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Questions:

(a). Advise the directors whether they are liable for breaching the insolvent trading provisions of the Corporations Act 2001. Also advise whether they have any defences available to them if they have in fact breach the insolvent trading provisions.
 
(2). Advise the directors and other officers whether they have any liability for signing off on the 2015 financial accounts.
 
(3). Advise what is the liability of Mr Smith for his actions leading up to the voluntary administration of XYZ Co Ltd? Explain what law might apply to Mr Smith and whether he has breached any duties owed to the company committed any offences.

 

Answers:

(a):

Mr. Smith is a retired director of the company named XYZ CO Ltd. He was not appointed as a director for the present year, 2014, however, he continued to attend many of the business matters within the company and is regularly part of the business meetings to advise and mentor the new directors. In return, Mr. Smith receives a consultancy fee for his work and the new directors generally follow the advice of Mr. Smith in the way in which they should run a company. The company was recently audited and the auditors and directors of the company with the recommendation of the company’s CFO, Brian, signed off the financial accounts in the year 2015 as true and correct. However, at the end of the year 2015, it was found that the company was unable to pay its debts and the company was held insolvent for the year 2015. Based on the facts, the issue that arises here is whether; the directors are liable for breaching the insolvent trading provisions of the Corporations Act, 2001.

A company is considered as a separate legal entity and it has the same rights and powers like that of any other normal person. This means that a company can borrow, enter into contracts and sell or buy its assets[1]. Every company has a director and the directors of the company should remember that the company owns their property, the company is responsible for paying their debts and the money that is invested by the company is for the repayment of their shares. Hence, it may concluded that a company is a separate legal entity[2]. Sometimes it may so happen, that directors are not formally appointed however, they continue to act as directors this is called “shadow directors.” In this case, Mr. Smith is considered as shadow director. He also discharged most of the duties as the director of the XYZ Company. Shadow directors can be held liable for breaches of the laws relating to the duties of the director, even though they were never appointed as a director of the company[3]. The first scenario invokes the provision relating to insolvent trading. “Insolvent trading” is when the directors allow their company to earn debts when the company had become insolvent. The liquidators can hold the directors liable for payment of the debts against the directors of the company the moment liquidation begins. A director may he held personally liable for the payment of the debts at the time when the company became insolvent. A company may be declared as insolvent when it cannot pay its debts. According to section 95 A of the Corporations Act, insolvency means a person who is unable to pay their debts the moment it becomes payable and due. Section 588A of the Corporations Act, 2001, deals with, how directors can be held liable for insolvent trading. According to section 588A, it is the duty of the director to prevent insolvent trading within the company[4]. A director can be held liable for contravening this section when the directors knowingly allow the company to incur the debt when they were aware of the fact that the company was insolvent. Hence, in the given case scenario if we apply section 588A of the Corporations Act, the directors of XYZ Company can be held liable for breaching the provisions relating to insolvent trading. The directors also signed off the financial reports without proper assessment and made a declaration that there is no scope that the company was insolvent. The defences that may available to the directors in this case as per the Corporations Act are as follows:

  • The directors had all grounds to believe that the company was solvent. In this case, the directors may use this defence, as the CFO audited the company and made a financial report stating that all the records of the company are fine[5].
  • A competent, reasonable person produced all information that made the directors belief that the company was solvent[6].
  • The director had a good reason for not taking part in the management of the company at that particular time.
  • The director took all the reasonable steps to prevent the company from earning debt; this includes attempting to appoint a voluntary administrator for the company that had become insolvent[7]. 
 

(b):

Following the facts that is stated in answer a, it was noted that XYZ Company was recently audited and the directors after proper recommendation of Brian had signed off the financial accounts declaring it as true and correct. As per the Australian Company Law, it is the responsibility of the company to file and lodge financial reports with the ASIC and the reports should contain a column wherein the declaration can be made from the director. This is particularly in regard with the financial report of the company. The declaration that is made by the directors includes:

  • That, in the opinion of the directors, the company shall have all means to pay off their debts as and when they become due on the company[8].
  • That, the statements that are made by the company comply with the general accounting standards and performance of the company.
  • If the company is listed then the directors of the company have to make a declaration that is to be provided by the Chief Executive Officer (CEO) and Chief Executive Officer (CFO)[9].

It is the duty of the director to ensure that each of them have proper duty, skill and diligence in understanding the financial report that will be disclosed to the public. It is the duty of the director to ensure that each of the clause contained in the report are fair, true and correct as to the knowledge of the director[10]. The director has the duty to ensure that the financial report that is issued is fair, and reasonable and correct. Section 314 of the Corporations Act, 2001 a company must report to all the members of the company at the end of the financial year, which shall be made in accordance with sections 1AA or, 1AE of the Corporations Act, 200[11]1.  According to section 314 of the Act, a company has to produce a director report, auditor report or financial report at the end of the year. The role of the audit committee plays a very important role in making sure that the audit quality or financial report of the company is fair and correct. However, the establishment of the audit committee does not affect the responsibility of the director in ensuring that the report was correct and fair. The director have the responsibility in ensuring that the CFO and the CEO of the company are qualified enough to have established roles while issuing the financial reports of the company[12]. The directors also have to ensure that the financial reports comply with the records of the company and comply with the basic accounting standards. Hence, it is expected that directors have the basic knowledge of the accounting standards and principles. If a company is a listed company then the declarations that are made by the CFO and CEO should comply with the financial accounting standards of the company. The directors of the company are considered as important watchdogs of the company it is believed that they have sufficient knowledge about the accounting principles and standards of the company. The directors of the company should be educated, they should be updated about the accounting principles and standards, and that the financial reports have met the requirements of the Corporations Act[13]. In this case, the CFO is considered as the main head of the financial industry, he is expected to have expertise in the field of financial industry and hence it is a general belief that he has the best knowledge of the company’s financial details. In this case, it was expected from Brian to understand when the company was going to become insolvent and at the right time, he should have informed the directors about it. Hence, it was the responsibility of the director and the CFO to ensure and make proper financial report of the company. The directors and the CFO of the company should have ensured that the financial reports are correct before signing off on the 2015 financial accounts. 

 

(c):

It was noted that at the end of the financial year, the company was not able to pay a number of their debts and that Mr Smith on behalf of the company, negotiates with the creditors for an extension of time to pay back what the company owes. However, in the beginning of the year 2016 the company declared voluntary administration. It was discovered by the external administrators of the company, that the company has sold some of their very valuable property to Mr Smith below the market price before his retirement as a director. Based on the facts, the issue that arises here is the liability of Mr Smith and his actions that has led to the voluntary administration of XYZ Co Ltd.

A voluntary administration is, when the company is assisted with the help of a qualified administrator, to improve the financial position of the company and to get the company back on its feet. The voluntary administration happens with the help of the creditors. If the voluntary administration is linked with the action of Mr. Smith that happened even before his retirement then he should be held liable for buying the assets of the company for a lesser price. Mr Smith can be held liable for breaching sections 180 to 183 of the Corporation Act, 2001. This section contains the general duty of the director[14]. According to section 180 of the Corporation Act, 2001 a director should exercise their power and discharge their duties using diligence and care. The directors of the company should act in good faith and should ensure that none of their acts affects the company in a way that causes their downfall. According to section 181 of the Corporations Act, 2001, the directors of the company should exercise their rights and powers that act in best interests of the company and for a good purpose[15]. The directors under no circumstances misuse the power that is endowed on them. The directors are restricted from misusing their powers in such a way that is helps them in taking advantage of their position and use them for their personal benefit. According to section 183 of the Act, a director should not act in a way that causes detriment to the company and to the other members of the company. The final two sections deal with the civil obligation of the directors. If the Court determines that the act of the director has violated the civil liability then the Court may order civil penalty to the directors. In the same way, if after due determination it is seen that the directors violated their duty that amounted to criminal breach then the court may pass an order of criminal action against the director. The Court may pass an order for a criminal action against the director if the director recklessly failed to discharge his duties as a director[16]. This means the capacity of the Directors in infringing a given power is determined with the extent of the breach committed. In the given case scenario, Mr Smith can be held liable for breach of his duty as a director because he bought the property of the company at a lower price than the market price and he used the property of the company for his personal gain or advantage. Hence, Mr. Smith can he held liable for breach of his duty as a director. 

 

References:

Bromley, Macaire. "Special report on the Productivity Commission's review of restructuring practices in Australia." Governance Directions 67.8 (2015): 471.

Frankel, Susy, and Megan Richardson. "Limits of Free Trade Agreements: The New Zealand/Australia Experience." Intellectual Property and Free Trade Agreements in the Asia-Pacific Region. Springer Berlin Heidelberg, 2015. 315-333.

Godwin, Andrew. "Teaching Transactional Law-A Case Study from Australia with Reference to the US Experience." Transactions: Tenn. J. Bus. L. 16 (2014): 343.

Gray, Anthony. "Development of good faith in Canada, Australia and Great Britain." Canadian Business Law Journal 57.1 (2015): 84-119.

Hanrahan, Pamela F., Ian Ramsay, and Geofrey P. Stapledon. "Commercial applications of company law." COMMERCIAL APPLICATIONS OF COMPANY LAW, CCH Australia Ltd, (2013).

Krever, Richard, and Peter Mellor. "Legal Interpretation of Tax Law: Australia." Legal Interpretation of Tax Law (Amsterdam: Kluwer, 2014)(2014): 15-45.

Krever, Richard, and Peter Mellor. "Legal Interpretation of Tax Law: Australia." Legal Interpretation of Tax Law (Amsterdam: Kluwer, 2014)(2014): 15-45.

Marginson, Simon. "Is Australia overdependent on international students?."International Higher Education 54 (2015).

Miller, Roger. Business Law Today, Standard: Text & Summarized Cases. Nelson Education, 2015.

Morrison, David, and Colin Anderson. "Is corporate rescue a realistic ideal? Business as usual in Australia and the United Kingdom." Nottingham Insolvency and Business Law e-Journal 2015.3 (2015): 417-435.

Semple, Noel, Russell G. Pearce, and Renee Newman Knake. "A Taxonomy of Lawyer Regulation: How Contrasting Theories of Regulation Explain the Divergent Regulatory Regimes in Australia, England and Wales, and North America." Legal Ethics 16.2 (2013): 258-283.

Stubbs, Wendy. "Investigation of emerging sustainable business models: the case of B Corps in Australia." Available at SSRN 2464758 (2014).

Taylor, Madeline. "Wrestling with giants-a critical account of supermarket power and competition laws in Australia and United Kingdom." Australian Business Law Review (2013).

Welsh, Michelle. "Realising the public potential of corporate law: Twenty years of civil penalty enforcement in Australia." Fed. L. Rev. 42 (2014): 217.

Wood, Azmi, and Jo-Anne Weinman. "Does law constitute identity? Indigenous allegiance and identity in Australia." Allegiance and Identity in a Globalised World (2014).

Zeller, Bruno, and Bill Cole. "Australian Trade Agreements–A Divergence between Trade Policy and Business Outcomes–Can They Deliver Trade-related Growth for Australia?." Global Journal of Comparative Law 3.2 (2014): 236-255.

[1] Miller, Roger. Business Law Today, Standard: Text & Summarized Cases. Nelson Education, 2015.

[2] Marginson, Simon. "Is Australia overdependent on international students?."International Higher Education 54 (2015). 

[3] Marginson, Simon. "Is Australia overdependent on international students?."International Higher Education 54 (2015).

[4] Miller, Roger. Business Law Today, Standard: Text & Summarized Cases. Nelson Education, 2015. 

[5] Marginson, Simon. "Is Australia overdependent on international students?."International Higher Education 54 (2015).

[6] Godwin, Andrew. "Teaching Transactional Law-A Case Study from Australia with Reference to the US Experience." Transactions: Tenn. J. Bus. L. 16 (2014): 343.

[7] Miller, Roger. Business Law Today, Standard: Text & Summarized Cases. Nelson Education, 2015. 

[8] Krever, Richard, and Peter Mellor. "Legal Interpretation of Tax Law: Australia." Legal Interpretation of Tax Law (Amsterdam: Kluwer, 2014)(2014): 15-45.

[9] Krever, Richard, and Peter Mellor. "Legal Interpretation of Tax Law: Australia." Legal Interpretation of Tax Law (Amsterdam: Kluwer, 2014)(2014): 15-45.

[10] Miller, Roger. Business Law Today, Standard: Text & Summarized Cases. Nelson Education, 2015. 

[11] Godwin, Andrew. "Teaching Transactional Law-A Case Study from Australia with Reference to the US Experience." Transactions: Tenn. J. Bus. L. 16 (2014): 343.

[12] Krever, Richard, and Peter Mellor. "Legal Interpretation of Tax Law: Australia." Legal Interpretation of Tax Law (Amsterdam: Kluwer, 2014)(2014): 15-45.

[13] Miller, Roger. Business Law Today, Standard: Text & Summarized Cases. Nelson Education, 2015. 

[14] Miller, Roger. Business Law Today, Standard: Text & Summarized Cases. Nelson Education, 2015.

[15] Godwin, Andrew. "Teaching Transactional Law-A Case Study from Australia with Reference to the US Experience." Transactions: Tenn. J. Bus. L. 16 (2014): 343.

[16] Miller, Roger. Business Law Today, Standard: Text & Summarized Cases. Nelson Education, 2015. 

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