Director Breaches and Insolvency Trading
An incorporated private limited company has two directors and shareholders namely Liam and Peta. The company was unable to meet its debt obligations and thus became insolvent in June 2017. Under the instructions of Liam and Peta the company continued to transact even though there were tax liabilities which were not paid and creditors who could not be paid by the company. The issue is the determination of whether ASIC can impose civil and/or criminal liabilities on Liam and Peta.
The Corporations Act, 2001 regulates and governs companies functioning within the jurisdiction of Australia. It has been decided in Sutherland v Hanson Construction Materials Pty Ltd [2009] NSWSC 232 that the solvency of a company is determined by its ability to meet its debt on a given day[1]. Section 95A (1) of the Corporations Act, 2001 states that when a company is unable to meet its debt obligations it is considered insolvent. It has been further provided for in Section 95A (2) that a company that is not solvent under the provisions of Section 95A (1) is considered insolvent[2].
The Corporations Act, 2001 prohibits insolvent trading. This means that when a company is not able to meet its debt obligations the directors of the company have a statutory duty to ensure that the company refrains from incurring further debt by entering into transactions. Even if no additional debt is incurred transaction during insolvency are prohibited. This liability of directors is stated under Section 588G of the Corporations Act, 2001[3]. In case the company continues to transact during insolvency and such transactions are carried on dishonestly the director would be guilty of a criminal offence. This has been stated in Section 588 (3) of the Corporations Act, 2001.
If insolvent trading is established, under a civil action ASIC would be entitled to impose the following liabilities[4]:
- Disqualification from managing companies;
- Imposing a fine that is substantially high;
- Demanding compensation on behalf of the company for any loss suffered by creditors as per the provisions of Section 588J of the Corporations Act, 2001.
As provided for in Section 588K of the Corporations Act, 2001 ASIC imposes criminal liabilities for dishonest insolvent trading.
The facts stated make it evident that the company could no longer meet its debt obligations and thus the company devised a mechanism to ensure priority creditors are paid while lower priority creditors were kept on hold. Thus it can be inferred that through its inability to meet its debts it would be considered insolvent as per the provisions of Section 95A (1) of the act. The directors of the organization were thus required to cease all business transactions on behalf of the company as provided in Section 588G of the Corporations Act, 2001.
Liam however was unaware of the financial position of the company and this was due to his terminal illness. Thus Liam was not acting in bad faith and could not have informed himself of the financial position of the company due to the illness. Thus Liam was in breach of his civil obligations but was not transacting dishonestly so liabilities under Section 588K would not apply. Peta however was not facing any such illness or hindrance and should have ideally ceased to transact on behalf of the company. Thus Peta would be liable to face civil and criminal penalties.
Conclusion
- ASIC would be entitled to initiate civil and criminal actions against Peta for her breach of statutory duties. However Liam would only be liable for the civil penalties.
- The civil penalties which ASIC can apply for are:
- Disqualification from managing companies;
- Imposing a fine that is substantially high;
- Demanding compensation on behalf of the company for any loss suffered by creditors as per the provisions of Section 588J of the Corporations Act, 2001.
ASIC could also demand compensation on behalf of the company due to the losses suffered by creditors as criminal penalties under Section 588K of the act.
The issue in this case is to determine if Alexandra can be legally pursued for her company’s (Banger Pty Ltd) contract with Gnosis Records and for her use of a client list obtained from CloudTech.
It has been statutorily provided for in Section 183 of the Corporations Act, 2001 that any information obtained by a director by virtue of the position held by him/her must not be used to gain an advantage for themselves or for others and the same must not be used to cause detriment to the company[5]. This duty extends post resignation from such a post[6].
A company is a separate legal entity as proclaimed in the judgment in Salomon v A Salomon and Co Ltd [1897] AC 22 and thus its liabilities and duties are not the same as its owners[7].
From the stated facts of the case we can infer that Alexandra incorporated her own company and there is no legal bar for the same. As her company and CloudTech were not competitors there was no conflict of interest and thus it was not prohibited.
The client list obtained by her a director of CloudTech was used to gain an advantage for her new company. However, this was breach of the provisions of Section 183 of the Corporations Act, 2001[8]. Thus she was in breach of her statutory duties.
Conclusion
- The remaining directors of CloudTech cannot legally pursue the Alexandra for the contract between Banger Pty Ltd and Gnosis Records.
- Alexandra can be pursued legally for the breach of her statutory duties under Section 183 of the Corporations Act, 2001.
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