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Is Your Company in Financial Distress?

business insolvency

The Corporations Act (Cth) 2001 (the Act) imposes a duty on directors to prevent their company from trading while insolvent. This duty seeks to balance two, often competing, interests: creditor protection and directors personal liability. It is a particularly onerous duty and, if breached, can make a director personally liable for the debts of the company. As such, there is an argument that the current statutory business judgment rule ought to be extended to act as a defence for directors for a breach of this duty.

CURRENT LAW AND POLICY

Pursuant to section 588G of the Act directors have a duty to prevent their company from engaging in insolvent trading. A contravention of section 588G may result in civil and criminal sanctions for the director.

A liquidator or creditor can recover from a director any loss suffered by creditors as a result of a breach of this duty. With significant civil and criminal penalties attached to a contravention of this duty, the legislative intention is clear: do not trade while insolvent.

A director may avoid personal liability pursuant to the defences in section 588H of the Act, or the general relief provisions. The decisions of Hall v Poolman and McLellan, in the matter of The Stake Man Pty Ltd v Carroll (Stake Man) emphasise the stringent interpretation of the currently available statutory defences. A director may further seek to rely on general relief provisions contained in sections 1317S and 1318 of the Act.

EXTENDING THE BUSINESS JUDGMENT RULE

Whether the current insolvency regime strikes the appropriate balance between directors’ personal liability and creditor protection is uncertain.

Advocates for the current regime view that the current duty of a director to prevent insolvent trading necessarily favour creditors. From this view, an extension of the statutory business judgment rule would unnecessarily weaken the current protection afforded to unsecured creditors.

At present, as illustrated in Stake Man, a director must prove that a person was engaged for the purpose of supplying information regarding the company’s state of solvency and not merely advice of a general nature, in order to successfully rely on the defence in section 588H(3).

Advocates for extension of the business judgment rule view that this addition to the current regime would provide further incentive to directors to work through issues faced by a company, rather than potentially prematurely placing a company into liquidation. Directors are under strict duties and obligations, and the current regime requires flexibility to allow directors to operate effectively, particularly in times of adverse financial circumstances.

The general relief provisions compliment the statutory defences in providing a fall-back position for those directors that fail to satisfy the criteria established by the defences in section 588H. These general relief provisions are purely discretionary and, unlike the section 588H defences, do not eliminate the breach but rather excuse the contravention.

Regardless of the above views, any extension of the statutory business judgment rule would suffer from the same deficiencies of present insolvent trading defences, that being the illusive test of ‘insolvency’ (as stated at section 95A of the Act). It is the uncertainty surrounding when a company is deemed to be insolvent that is, arguably, the cause for directors’ inconsistent behaviour in circumstances where their company is facing financial distress.

Should you wish to discuss your duties as a director or the implications of any breach, please feel free to contact our Brendan Pitman or Matthew Tyrrell on (07) 3470 3600.