Introduction Melbourne Pty Ltd suffered from financial crisis in the mid-2009, while during this time, the board of directors makes a decision for declaring a dividend to members, and, consequently, the company went into bankrupt shortly afterwards the dividend is paid. The legal issue that needs to be identified is whether the directors of the company have breached the relevant law in relation insolvent trading.
Afterwards, it is significant to ascertain whether there are any defences which are available to them, because all of the four directors in this case may be have some relevant evidences to prove their innocence under the Corporations Act 2001. Lastly, it also necessary to outline the possible penalties imposed on them if they are found to have contravened the relevant law in relation to company’s insolvency. Appling relevant law to this particular case study, s 588G states the duty to prevent insolvent trading for a director when the relevant debt is incurred.
Section 588H offer defences to directors if they have relevant evidence required in this section. Section 588J, 588K and 588M show the consequence of a contravention of s 588H. It is cannot deny that all the directors have breached s 588G, but each of them can apply certain defences if they provided the relevant proof noted in s 588H. as for the penalties, compensation in ss 588J, 588K and 588M is unavoidable because of breaching s 588G, but some of the director can relieve their duties through applying s 588H. Question 1
Advise whether there have been any breaches of the directors’ duties in relation to insolvent trading. In this case, the first issue that needs to be ascertained is, whether the directors contravene the relevant law in relation to insolvent trading. To solve this issue, it is helpful to thoroughly analyses section 588G. Section 588G states that a director has a duty to prevent a debt from being incurred when the company is insolvent or suspected that it is insolvent under reasonable grounds. To demonstrate whether a director has contravened s 588G, four points are offered here under s588G.
Initially, incurring a debt is an essential element as a condition of breaching s 588G. Then s 588G (1) (b) needs evidence that the company was insolvent when there was a debt incurred or became insolvent because of this debt, thus, it is absolutely necessary to ascertain when a debt is incurred. In addition, it also needs to prove that whether a company was insolvent or becoming insolvent. Again, a proof needs to be provided that a director cannot prevent the corporation from incurring a debt under s 588G (2).
In this case study, the financial situation of Melbourne Pty Ltd deteriorated in 2009. Chesterman J stated in Williams v Scholz  QSC 266 that ‘there were reasonable grounds for suspecting that the company was insolvent during the relevant period because the company traded unprofitably and accumulated losses continuously’. Likewise, the company’s financial situations can be suspected as insolvency. Also, the liquidator found that the company financial record was not kept properly.
Similarly, in Kenna & Brown Pty v Kenna  NSWSC 533, due to the company’s financial records was falsified which contravened the predecessor of s 289, the company was assumed as insolvency under s 588E (4). Those two points noted above have proved that as a matter of fact the company is insolvent or suspected insolvent under reasonable grounds. At this time of insolvency, however, the board of directors made a decision that they would declare a dividend to each member. Section 588G (1A) indicates that there are seven actions can be regarded as incurring a debt when the company is insolvent.
In particular, paying a dividend is deemed that the company incurred a debt under s 588G (1A). Furthermore, s 588G (1) (b) states that ‘the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt’. In this instance, the fact is the company went into bankrupt afterwards the dividend was paid. This means the company went into insolvent because of paying the dividend. Ultimately, s 588G (2) needs evidence that a director is unable to prevent the corporation from incurring a debt.
In this case, William had been fully aware of the company’s financial position, but the rest of directors were absent from the company management due to their own reasons which will be noted later and William did not tell them about this. Also, he made an improper report to inform the others. It means that only William was aware of the financial situation, but he fail to prevent insolvent trading under s 588G (2). Also, he breaches s 588G (3) (d) because his behavior of failing to prevent insolvent trading is dishonest and improper.
Section 588G (2) (a) states that a director will be under a contravention by failing to prevent the company incurring a debt if the director realize that there are reasonable grounds for suspecting the insolvency of the company when the debt is incurred. As for the rest of directors, they can be regarded as not being aware of the company’s financial crisis. However, section 588G (2) (b) states that a reasonable director would be aware of reasonable grounds for suspecting insolvency. This means even though the other three directors are unaware of the company financial position, they are still against to the s 588G.
This comes to a conclusion that all of the directors have contravened the section 588G in relation to insolvent trading. Question 2 Advise whether any defences are available to the director and what penalties may be imposed upon them if they are found to have breached the insolvent trading provision under the Corporations Act 2001. 1. defences In this case study, even though the four directors, William, Jack, Susan and Sarah, are reliable to the insolvency of the company, there may be some available defences for them.
To determine whether there are any defences are available to the four directors, it is very necessary to analyses the section 588H. Section 588H defences are used to help a director who fails to prevent a debt from being incurred if he has been actively involved in the operating of the company. Furthermore, there are four alternative defences which are available to directors who breach s 588G which will fully be analyzed later. In this case study, William, as a managing director, had been fully aware of the financial crisis of the company.
S 588H (2) states that ‘it is a defence if director proves that, at the time when the debt was incurred, the director had reasonable grounds to expect, and did expect, that the company was solvent at that time’. Applying this to William, it will be a defence if he can prove that he has been fully conscious of the company’s financial situation. However, the fact was even though William had totally realized that the company’s financial situation is gradually deteriorated in June 2009, he did not inform the other directors of this financial crisis for the reason that he did not want to trouble them.
He not only did not tell the other directors the real financial position of the company, but also lied to the others and made an improperly report proving this. Consequently, the board of directors declares a dividend because of this particular report and lead to insolvency of the company. Apparently, there are no evidences applied to prove that he has reasonable grounds to expect solvency. This means William cannot apply a defence under s 588H (2). As for Jack, he was diagnosed with a heart condition and failed to resign from his position because of being hospitalized.
Section 588H (4) states that it will be a defence if a director who absent from the company management is ill or has some good reasons when a debt is incurred. Apparently, Jack became very ill during the company’s financial crisis which will be regarded as a good reason to prove that he was absent from management when a debt is incurred. This means Jack is able to claim a defence to relieve his duties. With regard to Susan, she left the management of the company to William and depended on him.
The s 588H (3) defence is available to a director who has delegated the running of the company to others upon whom the director trusts and relies. Also, under s 588H (3) (a), ‘the director must prove that at the time when the debt was incurred, the director had reasonable grounds to believe, and did believe, that a competent and reliable person was responsibilities for providing the director with adequate information about whether the company was solvent and that the other person was fulfilling that responsibilities’ Meanwhile, it is necessary to look at the case of ASIC v Plymin  VSC 123.
In this case, Elliott, a non-executive and an experienced businessman, relied on Plymin who as a managing director provided company’s financial information to him and left the running of the company to Plymin. However, the court held that Plymin could not be regarded as a competent and reliable person who was satisfied his obligations under reasonable grounds. The court also deemed that Elliott blind himself to the situation of the company’s financial crisis. Apply these reasons to Susan, and her situation is similar to Elliott. he was a sophisticated business woman with other company interests, she do not take part in running the business and left the management of the company to William, also she was sure that if the company had financial difficulties William would inform her. In addition, she was absent from the meeting about declaring a dividend to members. It means that it is difficult for Susan to successfully apply a defence under s 588H (3). Lastly, to determine whether Sarah has any available defence to her, it is essential to inspect the case of Deputy Commissioner of Taxation v Clark  NSWCA 91.
In this special instance, the New South Wales Court of Appeal held that it would not be a proper reason for being absent from management that a female director of a family enterprise, who always depended on her husband in running the business of the company, never got involved in any company management. The court also held that a person who was not prepared to assume the responsibilities and duties should not become a director under s 588G.
Similarly, Sarah never attended any company board meetings, always relied on William and totally trusted him about all company matters. Applying to the case noted above, Sarah will fail to apply a defence under s 588H (3). 2. Penalties In this case study, some penalties may be imposed on the four directors if they have contravened the s 588G, in order to analyses this issue, it is absolutely necessary to apply the section 588J, 588K and 588M. Generally, a compensation order can be made by the court against a director who breaches s 588G.
Whether the company is insolvent or not, compensation orders can be imposed by the court as the application for civil penalty orders and proceedings for criminal offence under ss 588J and 588K. In addition, s 588M will give the liquidator the right to impose compensation on a director who breaches s 588G if the company that incurred a debt is easy to liquidate. In this instance, all of the four directors breach s 588G which has been proved in question 1. However, due to William breaches both s 588G (2) (a) and s 588G (3) (d), he will be imposed on a civil penalty and a criminal penalty under ss 588J and 588K.
As for the rest of directors, they only contravene s 588G (2) (b), so they will be ordered compensation as a civil penalty under s 588J to pay the equally amount if the loss or damage. 3. summary Finally, the possible outcome in this case study is that William cannot apply a defence under s 588H (2) and both Susan and Sarah can hardly apply a defence under s 588H (3), therefore, they will be imposed to pay the equally amount of the company’s loss or damages under ss 588J and 588K.
However, Jack is able to claim a defence to relieve his duty under s 588H (4) which has proved above, thus, as such, his penalties will be relieved. Overall conclusion To sum up, with all evidence of case and relevant law offered above, the four directors are recognized as a contravention of section 588G. However, each director can apply defences from s 588H to relieve their duties as long as they are able to provide relevant evidences. Furthermore, some penalties will be imposed under ss 588J, 588K and 588M if they are regarded as breaching of s 588G.
As far as I am concerned, the most possible outcome is that although all of the directors have breached s 588G, the four directors may meet different results. At first, William will have the main responsibilities because of his behaviors noted above and will be imposed on the most serious penalties as a civil application and a criminal offence. Then, both Susan and Sarah will be partly liable for the company’s insolvency, and a certain amount of pecuniary penalties as a civil penalty will be ordered by the court or liquidator.
Lastly, Jack has few responsibilities for the insolvency of the company even though there incurs a debt. The compensation imposed on him maybe just the amount of the dividend as a civil penalty. References 1. Australia Corporations Legislation 2010 (Cth). 2. Lipton, P, Herzberg, A and Welsh, M, Understanding Company Law, 15th ed, 2010. ——————————————– [ 1 ]. A director is under a duty to prevent the company incurring debts if there are reasonable grounds for suspecting that it is insolvent. P. Lipton et al, understanding Company Law (15th ed 2010) 405 [ 2 ].
S 588G (1) (b) applies if the company is insolvent at that time, or become insolvent by incurring that debt, or by incurring at that time debts including that debt. [ 3 ]. Ibid 409 [ 4 ]. Ibid 409 [ 5 ]. If a company paying a dividend, it incurs a debt at the time when the dividend is paid or, if the company has a constitution that provides for the declaration of dividends, when the dividend is declared. Corporation Act 2010 (Cth) 762 [ 6 ]. Ibid 761 [ 7 ]. A person commits an offence if the person’s failure to prevent the company incurring the debt was dishonest.
Ibid 762 [ 8 ]. By failing to prevent the company from incurring the debt, the person contravenes this section if: (a) the person is aware at that time that there are such grounds for suspecting; or (b) a reasonable person in a like position in a company in the company’s circumstances would be so aware. Ibid 762 [ 9 ]. Ibid 762 [ 10 ]. Lipton, above n1 411 [ 11 ]. It is a defence for a director who was absent from management because of illness or for some other good reason at the time when the company incurs the debt in question. Ibid 413 12 ]. The s 588H (3) defence applies to a director who has delegated the monitoring of the company’s financial position to others upon whom the director relies. Ibid 411 [ 13 ]. Ibid 412 [ 14 ]. Ibid 412 [ 15 ]. Lipton, above n1 413 [ 16 ]. Compensation orders can be made in the context of an application for civil penalty orders and as part of proceedings for the criminal offence: ss 588J and 588K Lipton, above n1 414 [ 17 ]. S 588M gives the liquidator the ability to seek compensation from a director who contravenes s 588G. Ibid 414