#10848 - The Duty To Prevent Insolvent Trading - Business Associations 1

S 588G – Director’s duty to prevent insolvent trading by company

1. Application: This section applies if:

   1. A person is a director of a company at the time the company incurs a debt; and

   2. The company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and

   3. At that time there are RG for suspecting that the company is insolvent, or would so become insolvent and

   4. That time is at or after the commencement of this Act

(1A) is a debt table which shows when certain debts are incurred

Dividend – when paid or when declared if the constitution provides for declaration

Reduction of share capital – when the reduction takes effect

Buying back shares – when the buy-back arrangement is entered into

Redeeming redeemable preference shares that are redeemable at its open – when the option is exercised

Issuing redeemable preference shares redeemable otherwise than by option – when the shares are issued

Financially assisting a person o acquire shares in itself or a holding company – when the agreement to provide assistance is entered into or, if there is no agreement, when assistance is provided

Entering into an uncommercial transaction other than by court order – When the transaction is entered into

2. Failure to prevent debt: By failing to prevent the company from incurring the debt, the person contravenes this section if

   1. They are aware that at the times there were such grounds for so suspecting or

   2. An RP in a like position in a company in the company’s circumstances would be so aware

3. Where a company commits offence: A person commits an offence if:

   1. A company incurs a debt at a particular time

aa. At that time, a person is a director of the company; and

2. The company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and

3. The person suspected at the time when the company incurred the debt that the company was insolvent or would become insolvent as a result of incurring that debt or other debts (as in (1)(b))

4. And the person’s failure to prevent the company incurring the debt was dishonest

(3A) An offence based on (3) absolute liability applies to (3)(a)

(3B) For the purpose of an offence based on (3); Strict liability applies to (3)(aa) and (b)

[Note Hall v Poolman – conduct of directors attempting to save the business by negotiating, though unsuccessfully, a settlement with the ATO was held to justify relief from liability until a reasonable business person would have been aware that the business couldn’t be saved in the short term [w/in 3 months ] under s 1317S]

S 588H – Defences

1. Application – This section has effect for the purpose of proceedings for a contravention of s 588G(2) irt the incurring of a debt (and proceedings under s 588M irt incurring a debt)

2. Defence of reasonable presumption of solvency – It is a defence if it is proved at the time when the debt was incurred that the person had RG to expect, and did expect, that the company was solvent and would remain solvent if the debt and any other debts incurred at the time, were so incurred

3. No general limits: WLOG (2) it is a defence if it is proved that, at the time the debt was incurred the person:

   1. Had RG to believe and did believe,

      1. That a competent and reliable person (other person – OP) was responsible for providing to the first person, adequate information about whether the company was solvent; and

      2. That the person was fulfilling that responsibility; and

   2. Expected, on the basis of information provided to them, that the company was solvent at the time and would remain solvent when the debt and any other debts incurred at the time, were so incurred

4. Defence of illness: If the person was a director of the company when the debt was incurred, it is a defence if it is proved that, because of illness or for some other good reason, he or she did not take part at that time in the management of the company

5. Defence of reasonable steps: It is a defence if it is proved that the person took all reasonable steps to prevent the company from incurring the debt

6. Matters in determining defence: In determining whether a defence under (5) has been proved, the matters which regard is had include:

   1. Action taken with a view to appointing an administrator and

   2. When that action was taken; and

   3. The results of that action

Division 4 – Director Liable to Compensate

Subdivision A – Proceedings against Director

s 588J On application for civil penalty order, court may order compensation

1. Where, on application for a CPO against a person in relation to a contravention of s 588G(2) if the court is satisfied that:

   1. The person committed a contravention irt incurring of a debt by a company; and

   2. The debt is wholly or partly unsecured; and

   3. The person to whom the debt is owed has suffered loss or damage irt the debt because of the company’s insolvency

The court may (w/o/n it makes a PPO under s 1317G or an order under s 206C for disqualification) order the person to pay compensation equivalent to the loss

2. Liquidator can intervene in proceedings relating to a CPO for contravention of s 588G(2)

3. And is entitled to be heard on certain matters (726)

S 588K (Criminal court can do the same on an application under s 588G(3)

S 588L Enforcement of order under s 588J-K – These two orders can be enforced as if a judgment of the court

S 588M – Recovery of compensation for loss resulting from insolvent trading

1. Application: This section applies where:

   1. A person (director) has contravened s 588G(2)-(3) irt the incurring of a debt and

   2. The person (creditor) to whom the debt is owed has suffered loss or damage irt the debt because of the company’s insolvency; and

   3. The debt was wholly or partly unsecured when the loss or damage was suffered; and

   4. The company is being wound up

Whether or not

5. The director has been convicted of an offence irt the contravention or

6. A CPO has been made against them irt the contravention

2. The liquidator can recover from the director, as a debt due to the company, an amount equal to the loss/damage

3. The creditor may, as provided in Subdivision B but not otherwise, recover from the creditor, as a debt due to the creditor, an amount equal to the amount of loss or damage

4. Proceedings can begin within 6 years of winding up

S 588N – Avoiding double recovery – an amount recovered in proceedings under s 588M in relation to the incurring of a debt by a company is to be taken into account in other proceedings relating to the incurring of the debt

S 588P – Effect of s 588J, K, M – these sections have effect in addition to any rule of law about their duty/liability because of the person’s office/employment in relation to the company and do not prevent proceedings being constituted in respect of a breach of that liability

S 588Q – A certificate evidencing contravention of these sections signed by the Registrar is conclusive evidence that a declaration was made, the person was convicted of an offence or the person was so found and the person committed the contravention

Subdivision B – Proceedings by a creditor

s 588R Creditor may sue for compensation with liquidator’s consent – They can bring proceedings under s 588M with consent of the liquidator

s 588S Creditor may give liquidator notice of intention to sue for compensation [(b) and ask them for consent or a written statement of reasons why the liquidator thinks proceedings shouldn’t be begun]

s 588T When creditor may sue for compensation without liquidator’s consent

1. This section is enlivened where notice is given under s 588S

2. The creditor can begin proceedings in a court under s 588M irt the incurring of the debt specified in the notice if:

   1. As at the end of the 3 months the liquidator receives the notice, he/she hasn’t consented to it

   2. On an application made after those 4 months, the court gives leave for proceedings to begin

3. The liquidator if they disagree with proceedings can give a written statement to the creditor which willb e considered by the court

S 588U – Events preventing the creditor from suing

1. Where creditor may not commence proceedings: A creditor of a company that is being wound up cannot begin proceedings under s 588M irt the incurring of a debt by the company if:

   1. There has been an application under s 588F

   2. The company’s liquidator has already begun proceedings under s 588M

   3. The liquidator has intervened in an application for a CPO against a person irt a contravention

[7.135] The duty comes amidst a number of reforms to do with the procedure for voluntary administration (s 436A(1) – directors can put a company into VA if insolvent or likely to be – thus avoiding the prospects of personal liability in respect of debts incurred)

[7.140] An overview of the elements of the duty

Redmond identifies five steps:

1. It applies to a person who was a director at the time the company incurred the debt (s 588G(1)(a))

2. The company must have been insolvent at the time, or became insolvent by incurring it, or by incurring at that time debts including that debt (s 588G(1)(b))

3. The debt must be incurred after commencement – 23 June 1993 (s 588G(1)(d))

4. At the time there were reasonable grounds for suspecting that the company was insolvent or would become insolvent (s 588G(1)(c))

5. The director must be aware at the time that here are such grounds for suspecting insolvency, or a reasonable person in a like position in a company in the company’s circumstances would be so aware (s 588G(2))

   1. The mere failure...