04 Business Law Assignment Sample
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Case Background
The case involves two parties – ASIC (Australian Securities and Investments Commission) and Malcom Leslie Edwards (defendant) who was the director of an Australian company and the case involves insolvent trading by the company while the company was debt ridden which was a breach of duty by the director. As a result, the company incurred a debt of $3.5 million that the company could not pay back.
Australian Securities & Investments Commission (ASIC): Australian Securities and Investments commission is a separate body of government of Australia which works as regulator for corporates. The role of the body is to regulate and enforce financial and corporate laws for securing consumers, creditors and investors of Australia.
ASIC was established on 1 July 1998 following recommendations from the Wallis Inquiry. ASIC’s authority and scope is determined by the Australian Securities and Investments Commission Act, 2001
ASIC established a case against the defendant, on not conforming to the laws put down in section 588G, by failing to restrict MRL from incurring many debts. ASIC thus depends on 588G (2) which refers to a person, company, a debt and the incurrence of a debt and the time of incurrence states that a person is in conflict with 588G by failing to control the company from incurring a debt if one of the two conditions is met: while at the time of incurring the debt person is suspicious that there can be chances of insolvency or might become insolvent by taking the debt.
Malcolm Leslie Edwards – along with Leonard George Jones were found offending the 588G (2) act in which they failed to control Murray River Limited (“MRL”) from incurring debts. Edwards has been referred to as the defendant. If ASIC is successful in establishing the elements provided in section 588G, the defendant will not be held to have gone against 588G, if the defendant is able to establish defence on the basis of rules laid down in 588H.
Duties And Responsibilities Breached
Insolvent Trading
It is the duty of the director to prevent the organisation from getting into insolvent trading. The liquidator can recover the losses suffered by the creditors from the directors, if the directors have allowed their company to participate in trading while being insolvent(588G and 588M), It is the duty of the director to take into consideration the creditors interests while the company is insolvent or facing insolvency. The directors may also be held liable if any steps have been taken by them to reduce the entitlements of the employees during the case of insolvency.
The purpose of the insolvent trading law is for the following:-
- Prevention and provision of remedy for particular types of commercial dishonesty and irresponsibility
- Companies which are approaching or becoming insolvent
- Obtaining loans, property or services on credit
- Directors who know or suspect insolvency
- Or any other reasonable person in the director’s position would be knowing or suspecting of insolvency
Directors have a duty to prevent insolvent trading. Directors have a duty to not let the company trade and incur further debts while its inability to pay current debts. It means that when the company does not have money to pay its current debts, it must cease all trading to facilitate the payment of existing debts.
A reasonable person while reviewing the financial circumstances of a company would conclude the inability of a company to meet its current debts is known as insolvent trading. In ASIC vs EDWARDS case, the defendant director was disqualified for allowing the company to incur debts of $3.5 million which it could not pay back.
Certain common signs of insolvency are:-
- Reducing or low operating profits and cash flow from the business
- Problems in paying the trade suppliers and different creditors on time
- When trade suppliers refuse to increase the credit period offered
- Problems in meeting loan repayments on time
- Legal action to be taken by suppliers or other creditors due to money owed
- Poor relationship with present banks due to pure credit history leading to inability to borrow further fund and the absence of alternative finances or sources of income, leading to reduced cash to spend on resources
Directors Liabilities When Things Go Wrong
While in most cases of responsible management, the debt of a company stays within the company. However in certain circumstances, directors who breach the law could personally become liable for the company’s debts or the subject of other regulatory action against them. A company has separate legal presence as opposed to its owners, managers, operators, employees and agents.
A company enjoys its own properties, rights and obligations. The obligations of a director may continue even after the company has stopped trading and has been deregistered. Only in certain situations one is personally liable as a director for the company’s debts and losses.
Directors will need to keep assessing to check for solvency and to pick up early signs of trending towards insolvency. The directors need to assess the cash flow of the company. They needs to estimate about the future cash flows and consider their current cash flows while assessing if they would be sufficient to pay the present and future debts as and when they fall due.
They also need to consider the financial position of the company while assessing the assets and debts it has on a whole. Ability of a company to liquidate its assets to pay its creditors while the business is at risk should also be taken into consideration.
A director can become personally liable when as a result of breaching one’s duties, it has resulted into the company incurring losses. Incorporated under the Corporations Act, 2001, the director may have to compensate the company for the losses incurred.
588 G: Duty To Prevent Insider Trading
Directors are obliged to not let the company trade and incur further debts while insolvent. The liquidator, in order to establish civil liability would need to establish a failure on the part of the director to prohibit the company from incurring further debts while the director was aware of reasonable grounds of suspicion of the company being insolvent.
The liquidator needs to establish a failure to prevention of the company incurring debts on the part of the director. It is held that this need not require the director, to be capable of preventing the incurring of the debt. The law of section have little control if the director proves that he has performed the action with the agreement of one or more authorities officers of the company even in the case when he is aware of the fact that company is becoming insolvent. In such situation, director might not have control on the authorised person entering into a debt contract.
Defence option for Directors under Section 588h
Section 588h has clause for proceedings against contravention under section 588 G(2) with respect to occurrence of debts. If the accused proved in defence that while incurring debt, there was no reason to believe that he/ she has any idea of firm going to be insolvent and add into contract which would result in more debt then the provision of law has separate provisions.
Without limiting the generality of subsection, it acts as a defence if proven that at the time of incurring of the debt, the person had reasonable reasons to perceive that a competent and trust worthy person was responsible to provide to the mentioned person enough and adequate information on whether the company was solvent and whether the other person was completing that responsibility and expected the company to be solvent at all times, at the present time and also the times to come.
If the concerned person was playing the role of a director of the company while the debt was incurred, it acts as a defence if proven that because of illness or for any other reason, sufficient enough, he was not involved in the decision making and management decisions of the organisation at that point of time. It is also a defence if proven that the company took enough reasonable steps to prevent the organisation form incurring debts.
In short, there are four alternatives to defence in section 558H as follows:-
- While the incurring of the debt, the director had enough reasons to believe that the company was solvent and would remain solvent even on incurring the debt
- While the incurring of the debt, subordinates providing information about the company’s solvency were competent, responsible and reliable
- The director did not take part in decision making or management decisions while the incurring of the debt due to illness or other reasons.
- All measurable steps were taken by the director to prevent the company form incurring the debt
The Court’s decision
In this case, the director Leslie Malcom Edwards was found guilty and was disqualified for a period of 10 years after it was found that there was breaching of section 588G on several occasions. On six instances the director very well knew that there were reasonable grounds of suspicion that the company was insolvent and unable to pay its debts.
He however made way for the innocent creditor to go on board with certain activities that would be disadvantageous to it, but in benefit of the director’s personal interest. Barett J held that a party could fail to act with honesty without having any subjective intention to deceive. This conduct of the director was described as morally wrong, not straightforward and there were elements of unconscionability and moral turpitude.
Relating to the insolvency of the company at the time when the relevant debt was incurred, the necessary ingredients of violation are dependent upon findings as to whether the company was insolvent while the debt was incurred or after incurring it would become insolvent. Also the alleged person who had contravened was aware of the fact that there exists a reasonable ground of suspecting insolvency.
The case concerned a penalty hearing, and whether a director should be relieved from liability, and consideration of Corporations Act 2001 (Cth), ss 206C, 206G, 588G(2), 1317E(1), and 1318. However, he got convicted and was disqualified for 10 years as a punishment.
Impact of the decision on the operation of companies in Australia
Laws related to insolvent trading have developed since the last few years, but there remain only a few cases being brought by liquidators. It still is a factor of costs and the knowledge of the substances of those under pursue. Insolvent trading cases are looked into in the hindsight and there is minimal definitive advice which one can give to directors of a company who faces an uncertain financial future.
Assessment of the ongoing solvency of a company is a fluid process requiring constant vigilance. The assessment process needs updated financial data and sensitivity analysis through which a director can assess the feedback on the impact of various events on the ability of the trade. Such steps when taken help the director in proving that steps were taken knowingly and diligently with due appreciation of facts.
It shall put directors in the best position to understand at which moment a company is tending towards solvency .In 2016, Australia came out with proposals in its Improving Bankruptcy and Insolvency Laws Proposal Paper to change the insolvency framework. The proposals aim to promote entrepreneurship and business rescue and creation of ‘safe-harbours’ for directors liability who involve in insolvent trading during financial distress to aim business turnaround by giving immunity from personal liability under 588G of the Corporations Act 2001.
The proposals also aim to void the ‘ipso facto’ clauses allowing for contract termination or variation where a counterparty suffers an “insolvency event”. These proposals aim to improve or lessen the impact of financial distress on companies. The Government has invited opinions from the stakeholders on these reformation measures.
Conclusion:
The case is about breach of section 588G and 588M regarding prevention from incurring debts by performing insolvent trading. The director of Malcom Leslie Edwards was penalised with a 10 years of disqualification and was also convicted. The section clearly mentioned the responsibility of director against insolvent trading which the defended failed in proving so. The judgement was delivered for protecting the right or investors as well as creditors and to make the business dealing more transparent.
References:
Smith, Mike (2014). “What is a Creditors’ Voluntary Liquidation (CVL) and How Could this Type of Voluntary Liquidation Help Us?”. Retrieved 30 July2014.
“Insolvency Act 1986: Section 214”. legislation.gov.uk. Crown. Retrieved 30 July2014.
Farrar, J. H (2008). Corporate governance : theories, principles and practice (SJ100 FAR).
Tomasic, R (2002). Corporations law in Australia (SJ100 TOM).
Australian Securities & Investments Commission v Hellicar[2012] HCA 17
Farrar, J. H (2001). Corporate governance in Australia and New Zealand (KU956 F24).
Ford, H. A. J (1999). Ford and Austin’s principles of corporation law (KD956 F69) (9th ed.).
Michelle Welsh (2015). “The Use of Civil Sanctions for Breaches of Corporate Law”. Retrieved 29 June2015.
Ace Contractors & Staff Pty Ltd v Westgarth Development Pty Ltd[1999] FCA 728, Federal Court (Australia).
Sydloq Pty Ltd v TG Kotselas Pty Ltd[1996] FCA 1384, (1996) 65 FCR 234, Federal Court (Australia).
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