’s deliberations. They consider the interest of the company and general body of shareholders. Insolvent trading:

In order to answer the question of insolvent trading, we will find out when company becomes insolvent. Under s95A definition of insolvency is regarded when a Company unable to pay its debt when it becomes due. Usually Insolvency is not determined by looking at the balance sheet of a company and the surplus of assets over liabilities. It emphasises on cash-flow which is called “cash flow test”. Companies may experience both types of insolvency simultaneously. If we see the Powell V Fryer[2001] SASC 59, the Judge ruled that from Companies financial position, insolvency must be derived that it should not look only cash resource but also to money. In this case we found while company paid dividends and went into liquidation and became insolvent.

If a company has few assets to pay its creditors while the company became insolvent and this insolvent trading section helps to protect creditors by lifting the corporation veil and put a duty on directors to prevent insolvent trading while there is a reasonable ground they can’t pay its debt. The directors became personally liable for its debt while company became insolvent.

Before finding out whether directors breach any law for insolvent trading or not under s 588G, we look at the case of Daniels V Anderson (1995) 13 ACLC 614. The court held that for company business and finances they should familiarise themselves and made inquires and monitoring management. In regards to management directors must be pro active and could be achieved through: they have to get information about company’s matter. Attendance of meeting, they should not rely on others and make their own inquires. In decision making process they have to participate. In this case we see, Susan is merely rely on William and doesn’t attend regular meeting. Sarah also relied on William as she is his wife and never questioned of activities done by William.

Only Jack is the active person who attended meeting and worked properly till July 2008. Due to illness, Jack decided to resign and he couldn’t attend meeting. Under s203A director can give to its company’s registered office and also to notify the ASIC under s205A (1) & (2) but he failed to do so. It is director’s duty to prevent insolvent trading under s 588G if there is reasonable ground that company will not be able to pay its due and become insolvent. Directors are controlling management and they have power to prevent debt while incurred. Under s 295(4) (c) director’s obligation to declare company’s financial statement whether or not there are any reasonable grounds, company will be able to pay its debt as when it is due and payable. In this case we found that William misleads other directors as well as declaration of financial statement.

Also we can use Morley v. State wide Tobacco Services Ltd (1992) 8 ACSR (305) case for this as after dying directors husband, wife who is also a director let her son to continue business and became failure but wife, didn’t participate to run the business and rely on son, court found guilty of wife. As Sarah also didn’t participate for running the business and relied on her husband William. According to this case Sarah would be liable. But we look more details for insolvent trading. Now the question who is liable for this debt of insolvent trading? There are four defences in regard to insolvent trading for directors. Defences:

Under s 588H , Directors who contravene this section, have four defences available. S588H (2), during the debt incurred, directors defences to establish: Reasonable ground to expect company was solvent even though the debt or any other debt during that time was incurred and would remain solvent. Also directors believe that company was solvent and would remain so. Also we can use the case of Metropolitan Fire Systems Pty Ltd V Miller (1997) 23 ASCR699, The court held that Company’s three directors couldn’t establish s588H(2) defence, their expectations of solvency were based on optimism regarding the company’ future. These expectations were based on hope not objectively reasonable expectations.

From this case we found that the company’s situation was going to worse and there was no sign that it was solvent. Therefore, directors can’t get defence from this section. Under s588H (3), In order to get defence from this section, directors has to establish a number of matters. The directors must prove when the debt was incurred, they had reasonable grounds to believe and did believe, that a competent and a reliable person was responsible for providing adequate information to directors whether the company was solvent and the other person was fulfilling his responsibility under s588H(3)(a).

Directors also prove that directors expected, other person who is providing information to director that the company was solvent and would remain solvent even though it incurred debt or any other debt during that time s588H(3)(b). In this defence we can use ASIC v Plymin, Elliott and Harrison (2003) VSC 123 (No 1) (Victorian Supreme Court), The Judge held that Plymin, Elliott and Harrison had breached s588G by failing to stop debt while insolvent. In regards to their defence for ss588H (2) or (3). The court found neither Plymin nor Elliott had proven any of the defences in s 588H.

Elliott did not have reasonable grounds to believe that others were fulfilling the responsibility of providing adequate information to him about company’s financial position and the information he had received did not give him reasonable grounds to believe the companies were solvent and would remain and they found guilty. If we look our case, we found that William was a responsible person and a Managing director. He gave information to Susan who trust him and told her that the company’s position is solid and no need to be worried. On the other hand Sarah is his wife and this is the relationship of husband and wife. As a wife, she always relied on him and never asks any question as she also trusts him. From this topic, we don’t have much knowledge whether Sarah, she knows about company’s financial position or not. As per the information provided,

Sarah and Susan both can get defence from this section. Jack is sick and doesn’t have any knowledge of it though he was trying to resign as per procedure. At this stage, Sarah and Susan can get defence from this section. Under s588H(4), there is another defence for director who is absent from management due to illness or for other good reason while the company incurs debt also didn’t participate in the management of the company. The case of Tourprint International Pty ltd V Bott (1999) NSWSC 581, the court held that there is no “good reason” from absent of management just not participating in managing company business. Insolvent trading provision requires director involvement with the management during financial difficulties.

The court held liable to Bott. In this case, we found that Jack was active before his life threatening sickness, he couldn’t attend any board meeting so there is very strong reason that Jack can get defence from this section but William doesn’t get any defence also. For Susan, she didn’t attend board meeting and Sarah never attended any board meeting too, both of them are relied on William. For Sarah, she might get defence as she doesn’t have any knowledge of the company’s financial situation whether it is going to be insolvent or not and didn’t attend meeting as she was busy with her business as we assume. Because she is always busy with her business. But for Sarah, she doesn’t have any good reason to be absent from meeting though she also didn’t attend meeting as she never attended meeting. So, William and Sarah both will not get any defence in this section.

Under s588H(5), Directors can take reasonable steps in order to prevent company’s debt by appointing a voluntary administrator to the company. In this case we don’t see any of this steps happened and also there is no information of it. So we assume that they didn’t appoint any voluntary administration. Therefore, there is no defence of this section for directors. Consequences of breaches of insolvent trading There are number of consequences may flow from a contravention of s588G. There will be civil, compensation proceedings and criminal charges on directors.

Civil penalty: Within the civil penalty, the court may disqualify a person from managing a corporation or imposing a pecuniary penalty order which is up to $200,000.00. However, a civil penalties disqualification court may not order if it is satisfied that the person is fit and proper to manage a corporation nor order a pecuniary penalty where it considers a contravention not to be a serious one. In this case, we found that William didn’t try to inform other directors about company’s financial condition and mislead them. Whether it is purposely or only just to avoid more question about company from other directors. We assume that as William didn’t do what he supposed to do in case of insolvent trading as a Managing directors so civil penalty may apply for this case.

Criminal Charges: Contravention of s588G(3) is a criminal offence and punishable by fine or imprisonment or both if directors dishonestly failure to prevent the company incurring debt while it is insolvent however, in this case we couldn’t find out any information that company was doing dishonestly and we assume William was trying to fix the company in regard to financial situation which he was thinking he will be able to put the company in better situation but he failed to do so.

Compensation proceeding: If the company incurred debt and placed under liquidator then liquidator can seek compensation under s 588M from directors due to contravention of s588G. However in this case the company has gone for liquidation and didn’t give any more details. Therefore, we assume that the company was placed under liquidation and can seek compensation under s588M.

Conclusion

On the above we already discussed some defences for directors, as we found that William was aware of the company’s situation and other directors didn’t have any knowledge at all. Also William misleads other directors too though he said that he didn’t let them to worry of company’s situation. But he has to inform other directors as this was also his job. He couldn’t fulfil his duty. As we can recommend William is liable for this debt, as Jack is sick and he has strong defence to avoid any penalty and he is not liable at all which we already discussed. Susan also get defence and will not liable. Sarah might get defence but it is not so strong. Therefore, Sarah may get little liability for her action.

-------------------------------------------- [ 1 ]. R. Donnelly et al, Corporations Law(2nd edn, 2003), 86 [ 2 ]. P. Lipton et al, Understanding Company Law(14th edn, 2008) 381 [ 3 ]. P. Latimer, Australian Business Law(28th edn, 2009) 666 [ 4 ]. M. Quilter, The Company Law Notes(3rd edn, 2008)81

[ 5 ]. Lipton, above n1, 379 [ 6 ]. http://www.rurallaw.org.au/handbook/xml/ch06s10s09.php [ 7 ]. B. Sweeney et al, Law In Commerce(2nd edn 2004) 377 [ 8 ]. Lipton, above n1, 384 [ 9 ]. Ibid 386 [ 10 ]. Sweeney , above n1, 380 [ 11 ]. Ibid 386 [ 12 ]. http://www.findlaw.com.au/articles/default.asp?task=read&id=4374&site=CN [ 13 ]. http://www.harwoodandrews.com.au/publications_bulletins_detail.aspx?view=46