Insolvent Trading Casts A Long Shadow

An ASIC investigation that commenced in 2009 has culminated in the first sentence of imprisonment for a shadow director. Although Andrew Young formally resigned as director of the Kleenmaid group of companies (Group) before the company became insolvent, he was convicted in the District Court (Brisbane) by a jury and sentenced to nine years’ imprisonment for criminal insolvent trading and fraud.

Background 

The Kleenmaid business involved importing and retailing whitegoods, through a chain of stores operated by the Group and franchisees across Australia. Andrew Young was a founder of the business in 1985 and a former director of the Group. 

The Group was in financial difficulty by 2007 and was ultimately placed in voluntary administration in April 2009. 

An ASIC investigation centred on the Group’s solvency and a corporate restructure undertaken by the directors in September 2007. ASIC alleged that the Group continued to trade while insolvent in March 2008.  

As a result of ASIC’s investigation, the Commonwealth Department of Public Prosecutions (CDPP) brought criminal charges against Young for: 

• one count of fraud for dishonestly gaining loan facilities for one of the Kleenmaid companies, EDIS Service Logistics Pty Ltd (EDIS), from Westpac in November 2007 totalling $13 million – where the dishonesty was alleged to be, in essence, misleading Westpac about the effect of a restructure;
• a further count of fraud for dishonestly removing $330,000 from a company bank account two days prior to the appointment of administrators in April 2009, and transferring it to an account of a company in which Young held an interest and from which he and his wife would benefit from the payment; 
• two counts of insolvent trading for dishonestly failing to prevent EDIS from incurring debts to Westpac in July 2008, amounting to $3.5 million for two additional loan facilities; and 
• 15 counts of insolvent trading of debts of more than $750,000, incurred during the period of October 2008 to April 2009. 

The charges were brought against Young on the basis that he was a shadow director.  

Shadow directors and the duty to prevent insolvent trading 

Directors are subject to various duties and obligations by virtue of their position. These duties and obligations extend to ‘shadow directors’ who are not formally or validly appointed as directors of a company, however are: 

• persons who act in the position of a director (de facto directors); and 
• persons whose instructions or wishes directors of the company are accustomed to act in accordance with (shadow directors). 

One such duty is to prevent the company from trading while insolvent. A director will breach this duty if the company incurs a debt when the company is insolvent (or becomes insolvent by incurring that debt) and there are reasonable grounds for suspecting that the company is insolvent (or would become insolvent by incurring the debt), as the case may be. 

If the director’s failure to prevent the company from incurring the debt was dishonest, criminal offence provisions apply and the court may order that the director pay a penalty of up to $220,000 or that the director be imprisoned for up to five years. 

The proceedings against Andrew Young 

ln January 2020, a jury found Andrew Young guilty on all 19 charges listed above and, the following month, he was sentenced to: 

• nine years’ imprisonment (with a non-parole period of four years) for the two counts of fraud; and  
• three years’ imprisonment (to commence from the parole eligibility date for the fraud) for the 17 counts of insolvent trading. 

The verdict was given more than 10 years after the collapse of the Kleenmaid business. At the time the offences were committed, Andrew Young was found to be acting as a shadow director – marking the decision as the first in which a shadow director has been convicted and sentenced to prison on insolvent trading charges. 

Commentary 

These proceedings were commenced before ASIC adopted and committed to its ‘why not litigate?’ enforcement approach – brought to the fore by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. It is likely that ASIC’s renewed and re-invigorated approach will create even more enforcement outcomes, including investigations and court-based enforcement. 

One effect of the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) (Act) was to provide temporary relief to directors from their duty to prevent insolvent trading (see our recent article here). A director may rely on a new safe harbour in relation to a debt incurred by the company if the debt is incurred:  

• in the ordinary course of the company’s business; 
• during the six-month period starting on 24 March 2020 (Effective Date), or a longer period as prescribed by the regulations; and 
• before any appointment during that period of an administrator or liquidator of the company. 

The Explanatory Memorandum to the Act (Explanatory Memorandum) provides that a director is taken to incur a debt in the ordinary course of business if that debt is necessary to facilitate the continuation of the business during the six month period commencing on the Effective Date. The Explanatory Memorandum states that this could include, for example: 

• taking out a loan to move some business operations online; and 
• debts incurred through continuing to pay employees during the pandemic. 

It is unclear how widely the expression ‘ordinary course of business’ is to be interpreted. Therefore, even with these relief measures in place, and given that the temporary safe harbour application period is due to expire on 24 September 2020, it may be fundamental to take advantage of other protections from liability. 

The safe harbour provisions introduced in September 2017 provide a director with protection from insolvent trading liability if, after starting to suspect that a company may become or is insolvent, the director develops one or more courses of action that are reasonably likely to lead to a better outcome for the company than would the appointment of an administrator or liquidator. In working out whether a course of action is reasonably likely to lead to a better outcome for the company, regard may be had to whether the director is obtaining advice from an appropriately qualified advisor, who was given sufficient information to offer appropriate advice, and whether the director is developing or implementing a restructuring plan (read more here). Obtaining advice and preparing and implementing a plan that meets the requirements of the existing safe harbour provisions may provide protection that extends beyond 24 September 2020. It is important for directors, and those closely associated with the decision–making of the company, to be aware of the risks of continuing to incur indebtedness while the trading activities and financial health of the company are declining.  

Identifying and taking action sooner rather than later can be the key to whether or not a director – or a shadow director – finds themselves personally at risk.   

We have a dedicated team to assist with restructuring and turnaround advice. 

Queries 

If you have any questions about this article, please get in touch with an author or a member of our Restructuring, Insolvency & Turnaround team. 

Disclaimer 

This information and the contents of this publication, current as at the date of publication, is general in nature to offer assistance to Cornwalls’ clients, prospective clients and stakeholders, and is for reference purposes only. It does not constitute legal or financial advice. If you are concerned about any topic covered, we recommend that you seek your own specific legal and financial advice before taking any action.