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Corporations Law

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Corporations Law

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Issue: 

Breach of director’s duties under Section 588G Corporations Act 2001, for the case of ASIC v Edwards wherein the defendant is one of the six directors for MRL. 

Rule: 

Solvency, according to Section 95A(1) under the Corporations Act 2001 is determined as the circumstance whereby the company is able to pay the debts undertaken in its name, when due and payable. According to Section 95A (2), the person is insolvent when the person or organization is not solvent. As per the Act there is no guidance on the method of assessing the debts that could be paid off. However, in the case of Sutherland v Hanson Construction Materials Pty Ltd, it was determined that the solvency of an entity is dependent on the cash flows and that the balance sheet is relevant to the solvency decision. 

According to Section 588 G, it is the director’s duty to prevent the company from being insolvent. The duty of director lies to prevent the insolvent trading as well. Such circumstances may be whereby the company is in debt when the director is part of the company and that there are sufficient reasons to suspect that the company is insolvent or would become so in the near future. Section 588G, the director has contravened his duties when the director is aware of the insolvency or its possibility or a person in a similar position would be aware for the same. (Quilter, 2010) 

The failure to prevent the company from incurring a debt is considered a breach of Section 588G if the same failure was a dishonest attempt. The onus to prove this fact lies with the person who is trying to make the director liable for the said insolvent trading. A director may be aware of the possibilities of the insolvency if he is informed about the financial position of the company, regularly assesses the solvency and investigate the financial difficulties, obtains professional advice to address such difficulties and act in a timely manner regarding the advice. (Horsington, 2007) 

According to the Commission’s (ASIC’s) Regulatory Guide 217 – Duty to Prevent Insolvent Trading: Guide for Directors (2010), Table 2, the indicators of insolvency may be one of the few such as company’s history of trading losses, cash flow difficulties, difficulty in collecting debts owed or selling stock and cheques are being dishonored. Other factors may be if the creditors are not being paid off on the trading terms as agreed or the Commonwealth and State taxes are not being paid off, the limits of funding have been reached or inaccurate financial position is being estimated and the directors have resigned in concern of the financial position of the company. 

If the solvency is suspected the directors may undertake certain steps such as seeking professional advice with a view to restructuring the financial debt or inviting a secured creditor. They may also try not to incur further debts, cease trading or acquire financial support.  The reason of the director’s duties and the emphasis on its performance is due to the maintenance of the confidence of shareholders towards the company. Therefore, it is necessary to consider legal advice before undertaking financial decisions on behalf of the company. (Rashleigh, 2006) 

If in certain circumstances the director is accused of insolvent trading, the director may use certain defences. These may be that at the time of incurring the debt, the company was solvent or the director had the reason to believe that it was and would remain solvent even after incurring the debt. It may also be defended that the director was referring to reasonability of a reliable person responsible to provide the required information and that the concerning person was fulfilling the responsibility.  If the director was not part of the management at the time of incurring the debt due to illness then it may be used as a defence as well. However, if the criminal proceedings are being carried out against the director then no defences are applicable under such circumstances. 

In situations of insolvent trading the director may face civil as well as criminal penalties while being personally liable for the loss so suffered by the company and the creditors. Directors are the appointed parties to act on behalf of the company and would include shadow directors as well as managing while being disqualified. Section 588G is only applicable to the directors and not the management. In case of insolvency the directors that were the director at the time of the insolvency are responsible to repay the creditors.  The civil liabilities may include disqualification from company management, fine and compensation to the company for the loss under Section 588J. The criminal penalties may involve directors to compensate for the loss. 

Application: 

ASIC in the present case alleged that the defendant had contravened Section 588G on exactly six occasions. These six debts led to MRL incurring a debt in turn leading to the operation of 588G for defendant.  The creditor in each of these debts was Colin Joss & Co. Pty Ltd that was a building contractor. According to ASIC these debts were owed and payable by MRL towards CJC due to the agreement or the quantum meruit for the work done by CJC. The work performed by CJC was duly met on time and completed for Lot 29. These debts were incurred over a period of time of which first two were paid in whole, third was paid to the extend of $365,000 and the rest were not paid off at all. (Symon, 2006)

The defendant contends that the MRL was solvent at all material times and that the alleged debt was not due and payable at the time. CJC through its conduct was estopped from debt owned by MRL, CJC continued to work on their own considered risks and that the breach occurred due to such actions is not incurred by MRL. Furthermore, if the breach had even occurred as alleged, MRL has a right to indemnify the same towards companies having interest in MRL. 

The defendant further contends that at any given time he did not have the reasonable belief that MRL was or could be insolvent even after incurring the debt for CJC. The defendant had reasons enough to believe resources outside the balance sheet to consider debts and liabilities.  The director also believed that the people providing the information were adequate evidence for MRL’s solvency while fulfilling their individual responsibilities. At the time of said incurring of the debt, the director was only one of the six directors of MRL and did not control the entire working of the company. Also, that there was no willful contravention of any provision under the Corporations Act 2001. (Harris, 2008) 

ASIC determined that the defendant was not working as a part of the board of directors in terms of funding. The other directors and the members of the Club had deferred to him in matter concerning financing. This is because no one except the defendant was well versed in the commercial skills or had any experience on matters of property development. Accordingly it could be interpreted that the defendant had enough reason and skill to step in at any given time in matters that were alarming and cause the work to cease. He could have contributed to shutting the work since the very beginning but did not do so. The information provided qualifies that the other directors from MLR would have valued his analytical approach and welcomed his intervention on the matter as he was held in high regards. (Quilter, 2010) 

The judge in making these findings also quoted the judgment of Morley v Statewide Tobacco Services Ltd (1991). It was provided that if a director had the power to rest and protest that he can’t act without agreeing with one or more colleagues in times of knowledge of the company’s insolvency then the section loses its purpose altogether. The word authority has to be construed in a broader sense and the circumstances so arising shall be obliging enough for the director to take the possible steps to inform the about the state of financial affairs in order to prevent the company from facing insolvency. The fact that he did not contractually authorize debt so incurred holds little value. If a situation occurs whereby the director with the knowledge of insolvency is unable to influence fellow directors regarding the same then the director in question should move to court for having the company wound up or resign. 

However, the defendant did not warn the fellow directors of the situation being faced by MRL and its potential of being insolvent while undertaking the project. He did communicate messages to the directors, both directly and indirectly; that the funds required continuing the project is within grasp. The defendant reassured the other directors that it is only a matter of time that things are back on track. It was further pointed out that the defendant has failed to exercise his abilities to avoid incurring the MRL debts or rejecting the project of construction. (Horsington, 2007) 

According to the findings, the defendant at all times had sufficient knowledge of the facts of the situations and the company’s liabilities and financial status to make a fair guess as to solvency of the company. Therefore, a combination of contravention has been observed on the part of the defendant in terms of Section 588G(1) and 588G(2). Defendant contended that the other directors were not active and only on board for formality purposes, to which it was held that even if the other two directors were not active part the resolutions so passed were unanimous and that there involvement was of no concern on this matter of breach. (Rashleigh, 2006) 

It was determined that defence of reasonable grounds of suspecting concerning the insolvency of MRL was present in the case. If an ordinary director had viewed the situation objectively when the quantum meruit debts were being incurred, that director would not have had any idea where could the required finances be sourced but at least there would have been a suspicion as to questioning the financial stability of MRL. These suspicions were enough cause to alert the fellow directors on said grounds for satisfying the duties correlated under Section 588G. 

Conclusion: 

The area of director’s liability in situations of insolvent trading is still evolving and there still may be many issues that are required to be considered. Directors should be careful and undertake that required measures necessary to collect as much information on the financial abilities of the company to ensure a healthy cycle of cash flows. 

It was determined by the judge that the defendant did not take the necessary preventive actions from incurring the debt and is in contravention of Section 588G of Corporations Act 2001. Furthermore, the defendant was disqualified from the corporation management for causing the company to incur $3.5 million in debts that could not be repaid. (Symon, 2006) 

References: 

·       Quilter, M. (2010). The company law notes. Pyrmont, NSW.:Lawbook Co. 

·       Horsington, H. (2007). Directors' duties during insolvency. Sydney: Lawbook Co. 

·       Rashleigh, P. (2006). Directors' duties. Melbourne: Leo Cussen Institute. 

·       Symon, H. (2006). Corporations Act 2001. Melbourne: Leo Cussen Institute. 

·       Harris, J. (2008). Corporations law. Chatswood, N.S.W.: LexisNexis Butterworths. 

 

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