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Directors’ Statutory Duty To Prevent Insolvent Trading Notes

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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. "director" of a company or other body means: (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:
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section 249C (power to call meetings of a company's members)
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subsection 251A(3) (signing minutes of meetings)
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section 205B (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. When debts are incurred Action of company 1 paying a dividend

2 3 4

[operative table]
When debt is incurred when the dividend is paid or, if the company has a constitution that provides for the declaration of dividends, when the dividend is declared making a reduction of share capital to when the reduction takes effect which Division 1 of Part 2J.1 applies (other than a reduction that consists only of the cancellation of a share or shares for no consideration) buying back shares (even if the when the buy-back agreement is entered into consideration is not a sum certain in money) redeeming redeemable preference when the company exercises the option shares that are redeemable at its option

When debts are incurred
[operative table]
Action of company When debt is incurred 5 issuing redeemable preference when the shares are issued shares that are redeemable otherwise than at its option 6 financially assisting a person to when the agreement to provide the acquire shares (or units of shares) in assistance is entered into or, if there is no itself or a holding company agreement, when the assistance is provided 7 entering into an uncommercial when the transaction is entered into transaction (within the meaning of section 588FB) other than one that a court orders, or a prescribed agency directs, the company to enter into (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 section 6.2 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 section 6.1 of the Criminal Code . (4) The provisions of Division 4 of this Part are additional to, and do not derogate from, Part 9.4B 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 section 588M 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 section 1317G or an order under section 206C 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. Note: Section 73A defines when a court is taken to find a person guilty of an offence. CORPORATIONS ACT 2001 - SECT 588L Enforcement of order under section 588J or 588K An order to pay compensation that a court makes under section 588J or 588K may be enforced as if it were a judgment of the court. CORPORATIONS ACT 2001 - SECT 588M Recovery of compensation for loss resulting from insolvent trading (1) This section applies where: (a) a person (in this section called the director ) has contravened subsection 588G(2) or (3) in relation to the incurring of a debt by a company; and (b) the person (in this section called the creditor ) to whom the debt is owed has suffered loss or damage in relation to the debt because of the company's insolvency; and (c) the debt was wholly or partly unsecured when the loss or damage was suffered; and (d) the company is being wound up; whether or not: (e) the director has been convicted of an offence in relation to the contravention; or (f) a civil penalty order has been made against the director in relation to the contravention. (2) The company's liquidator may recover from the director, as a debt due to the company, an amount equal to the amount of the loss or damage. (3) The creditor may, as provided in Subdivision B but not otherwise, recover from the director, as a debt due to the creditor, an amount equal to the amount of the loss or damage. (4) Proceedings under this section may only be begun within 6 years after the beginning of the winding up. CORPORATIONS ACT 2001 - SECT 588N Avoiding double recovery An amount recovered in proceedings under section 588M in relation to the incurring of a debt by a company is to be taken into account in working out the amount (if any) recoverable in: (a) any other proceedings under that section in relation to the incurring of the debt; and (b) proceedings under section 596AC in relation to a contravention of section 596AB that is linked to the incurring of the debt. CORPORATIONS ACT 2001 - SECT 588P Effect of sections 588J, 588K and 588M Sections 588J, 588K and 588M: (a) have effect in addition to, and not in derogation of, any rule of law about the duty or liability of a person because of the person's office or employment in relation to a company; and

(b) do not prevent proceedings from being instituted in respect of a breach of such a duty or in respect of such a liability. CORPORATIONS ACT 2001 - SECT 588Q Certificates evidencing contravention For the purposes of this Part, a certificate that: (a) purports to be signed by the Registrar or other proper officer of an Australian court; and (b) states: (i) that that court has declared that a specified person has, by failing to prevent a specified company from incurring a specified debt, contravened subsection 588G(3) in relation to the company; or (ii) that a specified person was convicted by that court for an offence constituted by a contravention of section 588G in relation to the incurring of a specified debt by a specified company; or (iii) that a specified person charged before that court with such an offence was found in that court to have committed the offence but that the court did not proceed to convict the person of the offence; is, unless it is proved that the declaration, conviction or finding was set aside, quashed or reversed, conclusive evidence: (c) that the declaration was made, that the person was convicted of the offence, or that the person was so found, as the case may be; and (d) that the person committed the contravention. CORPORATIONS ACT 2001 - SECT 588R Creditor may sue for compensation with liquidator's consent (1) A creditor of a company that is being wound up may, with the written consent of the company's liquidator, begin proceedings under section 588M in relation to the incurring by the company of a debt that is owed to the creditor. (2) Subsection (1) has effect despite section 588T, but subject to section 588U. CORPORATIONS ACT 2001 - SECT 588S Creditor may give liquidator notice of intention to sue for compensation After the end of 6 months beginning when a company begins to be wound up, a creditor of the company may give to the company's liquidator a written notice: (a) stating that the creditor intends to begin proceedings under section 588M in relation to the incurring by the company of a specified debt that is owed to the creditor; and (b) asking the liquidator to give to the creditor, within 3 months after receiving the notice: (i) a written consent to the creditor beginning the proceedings; or (ii) a written statement of the reasons why the liquidator thinks that proceedings under section 588M in relation to the incurring of that debt should not be begun. CORPORATIONS ACT 2001 - SECT 588T When creditor may sue for compensation without liquidator's consent (1) This section applies where a notice is given under section 588S. (2) The creditor may begin proceedings in a court under section 588M in relation to the incurring by the company of the debt specified in the notice if: (a) as at the end of 3 months after the liquidator receives the notice, he or she has not consented to the creditor beginning such proceedings; and (b) on an application made after those 3 months, the court has given leave for the proceedings to begin. (3) If: (a) during those 3 months, the liquidator gives to the creditor a written statement of the reasons why the liquidator thinks that such proceedings should not be begun; and (b) the creditor applies for leave under paragraph (2)(b); then: (c) the creditor must file the statement with the court when so applying; and (d) in determining the application, the court is to have regard to the reasons set out in the statement. CORPORATIONS ACT 2001 - SECT 588U Events preventing creditor from suing (1) A creditor of a company that is being wound up cannot begin proceedings under section 588M in relation to the incurring of a debt by the company if: (a) the company's liquidator has applied under section 588FF in relation to the debt, or in relation to a transaction under which the debt was incurred; or (b) the company's liquidator has begun proceedings under section 588M in relation to the incurring of the debt; or (c) the company's liquidator has intervened in an application for a civil penalty order against a person in relation to a contravention of subsection 588G(2) in relation to the incurring of the debt. (2) Subsection (1) has effect despite sections 588R and 588T.

Redmond [7.135]-7-210]. Director's Statutory Duty to Prevent Insolvent Trading

* Test of insolvency is when a company cannot pay its debts. They must have to pay all their debts as they become due and payable. Appointing a receiver is almost like appointing a one person board of receivers.

* A main way to show a company is insolvent is by making a statutory demand on a company under s459F? Compulsory winding up is ordered by the court, sole ground insolvency, persons who may apply are a creditor, contributory, director, liquidator, ASIC. Statutory demand- 459A-F. Mad by creditor for more than $2000. Not paid within 21 days of service. Only ground to resist is to prove solvency. Can prove debt is not owing but only by court application before end of 21 days.

* Prohibition on insolvent trading under 588G and H. Example of statutory veil piercing, avoid abuse of limited liability. Tough on directors? Cf USA. Trading out of trouble endgame and creditor protection? Makes directors too cautious? Have to compensate for higher risk? Extension of 588 pierces veil in groups.

* Elements of 588G and H. Company must be or be made insolvent; overlapping tests of insolvency- 95A, 588G(1)(b), 588G(1)(c), 588G(2). Company must incur a debt; 588G(2), director's duty is to avoid the company incurring debt if insolvent. What is debt? Debts must usually be liquidated not damages. Is giving a guarantee, incurring a debt? Contingent or current liability? Is it incurred or imposed? Voluntary act?
Taxes- sales, tax, not voluntary. But payroll tax is, because of voluntary act of hiring staff.

* Timing of incurring is important.

* Liability is imposed on directors s9 CA- includes shadow directors.

* Defences are in 588H. Reasons to expect Co to be solvent. Illness or other good reason. FCT v Clarke.

* Shareholders' remedies: o Theme. Protecting the few from the many. The limits of majority power. Protecting the company from the board. Still a shareholder primacy view. o Some legal baselines. Shareholders are property owners- freely dispose of rights including voting rights. Shareholders have no fiduciary duties to each other- including when voting. Shareholders can act in their own interests (cf directors). Directors owe duties to the company. Company is the proper plaintiff- foss v Harbottle. Fruits of litigation belong to the company. o Shareholder remedies: study of increasing list of exceptions under Harbottle.

* Four dimensions of shareholder remedies: o Shareholders personal actions. o Shareholders derivative actions o Winding up on just and equitable ground o Oppression remedy.

* Shareholder personal actions.

* On the contract- s140 CA. o Rights enjoyed as a member and by all members. o Eley v Positive Life Assurance Co. o Hickman v Kent and Romney Marsh Sheep Breeders.
? Hickman did not like what was happening in the sheep breeding association he belonged to and he took them to court. There was an arbitration clause requiring Hickman to take disputes to arbitration and the association won. o Bailey v NSW Medical Defence Union.
? Sued the medical defence union on the terms of the indemnity. He argued benefit of s140. He had got an indemnity and he enjoyed those rights with other members and he should be able to sue because he has the benefit. Court said indemnity is not part of the constitution and was given as a separate contract. Special contract.

o

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Limit to the types of rights that can be enforced on the contract of the constitution. Invidual rights to vote and get dividends. o The right to receive injunctive relief is a statutory right. So as a shareholder your interests are affected and may get injunctive religief under s1324. Statutory rights o Rights to enforce s140 contract o Right to seek injunctive relief 1324 o Rights to challenge class rights variations 246D o Rights to seek oppression remedy Pt 2F.1 o Right to seek winding up on 'just and equitable' ground s461 CA o Right to re misleading or deceptive conduct
? Sons of Gwalia v Margaretic
? S12DA ASICA or s1041H CA
? Subscriber or on market purchaser. Holdsworth's case.
? Is a deceived shareholder sueing 'as a member' or as a 'creditor'nature of claim.
? Not a case about fundamental change in shareholder/creditor priority and has now been reversed by statute. o Personal shareholder actions in equity. o A fiduciary relationship owed (exceptionally) by directors to shareholders. o Allotments of shares made for improper purpose. o Company (majority of shareholders) exercises a power to alter constitution that is beyond judicially set limits. A fiduciary relationship owed (exceptionally) by Directors to shareholders o Coleman v Myers
? There was a fiduciary relationship owed to the shareholders and this was exceptional finding because usually have duty to the corporation. o Brunninghausen v Glavanics Allotments of shares made for improper purposes- must be for capitalising the company or for something similar. That provides company with remedies against a director. o Residues Treatment and Trading v Southern Resources
? Emperor Mines made a takeover offer for Southern Resources. Southern Resources issued shares to another company called Square Gold so it wouldn't be taken over and this company became a major shareholder. The shareholder's have diminished controlling interest now that there is greater share capital- less premium of control- diluted. The plaintiffs did not have to observe the proper plaintiff rule but had a personal right to defend their share rights with wrongful issue in breach of director duties. This is a particular wrong of directors and not every breach gives a shareholder a personal equitable right to sue and mostly they don't have one because it won't be in an identifiable right in their parcel of rights that are being infringed. There is the right of the shareholder to have their say by virtue of their voting rights- and this standing is to preserve this against improper actions by directors.
? There can be no ratification to destroy individual rights. Its subject to difficulties about who gets the benefits. It is one straw in the wind towards the view that you need unanimous vote of shareholders to do this- vote in ratification of director's breach of duty. o Howard Smith v Ampol Petroleum o Dilution of voting power is fundamental to success of these claims as personal o Company (majority of shareholders) exercises a power to alter constitution that is beyond judicially set limits. o Greenhalgh v Aderne Cinemas

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