Director Obligations

WHAT OBLIGATIONS DO YOU HAVE AS A DIRECTOR?

The laws and rules governing directors’ duties and responsibilities generally arise from three areas:

  1. Common law
  2. Statute law, under the Corporations Act
  3. A company’s constitution

Generally speaking, your obligation as a director is to ensure that the company complies with general and specific laws which apply to your company and its operations. It is also your primary duty to act in the best interests of the company’s shareholders and maximise shareholder wealth.

The Corporation Act imposes the following statutory duties on directors and officers of companies:

Section 180 Duty to exercise their powers and discharge their duties with the degree of care and diligence that a ‘reasonable’ person would exercise
Section 181 Duty to exercise their powers and discharge their duties in good faith in the best interests of the company and for a proper purpose
Section 182 Duty not to improperly use their position to gain an advantage for themselves or someone else or cause detriment to the company
Section 183 Duty not to improperly use the information available to them as a result of their position to gain an advantage for themselves or someone else, or cause detriment to the company

Section 184 of the Corporations Act also imposes penalties relating to criminal offences in relation to the above duties.

In addition to the above, in the event your company is insolvent, or there is a risk of insolvency, your duties extend to the company’s various other stakeholders, such as the company’s creditors and employees. Section 588G of the Corporations Act imposes a duty on a director to prevent insolvent trading by a company.

Lastly, Section 286 of the Corporations Act states that a company must keep written financial records that correctly record and explain its transactions, financial position and performance, and would enable true and fair financial statements to be prepared and audited. Contravention of this section with an element of dishonesty is a criminal offence under Section 344(1) of the Corporations Act. Company records must be kept for a period of seven (7) years. Contraventions of Section 286 of the Corporations Act can be used under Section 588E of the Corporations Act to establish a presumption of insolvency.

INSOLVENT TRADING

Section 588G of the Corporations Act states that a director of a company has an obligation to prevent a company from trading whilst insolvent. A director will contravene Section 588G of the Corporations Act if all of the following apply:

  • A person is a director of a company at the time the company incurs a debt;
  • The company is insolvent at the time, or becomes insolvent by incurring that debt, or by incurring at that time including that debt;
  • At that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as case may be; and
  • The debt was incurred after 23 June 1993.

What is insolvent trading?

Insolvent trading is when a director allows the company to continue to trade its business and incur debts at a time it is insolvent.

When is the company deemed to be insolvent?

A company is deemed to be insolvent if it is unable to pay all its debts as and when they fall due.

Who can make a claim for insolvent trading?

A Liquidator usually brings a claim against a director for insolvent trading however, in instances where a Liquidator does not take such action, there may opportunities for creditors to commence their own action against a director.

Who can an insolvent trading claim be brought against?

In circumstances where it is determined that a director has traded the company whilst insolvent and breached Section 588G of the Corporations Act, a director may be held personally liable for the debts incurred by a company.

A holding company may also be liable for insolvent trading by its subsidiaries under Section 588V of the Corporations Act in the event the following is proved:

  • The corporation is the holding company of a company (subsidiary) at the time when the subsidiary incurs a debt; and
  • The subsidiary is insolvent at that time, or becomes insolvent be incurring that debt, or by incurring at that time debts including that debt; and
  • At that time, there are reasonable grounds for suspecting that the subsidiary is insolvent, or would so become insolvent, as the case may be; and
  • One or both of the following subparagraphs applies:
  1. the corporation, or one or more of its directors, is or are aware at that time that there are such grounds for so suspecting;
  2. having regard to the nature and extent of the corporation’s control over the company’s affairs and to any other relevant circumstances, it is reasonable to expect that:
  1. a holding company in the corporation’s circumstances would be so aware; or
  2. one or more of such a holding company’s directors would be so aware; and
  • The debt was incurred after 23 June 1993.

What is the quantum of an insolvent trading claim?

The quantum of the claim is usually assessed by a Liquidator from the investigations conducted by him/her into the business, property and affairs of the company. Any debts incurred by the company after the date it was deemed to be insolvent, may form a part of the quantum of the insolvent trading claim.

What are the defences for insolvent trading are available to a director?

Pursuant to Section 588H of the Corporations Act, a director may have the following statutory defences available to them, in circumstances where it is proved that the company has traded whilst insolvent:

  • The director had reasonable grounds to expect the company was solvent;
  • The director had reasonable grounds to rely on the information provided by another person;
  • The director at the time the debts were incurred had a good reason for not taking part in the management of the company (e.g. health issues which limited them from conducting the affairs of the company in a reasonable manner);
  • The director took all reasonable steps to prevent incurring the debts. This could include seeking independent legal advice or approaching and insolvency practitioner to assess options available.

The onus is on the director to prove that they have satisfied any one of the above, to successfully defend an insolvent trading claim brought against them.

How long do Liquidators have to bring an insolvent trading claim against a director?

Section 588M of the Corporations Act 2001 allows Liquidators six (6) years from the commencement from the liquidation to bring an action against a director for insolvent trading.

What are the consequences of insolvent trading?

There are various penalties and consequences of insolvent trading, which include:

  • Civil penalties (including pecuniary penalties up to $200,000). The ASIC may also consider disqualifying a director from managing companies in circumstances where they have been associated with two (2) or more failed companies where a dividend of less than fifty (50) cents in the dollar has been declared;
  • Either the ASIC or a Liquidator can commence proceedings against a director personally and seek compensation for loss resulting from insolvent trading;
  • Criminal proceedings may also be brought against a director by the ASIC for insolvent trading in circumstances where it is proved that a director has acted in a dishonest manner or intentionally traded the business of the company in a reckless manner.
  • If a director is found guilty of a criminal offence under Section 588G, of the Corporations Act they may be fined up to $220,000 or face imprisonment for up to five (5) years, or both. This will also lead to a director being disqualified from managing companies.