Duty to prevent insolvent trading - Corporations Law PDF

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Duty to prevent insolvent trading...

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Duty to Prevent Insolvent Trading S588G – a director is under a duty to prevent the coy incurring debts if there are reasonable grounds for suspecting that it is insolvent (insolvent trading)

Before a director is committed to be liable for insolvent trading, 4 things need to be proved: 1) must be a director when the coy incurs the debt 2) coy insolvent when debt was incurred 3) there are reasonable grounds for suspecting insolvency 4) director’s failure to prevent debt to be incurred.

1. Must be a director when the coy incurs the debt S588G(1)(a) – the duty to prevent insolvent trading applies to a person who is a director at the time when the coy incurs the relevant debt – Hawkins v Bank of China

2. The Coy must be insolvent when the debt was incurred S588G(1)(b) – the coy must be insolvent at the time the debt was incurred or became insolvent by incurring that debt s95 defines insolvency: s95(A)(1) – A person is solvent if, and only if, the person is able to pay all the person’s debts, as an when they became due and payable s95(A)(2) – A person who is not solvent is insolvent

Cases: 

Powell v Fryer – the ability of a coy to pay off debts when fall due is based on cash flow test (based on commercial reality), cannot be drawn from evidence of a temporary lack of liquidity.

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ASIC v Plymin – indicators of insolvency debt was incurred when contract was made and NOT when the deliveries were ordered (pg501)

Presumption of Insolvency S588E - two presumptions of insolvency are available to assist in providing that the coy is insolvent at the relevant time s588E(3) –presumption of continuing insolvency 

If it can be proved that a coy was insolvent at a particular time during the 12 months prior to the “relation-back day”, it is presumed that the coy remained insolvent thereafter.

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In case of compulsory winding up, is the date that creditors file the court application for winding up the coy: s 9.

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Example: wind-up order 1/7/2011. relation-back day 1/4/2011, If it can proved that the coy was insolvent on any day between 1/4/2010 and 1/4/2011, it will be presumed that the coy remained insolvent thereafter.

s588E(4) - Presumption of failing to keep or retain adequate financial records 

where the coy has for a time contravened either s 286(1) or (2) by failing to keep or retain adequate financial records, it must be presumed that the coy is insolvent during the period of contravention.  overcome difficulties of proving insolvency in the absence of proper acc records. Case: Kenna & Brown Pty Ltd v Kenna

** s588E(5) – does not apply to a minor or technical contravention of s286 **s588E(6) – does not apply if contravention of s286 is due solely to someone other than the director destroying, concealing or removing the coy’s accounting records.

3. Reasonable grounds to suspect insolvency S588G(1)(c) – there must be reasonable grounds for suspecting that the coy was insolvent at the time he debt was incurred. What is meant by “reasonable grounds” and “suspicions of insolvency”?

i.

Reasonable grounds for suspecting insolvency:

ASIC v Plymin - “reasonable” imported a standard of reasonableness appropriate to nonexecutive directors of reasonable competence and diligence, seeking to perform their duties as imposed by law and capable of reaching a reasonably informed opinion as to the company’s financial capacity. Williams v Scholz - some factors providing a reasonable ground for suspecting such as the coy traded unprofitably and accumulated losses, and these factors result that the business was running at a loss.

ii.

Suspicions of insolvency:

Queensland Bacon Pty Ltd v Rees - “suspicion” requires a degree of satisfaction, not necessarily amounting to actual belief but extending beyond speculation

4. Failure to prevent incurring of debt s588G(2)- Requires proof that a director failed to prevent the coy incurring the debt ASIC v Plymin – ‘failing to prevent’ covers the inactivity or the failure to attempt to prevent the coy from incurring the debt

A director contravenes s 588G 

s 588G(2)(a) if the director is aware that at the time the debt is incurred there are reasonable grounds for suspecting the coy’s insolvency: o In this case, it’s not necessary to prove that the director has an actual suspicion b/c it’s sufficient if the director was aware of facts which would cause a reasonably competent non-executive director to suspect that the company was insolvent at the time it incurred a debt.

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s 588G(2)(b)If a reasonable person in a like position in a company in the company’s circumstances would be aware of reasonable grounds for suspecting insolvency:

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Corresponding to the duty of care and diligence under s 180(1)

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Model case: Powell v Fryer

It’s not necessary for a plaintiff to prove that a director had the power to prevent incurring the debt/ continuing to trade, nor an individual director failed to take particular step to prevent: Elliott v ASIC

Defences S588H sets out four alternative defences available to directors who otherwise contravene s588G 1. Reasonable expectation of coy’s solvency S588H(2) – it is a defence if the director proves that, at the time when the debt was incurred, the director had reasonable grounds to expect, and did expect, that the coy was solvent at that time and would remain solvent even if it incurred that debt and any other debts that is incurred at that time -

Hall v Poolman – If directors can honestly and reasonably prove that the coy’s debts can CERTAINLY and PROBABLY be repaid, then the director can have a reasonable expectation of coy’s solvency

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Tourprint International Pty Ltd v Bott – NO DEFENCE if directors are UNAWARE of the coy’s financial position

2. Delegation and reliance on others S588H(3) – defence applies to a director who has delegated the monitoring of the coy’s financial position to others upon whom the director relies. But to rely on this defence, need to consider two matters: i.

S588H(3)(a) – director must prove that at the time when the debt was incurred, the director had reasonable grounds to believe, and did believe, that a competent and reliable person was responsible for providing the director with adequate information about whether the coy was solvent and that the other person was fulfilling that responsibility -

ASIC v Plymin the director didn’t have a reasonable ground to believe the person whom she relied on.

ii.

S588H(3)(b) – director must prove that the director expected, on the basis of information provided to the director by the other person, that the coy was solvent and would remain solvent even if it incurred that debt and any other debts that it incurred at that time. A director cannot said to have

expected that the coy was solvent if he does not obtain any info about the coy’s solvency from a competent and reliable person -

Metropolitan Fire Systems Pty Ltd v Miller - two directors failed to make inquiries/demand info when suspicions about the coy’s financial viability and survival which should be demanded by them

3. Absence from management S588H(4) – defence applies for directors who are absent from management because of illness or for some good reason at that time when the coy incurs the debt in question

 Good reason o Where director did not take part in board decision on matter because director had a material personal interest o ACCC v ASIC- After reinstatement of a deregistered coy, the coy’s directors would resume office but have no power to manage its affairs so it can rely on this defence and wont be liable for any insolvent trading:

 Bad Reason o A passive director who fails to be involved in the company’s management CANNOT use this defence as becoming a director, o that person is assumed and required to have a ‘necessary commitment to an involvement with the management of a company in financial difficulties’; o Deputy Commissioner of Taxation v Clark - a wife (director) who had not taken part in coy’s management could not rely on this type of offence merely b/c she has deferred to her husband.

4. All reasonable steps to prevent debt being incurred S588H(5) – it is a defence if the director proves that they took all reasonable steps to prevent the coy from incurring the debt, and directors have taken UNEQUIVOCAL ACTIONS (clear and unambiguous actions) S 588H(6) - encourage directors to make prompt use of the voluntary administration provisions (the court will regard whether the directors have made the action to seek voluntary administration and the results of it) o Byron v Southern Star Group Pty Ltd – Cannot rely on this defence and prevent personabl liability by simply telling other directors not to incur debts. o Statewide Tobacco Services Ltd v Morley- If director cannot prevent the debt being incurred, he should seek to have the company would up or resign as a director

Consequences (penalties) of breaching s588G Compensation 

S 588M: Liquidators have the ability to seek compensation from directors [recover the losses] who contravenes s 588G. The compensation orders can be made whether or not the court imposes a civil penalty order or a criminal penalty. And liquidators are permitted to mount compensation recovery proceedings whether or not ASIC has commenced an application for a civil penalty order or criminal proceedings: S 588M(1)(e) and (f).

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S 588M(3): Unsecured creditors are also given a limited right to initiate their own compensation claim against directors, if liquidator fails to launch an action, and so creditors have to prove that the director has contravened s 588G.

Civil penalty 

s 1317G- Contravention may result in the imposition of a pecuniary penalty order OR

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disqualification from managing corporations under s 206C

Criminal offence 

s588G(3)- contravention is a criminal offence, punishable by a fine or imprisonment (or both) if a director’s failure to prevent the company incurring the debt in breach of s 588G was dishonest....