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By submitting that the Flex Metal Industry Pty Limited ( Company) has been insolvent from 2009, the liquidator sought to bring an action against Andrew and Greg, and pass the company’s debts to them as their personal liability on the basis of s588G of the Corporations Act 2001 (Cth) (Act). Section 588G of the Act imposes a civil and criminal liability on company directors who cause the company to trade while it is insolvent. Its purpose is to discourage companies that are either insolvent or nearing insolvency from continuing to obtain loans, property or services on credit when the director either knows or suspects that the company may be insolvent or approaching insolvency or a reasonable person in the director’s position would know or suspect that the company was in such a position.1 Section 588G is applicable if: 

The duty is applicable to a person who is a director at the time the company incurred a debt;2



The company is insolvent at that time or become insolvent by incurring that debt;3



At that time there are reasonable grounds to suspecting that the company was insolvent or would become insolvent;4



The director must have been aware at the time that there were grounds for suspecting insolvency, or a reasonable person in a similar position in a company in the company’s circumstances would be aware of insolvency.5

Based on the given information, it is evident that Andrew and Greg were the directors of the company in 2009 therefore s588G(1)(a) is met. The question is whether the other criteria listed above are also met for s588G to be applicable. Solvency is defined in section 9 and 95A(1) of the Act, a company is regarded as insolvent if it is unable to meet its debts as and when they fall due. When 1

Edwar dsvASI C( 2009)264ALR723;[ 2009]NSWCA424 Corporations Act 2001 (Cth), s588G(1)(a) 3 Ibid, s588G(1)(b) 4 Ibid, s588G(1)(c) 5 Ibid, s588G(2) 2

2 assessing the insolvency status of the company, consideration must be given to all indicators listed in ASI CvPl ymi n,El l i ot&Har r i son( 2003)21ACLC 700. These include: 1. Continuing losses 2. Liquidity ratios below 1 3. Overdue Commonwealth and State taxes 4. Poor relationship with present Bank, including inability to borrow further funds 5. No access to alternative finance 6. Inability to raise further equity capital 7. Suppliers placing the company on Cancellation of Debt Income, or otherwise demanding special payments before resuming supply 8. Creditors unpaid outside trading terms 9. Issuing of post-dated cheques 10. Dishonoured cheques 11. Special arrangements with selected creditors 12. Solicitors’ letters, summonses, judgments or warrants issued against the company 13. Payments to creditors of rounded sums which are not reconcilable to specific invoices 14. Inability to produce timely and accurate financial information to display the company’s trading performance and financial position, and make reliable forecasts 15. The fourteen indicators of insolvency have withstood the test of time and it is the standard list of indicators that liquidators use to justify assertions of insolvency

Notably, among the above the court may hold that indicators 1, 2, 3, 5 and 6 are relevant as the company had not made a profit since 2008, and as at 2009 made losses and had a deficiency of asset over liabilities of $50,000. The company was also not able to pay its tax debts as per its running account balance. However, it is uncertain whether five indicators are determinative of a finding of insolvency because the courts still make findings of insolvency “on the

3 facts” of each case. Assuming s588G(1)(b) was met, the next question is whether there was reasonable ground for Andrew and Greg to suspect that the company was insolvent or would become insolvent. Palmer J in Hall v Poolman6 held that a suspicion of insolvency falls somewhere between a belief that insolvency exists, on the one hand, and a mere wondering whether it exists, on the other. To determine whether a director can be held to have had the required suspicion, either it is evident that he had actual awareness7 or a reasonable person in the same position and circumstances would have been so aware. 8 The existence of the objective test means Andrew and Greg may still be found liable even if they have had no actual awareness of insolvency because it is reasonable to expect a director of ordinary competence, being the standard for assessing the reasonableness of a director, to make himself aware of the financial situation of the company.9 If all elements of s588G are found satisfied in the court, Andrew and Greg will be held breaching their duties as directors to prevent insolvent trading and the liquidator’s application for compensation may be successful. Possible defences for Andrew and Greg There are several defences available to Andrew and Greg which will be aroused in the situations: 1. that when the debt was incurred the director had reasonable grounds to expect that the company was solvent and would remain solvent even if the debt was incurred;10 2. that when the debt was incurred the director had reasonable grounds to believe, and did believe, that a subordinate was competent, reliable and responsible for providing adequate information about the company’s solvency and the director expected, on the basis of this information that the company was solvent and would remain solvent; 11 6

Hal l vPool man( 2007)65ACSR123 Ibid, s588G(2)(a) 8 Ibid, s588G(2)(a) 9 Mc Lel l an,ReTheSt ak eManPt yLt dvCar r ol l( 2009)76ACSR67;[ 2009]FCA1415 10 Ibid, s588H(2) 11 Ibid, s588H(3) 7

4 3. that when the debt was incurred the director, because of illness or for some other good reason, did not take part in the management of the company at that time;12 or 4. that the director took all reasonable steps to stop the company from incurring the debt.13 From the evidence provided, it does not appear that Andrew and Greg would be able to prove any of the above defences. Andrew and Greg may also seek “safe harbour” under the section 588GA which has been added to the Act in September 2017. This section allows the director of a company that is insolvent to continue to run the business if he starts to put together a plan that is reasonably likely to put the company in a better position than it would have been compared to a liquidation or voluntary administration. To assess whether the plan is “reasonably likely” to lead to a better outcome, regard may be had to whether the director: 1. is properly informing himself or herself of the company’s financial position; or 14 2. is taking appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company’s ability to pay all its debts;15 or 3. is taking appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company;16 or 4. is obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice;17 or

12

Ibid, s588H(4) Ibid, s588H(5) 14 Ibid, s588GA(2)(a) 15 Ibid, s588GA(2)(b) 16 Ibid, s588GA(2)(c) 17 Ibid, s588GA(2)(d) 13

5 5. is developing or implementing a plan for restructuring the company to improve its financial position.18 Notably, two main hurdles are set out in section 588GA (4) & (5), which restricts access to the safe harbour provisions if: 

all employee entitlements of the company were not paid as they fall due;19 or



all of the company’s tax returns was not filed properly;20 or



the directors fail to cooperate with the controller or the liquidator. 21

In this case, the company failed to lodge tax returns or prepare financial statements after the financial year ended 30 June 2013 or to lodge BAS Statements after the quarter ending 31 December 2013, and Andrew and Greg failed to cooperate with the liquidator and provide the requested information under section 530A. Therefore, it appears that both section 588GA(4)(b)(ii) and (5) are applicable here, either of them could stop Andrew and Greg from taking advantage of the safe harbour provisions. However, understanding that the above failures were partly caused by the misconduct of the company accountant who lost the company’s books and records, Andrew and Greg may seek waiver of section 588GA (4) & (5) to the court by claiming that the failure were due to exceptional circumstance under section 588GA(6). If Andrew and Greg are deemed to have contravened s588G of the Act, an application can be made to the court seeking relief from liability under section 1317S and 1318 of the Act. The purpose of the relief provisions is to “excuse company officers from liability in situations where it would be unjust and oppressive not to do so…”. 22 In is also held that by a broad legislative policy it should not impose liability on a director if the contravention of s588G of the Act was the result of an honest 18

Ibid, s588GA(2)(e) Ibid, s588GA(4)(a)(i) 20 Ibid, s588GA(4)(b)(ii) 21 Ibid, s588GA(5) 22 Hal l vPool man( 2007)65ACSR123 19

6 error or inadvertence. That said, this policy must be balanced with third party and public interest by ensuring that the company complies with obligations of the Act.23 In determining whether relief should be granted, there are two stages of assessment for these provisions: 1. Andrew and Greg prove that they have acted honestly; and 2. When considering all the circumstances, Andrew and Greg ought fairly to be exonerated from liability either wholly or partly. For the stage one assessment, the court held that if a director, in carrying out its duties acted without deceit and intent to obtain an improper advantage then this can be accepted as proving the director acted honestly. source not found

Error: Reference

The court also held that the test for honesty should be determined

based on the ordinary meaning of the word having regard to the commercial context.Error: Reference source not found Based on the information provided, it is likely the court may hold that Andrew and Greg have acted honestly. Once they are held to have acted honestly, the court then considers whether they ought fairly to be excused from liability. In considering whether the breach ought to be excused, the court can consider how the breach occurred and the seriousness of the breach,24 and whether they have “acted honourably, fairly, in good faith and in a common-sense manner as judged by the standards of others of a similar professional background.” 25 In this case, Andrew and Greg, being the director of the business who supervised the work of the company accountant, should have noticed the loss of the financial documents and rectified the issue as soon as it occurred. Their omission may amount to the failure of stage two assessment if we consider the decision in Smith v Boné.

26

In this case, the court dismissed the

applicants’ claim for relief based on the finding that the director, in the entire duration of the insolvent trading period, failed to seek credible advice about the true financial status of the company.Error: Reference source not found 23

Wav eCapi t alLt d( 2003)FCA969at29 Vi nesvAust r al i aSecur i t i esandI nv est ment sCommi ssi on( 2007)73NSWLR451 25 ASI CvEdwar ds( No.3)( 2006)NSWSC376at10 26 Smi t hvBoné,i nt hemat t erofACN002864002Pt yLt d( i nl i q)[ 2015]FCA319

24

7 In conclusion, because of the apparent failure to meet section 588GA(4)(b)(ii) and (5), Andrew and Greg may make a defence against the liquidator’s action under the section 588GA safe harbour provision only if the court accepts a waiver

due

to

exceptional

circumstance

under

section

588GA(6).

Furthermore, if Andrew and Greg are held liable, they may have grounds for an application to the court seeking relief from liability under section 1317S and 1318 of the Act. However, the relief application is likely to fail because the court may not be satisfied that they ought fairly to be exonerated from liability either wholly or partly despite they appear to have acted honestly....