Question:
Write a brief explanation about why the directors’ duty to prevent insolvent trading exists and the circumstances and consequences of the ‘veil of incorporation’ being lifted for insolvent trading.(Do not just repeat the words of the relevant sections in the Corporations Act).From what you know of OHS Solutions’ predicament, DISCUSS whether any of the directors may be about to breach or have already breached the duty to prevent insolvent trading. (In order to do this you will need to compare what is happening in OHS Solutions case with other precedent cases and refer to the relevant sections in the Corporations Act.) What will you advise Ying?
In modern times, it is required that the directors should be made more responsible for the acts of the companies controlled by them. For example in case a company is allowed by its directors to incur a debt while it is suspected or any other reasonable person under similar circumstances would have suspected it to be insolvent, the Corporations Act, 2001 (Cth) provides in its section 588 that in such a case the director may have to compensate the company and ultimately the creditor of the company on orders of the court in case of the loss of the creditors. The reason is that in such a case it is considered that it was the fault of the director that the company was able to incur a debt when it was not in a position to repay the debt and at the same time, it was the responsibility of the directors of the company to prevent it from incurring the debt.
In this way, the applicable provisions of Corporations Act provide that the directors should not be allowed to incur debts recklessly which cannot be repaid by the company later on and in this way, avoid their personal liability by hiding behind the corporate veil.These provisions can be applied if the debts have been incurred intentionally and at the same time if the director has been negligent in its duty to keep aware of company’s financial position at the time of incurring the debt and when the director did not act to stop the company.
It is the responsibility of the directors of the company to prevent it from incurring a debt when the company is insolvent or reasonable grounds are there to suspect that it may not be insolvent at the time of incurring the debt. In this way, this duty of the directors is called duty to prevent insolvent trading. This duty has also been incorporated in the Corporations Act and can be found in section 588G in this regard, it needs to be noted that this duty applies to all the directors including any alternative director that has been appointed by the duly appointed director of the company as well as the persons acting as company’s directors. At the same time, duty to prevent insolvent trading is also applicable in case of a person who may not be validly or formally appointed as its director but when such person has been acting as company’s director. In the same way, duty to prevent insolvent trading is also applicable in case of the persons generally from whom the directors of the company take instructions.At the same time, shadow directors and de facto directors are also considered as the directors of the company according to the definition of director as mentioned in section 9 of the Act.At the same time, the earlier defense of silent directors has also been removed now that is in accordance with the current trend. The courts have also verified on several occasions that there are some responsibilities related with the position of director. These responsibilities include the duty of the directors to keep an eye on the financial position of the company as well as on its solvency.Similarly directors should also keep an eye on the debts that are being incurred by the company. These responsibilities cannot be ignored by the directors of companies and if a director ignores these responses this, such a director can be held liable by the court.A number of factors are present which have to be established in case of clean related with insolvent trading. Therefore, while dealing with a claim of insolvent trading, there are certain factors that need to be decided. These include:-
The directors of the company have not satisfied the duty to prevent insolvent trading, if these characters have not been successful in stopping the corporation from taking the loan when the directors knew of the reasonable grounds to believe they should have suspected that the company may not solvent at the relevant time or may become insolvent very soon.[8] In such a case, the assessment that needs to be applied is that of a reasonable person.[9] Therefore, it needs to be seen if any other reasonable person under similar circumstances would have come to know regarding the grounds related with the solvency of the company.[10]The legal position in this regard is that the duty of preventing insolvent trading can be breached if a person is acting as the director; the corporation is insolvent or may become so after taking the loan; and the director should have suspected the solvency of the company at such a time. This duty is not only applicable in case of the persons who have been appointed formerly but also to the persons who are acting as the director of the company.[11] As a result it is important for the directors remain unaware of the financial position of their corporation and also regarding the cash flow requirements of the company regularly. At the same time, it is also important that the directors should ensure that the company maintains proper books and accounts. The directors should monitor them actively and at the same time, they should also take all reasonable steps that are necessary for keeping an eye on company’s financial position. The financial position of the company should be under the consideration of the directors at all times so that the directors of the company become aware of any signs immediately related with the inability of the company to pay its debts.[12]
A company can be said to be insolvent if such a company cannot pay its debts when they are due for payment. But the ability of the Company to pay its debt needs to be decided by considering the overall circumstances. Generally the cash flow test is employed for the purpose of evaluating a company’s solvency. According to the cash flow test, a realistic evaluation is made of the current as well as the future cash flow. At the same time, it is also seen in case of this test if the cash flow of the company will be enough to pay present as well as the future liabilities. Similarly it also evaluates the general financial position as well as some other important commercial factors in order to decide the solvency of the company.
The director of a company can be held liable in case of a claim related with insolvent trading. In the present case, OHS Solutions Pty has been established by Des, Emma and Satish as they introduced in the business various skills and abilities. While Emma has done graduation in accounting, the expertise of Des lies in occupational health and safety. At the same time, an IT degree is possessed by Satish. However after operating for six months, problems start to surface within the company. The accountant that has been hired by Emma failed to give the necessary information. At the same time, in such a case another employee could also been hired so that the financial records of OHS Solutions could have been maintained properly. In this regard, it needs to be noted that it is the duty of a director to act in a timely manner after an advice has been received by the director in this regard and at the same time, the director is also required to evaluate the fairness of the assumption which are provided the basis for such advice.[13] When the directors of the company received an advice according to which, even if the company may not be insolvent at that time, it may become so as a result of the financial problems present before the company, it is the duty of the directors to take timely action. Such an action may include dealing with the cause that has resulted in the temporary lack of cash flow (Standard Chartered Bank of Australia Ltd v Antico, 1995). At the same time, if reasonable grounds are present for the directors of the company according to which, it is not likely that the company’s financial position will improve in future or may deteriorate further, immediate steps should be taken by the directors and if they fail to do so, it may result in the breach of duty to stop insolvent trading by the company.In the same way, if the information is received by the directors according to which, the company may have become insolvent, immediate action is required by the directors. Such action may also include the taking of further advice from professionals like a lawyer or an accountant at the generally provide advice regarding the ways in which the financial problems of the corporation can be dealt with.[14]
At the same time, by following certain principles, it is possible for the directors of companies to reduce the chances of a breach of their duties. Therefore it is important for the directors to remain aware of the financial position of the company. In the same way, it is also required that the solvency of the companies evaluated regularly by the directors. In case any concern has been identified by the directors related with the solvency of the company, it is important that immediate positive action should be taken by the director with a view to confirm the solvency of the company and at the same time, all the available options should be assessed and realistically by the director. A director is also required to take appropriate advice and then act on such advice that has been received by the director.[15]The law also provides in this regard that the director may rely upon the information given by a third party but it is required that such third party should be briefed in detail and at the same time, sufficient information should also be given to such third party by the directors so that the risk, if any, paced by the company can be properly evaluated by such party.[16]
Therefore if a director knows about the financial problems of the company or reasonable grounds are present before such director on the basis of which it can be said that the corporation may not be in the position to repay its debts, it is necessary that the director takes all reasonable steps with a view to prevent the company from taking the loan. It is also required that just as taken by the director should be clear and unequivocal. For example, a director may be required to persuade other directors in writing to prevent the company from taking the loan. In this regard, the director should take appropriate advice if other directors of the company decide to allow the company to take the loan.[17]
While in the past, there are two defenses available to the directors according to which, if the debt has not been incurred actively by the director or if it is not likely that action will be taken against the director by the creditors, are not available to the directors of corporations now. The directors may have to face claims of compensation from the liquidator and at the same time, civil or criminal action may also be taken against them.[18] In this regard it needs to be noted that the statutory defenses that are available to the directors of companies can be used only in case of legitimate circumstances[19]. As a result, it is important that these responsibilities should be taken seriously by the directors otherwise they may have to face liability for the breach of their duties.For example in the present case, the managing director of the company, Des has a duty to prevent the company from signing a new contract if the company is facing serious financial problems. At the same time, the other directors of the company have also not been able to fulfill their duty which requires them to prevent OHS Solutions from trading while being insolvent. It is also required that Satish and Ying, the other directors of the company also share this liability. The law provides in this regard that it is the duty of the silent directors also to keep an eye on the financial position of the corporation. In this case, it was important that all the directors of OHS Solution Pty Ltd should have kept an eye on the financial position of the company.At the same time, as the Finance Director of OHS Solutions, it was the duty of Emma and also the other directors of the company to prevent the company from trading while the company was insolvent. In the same way, Des was aware of the financial problems that are being faced by OHS Solutions but he had not taken any steps to deal with these problems or to prevent the company from indulging in insolvent trading. In the same way, in the present case, Ying was also a director of OHS Solutions and therefore it was also the duty of Ying to remain aware of the financial position of the company and to prevent the company from indulging in insolvent trading if reasonable grounds were present to suspect that the company may not be solvent at that time. In this way, it can be said that in this case, all the directors of OHS Solutions Pty Ltd can be held liable for the breach of the duty to prevent insolvent trading.On the other hand, it is the duty of Ying as the director of OHS Solutions to prevent the company from indulging in insolvent trading. For this purpose, Ying can give a written notice to the other directors of the company, Des, Emma and Satish. In case the other directors of OHS Solutions decide that there will not stop the company from indulging in insolvent trading, Ying is required to take professional advice and stop the company from indulging in insolvent trading.
References
Cassidy J, (1997) ‘Has the Sleeping Director Finally Been Laid to Rest?’ 25 Australian Business Law Review 102
Goldman D, (2005) ‘Directors Beware! Creditor protection from insolvent trading’ 23 Company and Securities Law Journal 216
Goode R, (1998) ‘Insolvent Trading Under English and Australian Law’ 16 Company and Securities Law Journal 170
Hargovan A, (2004) ‘Geneva Finance and the “Duty” of Directors to Creditors: Imperfect obligation and critique’ 12 Insolvency Law Journal 134
Herzberg A, (1998) ‘Why Are There So Few Insolvent Trading Cases?’ 6 Insolvency Law Journal 77
James P, Ramsay I and Siva P, (2004) ‘Insolvent Trading — An Empirical Study’ 12 Insolvency Law Journal 210
Law L, (1997) ‘Business Judgment Rule in Australia: A reappraisal since the AWA case’ 15 Company and Securities Law Journal 174
Mannolini J, (1996) ‘Creditors’ Interests in the Corporate Contract: A case for the reform’ 6 Australian Journal of Corporate Law 14
Mescher B, (1998) ‘Company Directors’ Knowledge of the Insolvent Trading Provisions’ 6 Insolvency Law Journal 186
Mosley J, (1996) ‘Insolvent Trading:What is a debt and when is one incurred?’ 4 Insolvency Law Journal 155
Sivehla J, (2006) ‘Directors’ Fiduciary Duties’ 27 Australian Bar Review 192
Welsh M and Anderson H, (2006) ‘Directors’ Personal Liability for Corporate Fault: An alternative model’ 26 Adelaide Law Review 29
Case Law:
Clark v Perkins [2002] SASC 382
DCT v Clarke (2003) 57 NSWLR 113
Gye v McIntyre (1991) 171 CLR 609
Morley v Statewide Tobacco Services Ltd [1993] 1 VR 423
Tolcher v National Australia Bank Ltd [2003] NSWSC 207
[1] Cassidy J, (1997) ‘Has the Sleeping Director Finally Been Laid to Rest?’ 25 Australian Business Law Review 102
[2] Clark v Perkins [2002] SASC 382
[3] Law L, (1997) ‘Business Judgment Rule in Australia: A reappraisal since the AWA case’ 15 Company and Securities Law Journal 174
[4] James P, Ramsay I and Siva P, (2004) ‘Insolvent Trading — An Empirical Study’ 12 Insolvency Law Journal 210
[5] Goode R, (1998) ‘Insolvent Trading Under English and Australian Law’ 16 Company and Securities Law Journal 170
[6] Mannolini J, (1996) ‘Creditors’ Interests in the Corporate Contract: A case for the reform’ 6 Australian Journal of Corporate Law 14
[7] Goldman D, (2005) ‘Directors Beware! Creditor protection from insolvent trading’ 23 Company and Securities Law Journal 216
[8] Mescher B, (1998) ‘Company Directors’ Knowledge of the Insolvent Trading Provisions’ 6 Insolvency Law Journal 186
[9] Credit Corporation Australia Pty Ltd v Atkins, 1990
[10] Mosley J, (1996) ‘Insolvent Trading:What is a debt and when is one incurred?’ 4 Insolvency Law Journal 155
[11] Morley v Statewide Tobacco Services Ltd, 1993
[12] Gye v McIntyre (1991) 171 CLR 609
[13] DCT v Clarke (2003) 57 NSWLR 113
[14] Welsh M and Anderson H, (2006) ‘Directors’ Personal Liability for Corporate Fault: An alternative model’ 26 Adelaide Law Review 299
[15] Herzberg A, (1998) ‘Why Are There So Few Insolvent Trading Cases?’ 6 Insolvency Law Journal 77
[16] Sivehla J, (2006) ‘Directors’ Fiduciary Duties’ 27 Australian Bar Review 192
[17] Hargovan A, (2004) ‘Geneva Finance and the “Duty” of Directors to Creditors: Imperfect obligation and critique’ 12 Insolvency Law Journal 134
[18] Goode R, (1998) ‘Insolvent Trading Under English and Australian Law’ 16 Company and Securities Law Journal 170
[19] Tolcher v National Australia Bank Ltd [2003] NSWSC 207
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