#7412 - Directors’ Statutory Duty To Prevent Insolvent Trading - Business Associations I

Class 16 Directors’ statutory duty to prevent insolvent trading

Corporations Act ss 588G-588U. Note: Definition of insolvency in s 95A; definition of director in s 9.

CORPORATIONS ACT 2001 - SECT 95A

Solvency and insolvency

Definition of insolvency- s95A- cash flow test. Two important changes at insolvency. Insolvency official not directors. Creditors not shareholders. Reasons for insolvency regulation. No creditors free for all. Preserve priorities. Maintenance of capital for creditors. Avoidance provisions for fraudulent and uncommercial transactions. Solvent versus insolvent winding up.

Types and stages of insolvent administration. External administration. Voluntary administration. Appointment of a receiver. Creditors scheme of arrangement. Winding up. Liquidation.

588G is a civil remedy provisions but also provides a way to sue the directors on behalf of the creditors who have been harmed as a result of 588G.

(1) A person is solvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable.

(2) A person who is not solvent is insolvent.

(a) a person who:

(i) is appointed to the position of a director; or

(ii) is appointed to the position of an alternate director and is acting in that capacity;

regardless of the name that is given to their position; and

(b) unless the contrary intention appears, a person who is not validly appointed as a director if:

(i) they act in the position of a director; or

(ii) the directors of the company or body are accustomed to act in accordance with the person's instructions or wishes.

Subparagraph(b)(ii) does not apply merely because the directors act on advice given by the person in the proper performance of functions attaching to the person's professional capacity, or the person's business relationship with the directors or the company or body.

Note: Paragraph(b)--Contrary intention--Examples of provisions for which a person referred to in paragraph(b) would not be included in the term "director" are:

* section249C (power to call meetings of a company's members)

* subsection 251A(3) (signing minutes of meetings)

* section205B (notice to ASIC of change of address).

CORPORATIONS ACT 2001 - SECT 588G

Director's duty to prevent insolvent trading by company

(1) This section applies if:

(a) a person is a director of a company at the time when the company incurs a debt; and

(b) 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

(c) at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be; and

(d) that time is at or after the commencement of this Act.

(1A) For the purposes of this section, if a company takes action set out in column 2 of the following table, it incurs a debt at the time set out in column 3.

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

(a) the person is aware at that time that there are such grounds for so suspecting; or

(b) a reasonable person in a like position in a company in the company's circumstances would be so aware.

Note: This subsection is a civil penalty provision (see subsection 1317E(1)).

(3) A person commits an offence if:

(a) a company incurs a debt at a particular time; and

(aa) at that time, a person is a director of the company; and

(b) 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

(c) 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 paragraph(1)(b)); and

(d) the person's failure to prevent the company incurring the debt was dishonest.

(3A) For the purposes of an offence based on subsection(3), absolute liability applies to paragraph(3)(a).

Note: For absolute liability , see section6.2 of the Criminal Code .

(3B) For the purposes of an offence based on subsection(3), strict liability applies to paragraphs(3)(aa) and (b).

Note: For strict liability , see section6.1 of the Criminal Code .

(4) The provisions of Division4 of this Part are additional to, and do not derogate from, Part9.4B as it applies in relation to a contravention of this section.

CORPORATIONS ACT 2001 - SECT 588H

Defences

(1) This section has effect for the purposes of proceedings for a contravention of subsection 588G(2) in relation to the incurring of a debt (including proceedings under section588M in relation to the incurring of the debt).

(2) It is a defence if it is proved that, at the time when the debt was incurred, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.

(3) Without limiting the generality of subsection(2), it is a defence if it is proved that, at the time when the debt was incurred, the person:

(a) had reasonable grounds to believe, and did believe:

(i) that a competent and reliable person (the other person ) was responsible for providing to the first-mentioned person adequate information about whether the company was solvent; and

(ii) that the other person was fulfilling that responsibility; and

(b) expected, on the basis of information provided to the first-mentioned person by the other person, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.

(4) If the person was a director of the company at the time 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) It is a defence if it is proved that the person took all reasonable steps to prevent the company from incurring the debt.

(6) In determining whether a defence under subsection(5) has been proved, the matters to which regard is to be had include, but are not limited to:

(a) any action the person took with a view to appointing an administrator of the company; and

(b) when that action was taken; and

(c) the results of that action.

CORPORATIONS ACT 2001 - SECT 588J

On application for civil penalty order, Court may order compensation

(1) Where, on an application for a civil penalty order against a person in relation to a contravention of subsection 588G(2) , the Court is satisfied that:

(a) the person committed the contravention in relation to the incurring of a debt by a company; and

(b) the debt is wholly or partly unsecured; and

(c) the person to whom the debt is owed has suffered loss or damage in relation to the debt because of the company's insolvency;

the Court may (whether or not it makes a pecuniary penalty order under section1317G or an order under section206C disqualifying a person from managing corporations) order the first-mentioned person to pay to the company compensation equal to the amount of that loss or damage.

(2) A company's liquidator may intervene in an application for a civil penalty order against a person in relation to a contravention of subsection 588G(2).

(3) A company's liquidator who so intervenes is entitled to be heard:

(a) only if the Court is satisfied that the person committed the contravention in relation to the incurring of a debt by that company; and

(b) only on the question whether the Court should order the person to pay compensation to the company.

CORPORATIONS ACT 2001 - SECT 588K

Criminal court may order compensation

If:

(a) a court finds a person guilty of an offence under subsection 588G(3) in relation to the incurring of a debt by a company; and

(b) the court is satisfied that:

(i) the debt is wholly or partly unsecured; and

(ii) the person to whom the debt is owed has suffered loss or damage in relation to the debt because of the company's insolvency;

the court may (whether or not it imposes a penalty) order the first-mentioned person to pay to the company compensation equal to the amount of that loss or damage.