Written by Mark Franklin in February, 2010

The Corporations Act provides for civil and criminal sanctions against directors (and shadow directors) for insolvent trading.

Section 588H provides directors limited defence to civil insolvent trading actions.

However, Sections 1317S and 1318 of the Corporations Act gives the Courts discretion to excuse directors either wholly or in part from liability for insolvent trading.

ASIC have issued Consultation Paper 124 Duty to prevent Insolvent Trading: Guide for directors, which was issued on 24 November 2009 and sought comments and submissions by 22 January 2010.

The consultation paper appears to have been issued in a rebellious response to several recent Court decisions which appear to give directors leniency when civil action has been taken by liquidators against directors for insolvent trading.

The paper outlines ASIC’s proposals to help directors understand and comply with their duty to prevent insolvent trading and seeks to reinforce the insolvent trading provisions as currently provided by the Corporations Act.

According to ASIC the principles directors need to be aware of are:

-          Must keep him or herself informed about the financial affairs of the company and regularly assess the company’s solvency;

-          Immediately on identifying concerns about the company’s viability, should take positive steps to confirm the company’s financial position and realistically assess the options available to deal with the company’s financial difficulties;

-          Should obtain appropriate advice from a suitably qualified person; and

-          Should consider and act appropriately on the advice received in a timely manner.

The Law Council of Australia and Senior Barrister Leon Zwier made submissions to Treasury during 2009 seeking changes to the insolvency provisions of the Corporations Act to essentially expand the defence available to directors under Section 588H to make them sufficiently flexible and fair to assist directors to engage in meaningful and honest restructuring without the concern of being found liable for insolvent trading if the attempt fails.

The submission has been made following comments by Robson J in Re Locktronic Systems Pty Ltd (in liquidation) (receivers appointed) (No 2) (2009) VSC 533 whom asked senior counsel to draw his comments to the attention of legislators “ because I think this is a classic case which demonstrates that the flaw needs to be adjusted.”

Robson J further commented the three directors were “honest men who were seeking to save the company they had worked so hard to make a success of “and further noted the prospect of recapitalising the company “does not appear to be sufficient (to shield directors) under our present law.”

He also went on to say the consequences of the law in its current state were “not in the interests of creditors”.

In Hall and Ors v Poolman and Ors (2007) NSWSC 1330, Palmer J decided as a director acted honestly he was relieved of an insolvent trading liability pursuant to Sections 1317S and 1318 of the Corporations Act for 3 months after he was aware of the company’s insolvency as “it was sometimes a difficult decision for a director of a trading corporation suffering from liquidity problems to decide whether , and when, to abandon hope of a change in the company’s fortunes and to summon the Administrators.”

In a more recent case, The Stakeman Pty Ltd v Caroll (2009) FCA 1415 Goldberg J found the director to have breached Section 588G of the Corporations Act and while he was not able to rely on the defence in Section 588H was nevertheless excused from liability under Section 1317S as the judge stated “to adopt and adapt the words of Hamlet, to trade or not to trade, that is the question.”

Nothing in the draft Regulatory Guide attached to ASIC’s Consultation Paper is supposed to affect the ability of a liquidator of a company to bring proceedings against the company’s directors to recover compensation for loss resulting from insolvent trading, or that of the company’s creditors to bring similar action if they have first obtained the liquidator’s consent or the leave of the Court.

However, it appears the legal fraternity is seeking to make insolvent trading recovery from directors even harder for liquidators than has already been the case and they will have to be even more careful in future unless they themselves get costs awarded against them for trying to recover funds for creditors.

It will be interesting to see if ASIC who appear to be maintaining a hard line on insolvent trading will back up that position with more insolvent trading prosecutions. To do so, they will require Treasury’s support with increased funding. Somehow I have my doubts.