Director liabilities – Update

June 3, 2014

Director Liabilities

This article focuses on director liabilities and we revisit two (2) old insolvency chestnuts relating to director exposure – insolvent trading and unreasonable director related transactions. Not again you say? Before you hit the delete button there’s been a little bit happening in these spaces worthy of a read. There are 2 areas in particular you need to be aware of:

1.Sections 588R to Section 588U of the Corporations Act 2001 which deal with insolvent trading; and
2.Section 588FDA of the Corporations Act 2001 – Unreasonable Director Related Transactions.

 

Proceedings by Creditors for Insolvent Trading

There are a number of obscure recovery provisions contained within the Corporations Act 2001, and this is one of them, although anecdotal evidence suggests a pick up in recent use of the little known and rarely used powers contained in Section 588R.

This section allows an unsecured creditor in a liquidation to seek compensation directly from a company director, for insolvent trading, without having concern for the other unsecured creditors claims in the winding up, just their own debt.

An unsecured creditor can take this course of action and sue for compensation with or without the liquidator’s consent.

No doubt you have read a number of liquidator’s reports where they do believe there has been insolvent trading by a director but declare in the same breath that they do not believe it is commercial to pursue a director for insolvent trading, for one reason or another and therefore do not intend to take recovery action.

So why then would a creditor wish to pursue the director for an insolvent trading claim when the liquidator isn’t prepared to?

The reason is quite simple, a liquidator usually makes his or her decision based upon the commerciality of the action with due regard to the general body of unsecured creditors, relative to the directors net wealth position.

For example, despite the liquidator having determined that insolvent trading may have occurred in his or her investigations, if unsecured creditors amount to $1,000,000, and it is estimated that the Director may have a net worth of between $50,000 and $100,000, (taking into action fees and recovery costs), it may not be commercial for the liquidator to negotiate a settlement, let alone take legal action. If however, the Director was worth five (5) times that amount, it may be a different story.

Using the numbers above, if an individual unsecured creditor is owed say, $20,000, and the directors net wealth is somewhere between $50,000 and $100,000, such circumstances (particularly if the liquidator has argued a case for insolvent trading in his or her report), make it commercial for the individual creditor to make a claim.

The costs to get approval from the liquidator to pursue the claim/action are minimal, however, the associated recovery powers are invaluable, allowing the unsecured creditor to confront the Director with an insolvent trading claim and possibly opening the door for an out of court settlement and the hope of a greater return than in the liquidation. From my experience far more insolvent trading claims settle out of court, thus avoiding the need for costly litigation.

So when can a creditor pursue a company director for insolvent trading?

Section 588R of the Corporations Act 2001, states that a creditor of a company may commence an action with the written consent of the company’s liquidator.

Section 588T allows a creditor to bring proceedings under the insolvent trading provisions without consent of the liquidator where the liquidator has failed to respond to the creditors notice in writing within three (3) month of the request or on application the Court.

If the liquidator does respond within the three month period setting out the reasons why he or she believes proceedings should not be brought, the creditor still may make an application to the Court to assess the liquidator’s reasoning and seek to continue with the action.

In summary, your clients should consider s588R as another means to recover monies owing to them when confronted with an insolvent debtor. When we act for creditors on Committees we always give s588R due consideration.
 

Unreasonable Director Related Transaction

Unlike the above, Unreasonable Director Related Transactions are better known, but still underutilised by liquidators.

Section 588FDA states that a transaction is deemed an unreasonable director related transaction, where the company enters into a transaction, conveyance, transfer, or other disposition, for the benefit of a director or close associate.

When trying to unwind the transaction, a liquidator doesn’t have to determine if the company was insolvent at the time of the transaction. An unreasonable director related transaction applies to any transaction occurring in the period, 4 years prior to the winding up, and the recipient cannot avail themselves to the defences of good faith, no knowledge of insolvency or valuable consideration.

So why has is it been underutilised so far? Primarily due to the narrow definition the Courts have held as to when a transaction is “for the benefit” of a Director or close associate.

The Courts up until recently continued to hold that a transaction will only be considered to be one made for the benefit of a director where the director receives a direct benefit.

In the matter of Great Wall Resources Pty Limited (In Liquidation) (2013) NSW SC354, it was held that a benefit to a company of which the director was a sole shareholder was not a benefit within the meaning of Section 588FDA.

However, in March of this year in the decision of Vasudevan (as Joint and Several Liquidator of Wulguru Retail Investment Pty Ltd) (In Liq) & Ors v Becon Constructions (Australia) Pty Ltd & Anor [2014] VSCA14 (Vasudevan case) may have significantly broadened the meaning of the term “for the benefit of” to include indirect benefits obtained by directors.

The facts of the case centre around a company which entered into liquidation shortly after taking over financial obligations belonging to the company director. The financial obligations were with a third party. The company prior to liquidation also granted a mortgage to the third party over its assets to secure the obligations.

The liquidators applied to the Court to set aside the deed assigning the director’s obligations to the company as well as the security the company had granted to the third party.

The liquidators were successful.

While the circumstances in the Vasudevan case are somewhat complicated, the broadening of the definition of the phrase “for the benefit” will now ensure that liquidators give further consideration to s588FDA in their investigations.

Section 588FDA will continued to be considered by a liquidator where the company pays out personal credit cards or other obligations, or the payment of large unjustified bonuses or wages and subsequently enters liquidation.

Article written and provided by permission of James Shaw and Paul Gidley of Shaw Gidley Insolvency and Reconstruction Specialists.

Disclaimer
 

For your accounting and business needs please ensure you

give Leenane Templeton a call or email us.

 

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