Insolvent Trading Liability Of Directors Under Section 588G Essay.

Director's duty to prevent Insolvent Trading

Discuss about the Australian Securities and Investments Commission.

The brief facts of this case are that a director was disqualified by the court for 10 years after the court discovered that there had been a breach of section 588G by such director on many occasions. It was stated by Barrett J that it is possible for a party to fail to act honestly without any subjective intention of deceiving the other by party. In this context, the court noted that there were at least six occasions when the director was aware that reasonable grounds existed to suspect that the corporation had become insolvent. So the director allowed the innocent creditor to move on the course of conduct that was certainly for the disadvantage of the director and it was beneficial for the personal interests of the director (ASIC v Vines, 2005]). Therefore such conduct was described by the court as being "not straightforward" and "morally wrong". The court also stated that the conduct had the elements of "moral terpitude".

In this regard, a duty has been enforced on the directors by s588G, which provides that the directors ought to stop insolvent trading. When it is considered by the law that the corporation is a separate legal entity that can enter into a contract in its own right, it is also followed that the persons behind the company, including the directors and shareholders of both missions, not personally liable regarding the debs of the Corporation. This principle has been firmly established in the decision given Solomon's case and is followed even today (Rich v ASIC, 2004). As a result of this basic concept is recognized by the law that there is a need for building the duties of the directors and particularly the need for introducing the liability of the directors in case of the debts taken by the corporation under certain state of affairs (Commonwealth Bank of Australia v Friedrich, 1991). The conduct of the directors, while managing the affairs of the Corporation, is governed by several duties that have been mentioned mainly in the Corporations Act, 2001 (The Act). In this regard, a specific deity has been imposed on the villages by section 588G. This duty requires the directors to stop the company from entering into a debt if the corporation is insolvent. The consequences of the breach of duty that has been mentioned in this section are as follows:

Consequences of Breach of Duty

Where the failure on the part of the directors to stop the company from incurring the debt was deceitful, a criminal offenses established by s588G(3). Therefore in such a case, as a result of the function of s1311 of the Act and schedule 3, a punishment can be given to the director in the form of conviction by penalty of 2000 units or imprisonment of five years or both;

Where the director is established as liable for an offense under section 588G(3),  it is available to the court to order. The directive of the compensation to the company for any loss that may be suffered by the creditors on account of the breach of duty by the director (588K);

A civil penalty provision is prescribed by section 3017E according to which the court may order that directed to pay pecuniary penalty. That may go up to $200,000 per charge on the application made by the ASIC or the director may be ordered by the court to pay compensation for the loss or damage on an application made by ASIC or to the company where the liquidator has intervened;

• A director can also be asked to pay compensation to the corporation on the application made by a liquidator for violating section 588G(2) in accordance with s588M; and
• The director can also be ordered by the court to pay compensation to the creditor on an application made by the editor in accordance with section 588R.

In this regard, it needs to be noted that section 588G is applicable if the person is a director of the corporation at the pertinent time when a debt was taken by the company; and the company is insolvent at the relevant time or has become insolvent after incurring such debt; and at the relevant time, reasonable grounds were present for the director to suspect that the company is insolvent or may become insolvent; and the failure of the person to prevent the company from incurring such debt can be considered as the contravention of this section if: the person is aware that such grounds are present for suspecting so; or , any reasonable person would have been so aware holding similar position in the company and under similar circumstances. Therefore an offense would be committed by the person if:

• The person is director of the company at the time of entering the debt;
• The company is insolvent at the relevant time or it may become insolvent after incurring the debt;
• The person suspected at the relevant time that the company was insolvent or may become insolvent due to incurring the debt; and
• The person dishonestly failed to prevent the company from incurring such a debt.

First of all, it has to establish that the person is the director of the company at the relevant time when the debt was incurred. However, generally this is not the main issue. It needs to be mentioned that the term "director" has been defined in section 9 of the Act. It also includes the persons who have not been validly appointed by still waiting in the position of the director and the persons upon whose directions the directors of the company generally acted or in other words, the shadow director. It needs to be noted in this regard that merely the fact that a person appears as a director in the ASIC search is not steadily conclusive proof of this fact (Maelor Jones Investments (Noarlunga) Pty Ltd v Heywood-Smith, 1989). There are certain situations where the spouse of the director appeared as a director in the years since his search but the sauce did not have any knowledge that he or she was a director and therefore never acted in the publicity as a director. Under such circumstances, even if a document signed by the person is produced, the question of whether the consent can still be raised. Similarly, the definition of director should not be confused with the "officer" of the company as it has much wider meaning. The provisions relating with insolvent trading have extra-territorial operations. Therefore, these provisions apply to the directors even if they are not the residents of Australia and even if the board meetings have taken place outside Australia.

Definition of Director under the Corporations Act

Another issue is the time when the company has incurred the debt. They liquidated is required to consider if the debts remain outstanding on the date of liquidation and in out of these debts, which debts were incurred at the relevant time. Therefore, only the debts that have been incurred at the relevant time and which were outstanding at the liquidation are relevant for the purpose of making compensation order. However this exercise can have certain problems. For example in the case, it was stated by the court that a contingent debt for payroll tax was a debt for the purpose of the current provisions related with insolvent trading. It was also stated by the court that the reference to incurring the debt needs to be applied in common sense and practical way. Therefore, for instance, if a company has entered into a contract of hire, and also agrees that it will pay premiums every month, the time when the company concluded such contract and incurred the liability, it was solvent. However after eight months, the company became insolvent and could not pay the fee. Therefore in such a case it cannot be said that the debt was incurred at that time.

In order to establish the civil liability of the director under s588G, it is essential for the liquidated to establish that the director and failed to stop the corporation from taking the debt when either the director was aware that reasonable grounds existed to suspect that company was insolvent; or any reasonable person acting in similar position and under the circumstances of the company would have been so aware (Corporate Affairs Commission v Papoulias, 1990). Therefore, the first issue that arises in this regard is in the liquidated his required to establish the failure of the director to prevent the company from incurring the debt. There are number of cases it has been stated by the court that this does not need that the director, acting alone, should be capable of preventing the company from incurring such debt (Australian Securities Commission v Forem-Freeway Enterprises Pty Ltd., 1999). In this regard obligations of the director can be described as follows. In case the director was indicted in rest supinely and protest that is not capable of acting without the contents of one or more of the directors when he was aware of the fact that the company was insolvent, the section would have little practical purpose. In such a case it would be wrong in the term 'authority' is construed narrowly and under the circumstances, the director was not required to take all the steps that were practical to prevent the company from trading when it had become insolvent (R J Elrington Nominees Pty Ltd v Corporate Affairs Commission, 1989)). The fact that generally a single director is not in a position to prevent the authorized person of the company to enter a contract regarding a debt is not relevant. If the director is unable to persuade the fellow directors for withdrawing such authority when the company has become insolvent, such director should try to have the company wound up or to resign from the company. If each director considers these obligations and acts accordingly, the company would soon be prevented from trading.

Time when Company incurs Debt

In this case, the court considered two points raised by the defendant. The first point was that in this case it was not found that the defendant had been involved in their deeply dishonest scheme or any criminal conduct or deception. Similarly, the defendant pointed out towards the fact that the defendant as good character, and it is unlikely that the defendant will re-offend. However, regarding the first issue, the court stated that first of all. It had already stated that the defendant had not acted honestly. Moreover, in context of statutory civil penalty that was relevant in the present case, it is not relevant that the particular conduct of the defendant cannot be described as a crime or, it involves any dishonest deception as a necessary element. The conduct amounting to particular statutory wrong cannot be discounted only due to the fact that it does not fit in any other category of wrongdoing. Regarding the matter related with the director of the defendant, the court stated that the affidavit evidence that was produced by the defendant does the defendant some sort of disservice (ASIC v Adler, 2002]). It is regarded needs to be noted that three out of the five character witnesses, argues exactly the same form of words, while commenting on the findings of the court regarding the defendant. Therefore this fact points out towards a strong impression of adoption of prepared text.

Under these circumstances, the finding of the court was that the defendant, Mr. Edwards had not acted honestly. Defining along with the fact that the past conduct of the defendant in other corporate context has on three occasions, resulted in adverse reports from the liquidators and receivers and also adverse comments made by Rogers CJ can be interpreted that the court should the defendant from the situations where the lack of honesty may again rebound to the disadvantage of the persons were dealing with the companies in which the defendant is involved. It has been shown that the defendant has misused the corporate structure in the present case and has also attracted criticism on similar grounds in earlier cases. Although at the theoretical level, the defendant may have understanding regarding the proper role of a director of the company but the defendant failed to translate theory into practice.

References

Australian Securities and Investments Commission v Adler [2002] NSWSC 483

Australian Securities and Investments Commission v Vines [2005] NSWSC 1349

Australian Securities Commission v Forem-Freeway Enterprises Pty Ltd (1999) 30 ACSR 339

Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115

Corporate Affairs Commission v Papoulias (1990) 20 NSWLR 503

Maelor Jones Investments (Noarlunga) Pty Ltd v Heywood-Smith [1989] SASC 1928

R J Elrington Nominees Pty Ltd v Corporate Affairs Commission (SA) (1989) 1 ACSR 93

Rich v Australian Securities and Investments Commission [2004] HCA 42