Overview
The Federal Court has recently excused a director from breaching
insolvent trading laws. This case is the first decision in which
the court has exercised its discretion and completely relieved a
director from civil penalties where it has been established that
the director allowed the company to trade while insolvent.
Facts
The Stake Man Pty Ltd (Company) had operated a
profitable business of processing and wholesaling raw timber up
until 2004, when the decision to acquire new machinery to expand
production caused financial problems for the Company, resulting in
significant cash-flow issues.
The sole director, Mr Carroll, sought the advice of an
accountant - and later an insolvency practitioner - regarding the
Company's financial health. Mr Caroll was advised that the Company
was nearing insolvency. On this advice and with the aid of an
investor, Mr Carroll subsequently advanced further funds to the
Company. He also engaged a consultant to help him find an investor
and sought further avenues of finance for the Company's
business.
In May 2006, the Company was placed into voluntary
administration. The following month, creditors resolved that the
Company be wound up and a liquidator was appointed.
The liquidator alleged that, between 31 December 2005 and 10 May
2006, the Company traded while insolvent.
In his defence, Mr Carroll relied on section 588H(2) of the
Corporations Act 2001 (Act), contending
he had reasonable grounds to expect the Company was solvent during
the relevant period, given the Company's stock inventory and
ability to realise and sell that stock.
Mr Carroll also relied on s588H(3) and stated that, based on the
information conveyed to him by the Company's accountant, the
Company was and would remain solvent, even if it incurred further
debts.
In the alternative, Mr Carroll relied on s1317S and s1318 of the
Act. These sections give the court a discretion to excuse a
director from liability for insolvent trading, where the director
has acted honestly and, having regard to all the circumstances of
the case, he ought fairly to be excused.
Decision
Justice Goldberg in the Federal Court held that the liquidator
had established all the elements in s588G and rejected the defence
advanced by Mr Carroll under s588H(2), stating that in the
circumstances and given the financial difficulties experienced by
the Company, it was not reasonable for Mr Carroll to expect the
Company's stock could be sold in a timeframe to effect the payment
of all the Company's debts as and when they fell due.
Justice Goldberg also rejected the defence relied on by Mr
Carroll under s588H(3), stating that although the accountant had
given advice regarding whether the company was solvent, the
evidence before his Honour did not demonstrate that the accountant
was specifically given the role of providing Mr Carroll with such
advice. Rather, the accountant's advice was given as part of the
general accountancy and advisory work he was providing to the
Company.
His Honour stated: "when considering whether a person has
acted honestly for the purposes of a defence under ss
1317S(2)(b)(i) or 1318 of the Act, the court should be concerned
only with the question whether the person has acted honestly in the
ordinary meaning of that term, that is, whether the person has
acted without deceit or conscious impropriety, without intent to
gain improper benefit or advantage for himself, herself or for
another, and without carelessness or imprudence to such a degree as
to demonstrate that no genuine attempt at all has been to carry out
the duties and obligations of his or her office imposed by the
Corporations Act or the general law. A failure to consider the
interests of the company as a whole, or more particularly the
interests of creditors, may be of such a high degree as to
demonstrate failure to act honestly in this sense. However, if
failure to consider the interests of the company as a whole,
including the interests of its creditors, does not rise to such a
high degree but is the result of error of judgment, no finding of
failure to act honestly should be made, but the failure must be
taken into account as one of the circumstances of the case to which
the court must have regard under ss 1317S(2)(b)(ii) and 1318 of the
Act".
Applying these criteria to the case before him, Justice Goldberg
found that Mr Carroll acted honestly and, in light of all the
circumstances, considered that he ought to be fairly excused for
contravention of the insolvent trading provisions under s1317S.
His Honour reasoned that:
- although the accountant did not formally satisfy the criteria
to meet the defence available to Mr Carroll in s588H(3)(a)(i) of
the Act, the accountant was nevertheless providing advice to Mr
Carroll throughout the relevant period and it was reasonable for Mr
Carroll to rely on this advice, despite Mr Carroll's own suspicions
and knowledge as to the Company's solvency. During the relevant
period, the accountant had told Mr Carroll on several occasions
that he did not believe the Company was insolvent;
- Mr Carroll had taken action to increase sales and make the
business successful;
- Mr Carroll sought investors to provide further capital and
monitored the assets of the Company;
- Mr Carroll requested the advice of an insolvency practitioner
and then acted on that advice during the relevant period; and
- upon receiving a bill from the Australian Taxation Office for
$110,000, Mr Carroll immediately sought advice from the accountant,
who then put him in contact with the liquidator and the Company was
subsequently wound up.
Although Mr Carroll allowed the Company to incur debts while it
was insolvent in breach of s588G, in light of the surrounding
circumstances and the fact that Mr Carroll neither gained
personally from the breach nor acted against professional advice,
His Honour considered it appropriate that he be wholly excused from
liability for contravention of the insolvent trading
provisions.
Comment
This case is the first decision where the court has exercised
its discretion and completely relieved a director from civil
penalties where it has been established that the director allowed
the company to trade while insolvent.
The decision highlights the significance that a court will place
on evidence that a director has relied on expert or professional
advice, as well as evidence that a director has taken pro-active
steps to address any financial issues their company is
experiencing.
This decision reinforces the need for directors to actively seek
out professional advice and monitor the affairs of their company if
they suspect the company may be, or is close to being,
insolvent.
For more information, please contact:
Graeme Scott, Special Counsel
Phone (direct): +61 3 9608 2172
Email:
g.scott@cornwalls.com.au
or
Natalie Ayoub, Lawyer
Phone (direct): +61 3 9608 2254
Email:
n.ayoub@cornwalls.com.au