Director's Duty to Take Into Account the Interests of Creditors - Assignment Example

Company Law Name Tutor TLAW 402 Date a. The legal issue is whether the Max can be held liable for engaging in insolvent trading. Is Max, the director of Shifty Sellers Pty Ltd, liable for entering into a credit arrangement with for the supply of steel cables from Smart Engineering Pty Ltd? The area of law is company law. Companies are separate entities with limited liability. Directors are appointed to manage the company operations and therefore they have the duty to act on behalf of the company. One key duty of directors is to keep away from insolvent trading1. Insolvent trading occurs when the director knows that or is expected to be aware that the debt the company has incurred or intends to incur cannot be paid and is not repaid. The Act specifies that the director ought to be held liable and should pay a compensation totalling to the amount of that debt. Insolvency is defined under section 95A of the Corporations Act as to “the inability of the company to pay all its debts, as and when they become due for payment”. In the case of Elliott v Australian Securities and Investments Commission [2004]2 the court held that a director fails in their duty of avoiding insolvent trading "by not preventing" or "by failing to prevent" a company from incurring a debt. If there are “reasonable grounds for suspecting that the company is insolvent” the court stated that the director will be deemed liable for debts incurred by the company. Therefore, no further proof is needed to indicate that the director did not perform their duty as required seeing as they could have prevented the company from incurring the debt. In this case, Max was aware that the company could not be able to pay its debt. The situation here is that Max knew that the company was likely to become insolvent. However, he allowed the company to take goods from Smart Engineering Pty Ltd on credit. In conclusion, Max has a case for the unpaid debt to Shifty Sellers Pty Ltd. He failed to prevent the transaction from being effected and therefore should be held liable. b. The legal issue is whether Betty can be held liable for company debt. Is Betty, the non-executive director of Smart Engineering Pty Ltd, liable for the repayment of the $500,000 debt to Eastpac Bank Ltd? The area of law is company law. Legally, a company is regarded as a separate legal entity. The company, therefore, owns its own assets and liabilities. It also has its own rights. The company directors can, however, be held personally liable for company debts. The debts for which the directors can be held liable emanate from several areas; key among them is insolvent trading. Even though a company may not be insolvent at the time of taking the debt, there are several signs, such as declining profitability, loss making and low cash reserves, which show that the company is disposed to become insolvent. Therefore directors are expected to assess the company’s cash-flow and financial position so as to determine whether it is insolvent or not. The directors can be held liable if they engage in insolvent trading as outlined by section 588G of the Corporations Act. Some of the factors that show that the company is insolvent are when the company issues cheques that are bounce back. In the case of Commonwealth Bank v Friedrich [1991]3 it was ruled that “there is no difference between executive and non-executive directors”. This means that a part-time non-executive director cannot be treated differently from other directors. All directors are obligated to “exercise a reasonable degree of care and diligence in the exercise of their powers and discharge of their duties”. Furthermore, in the case of Fletcher v National Mutual Nominees Ltd [1992]4 is was ruled that the standard of care to be exercised by directors “is to be evaluated by also considering the circumstances relating to the responsibilities which the directors have undertaken”. In this case, Betty knew of the business situation. Smart Engineering Pty Ltd had been making losses since operations in China were launched. Over the six-month period, the company had been making losses. Further available projections indicated that China’s business environment was not favourable. She still went ahead and allowed Max to acquire a $500,000 loan from Eastpac Bank Ltd. Moreover, she had a feeling that the company would not be able to overcome the prevailing circumstances. In conclusion, Betty has a case for the unpaid debt of $500,000 to Eastpac Bank Ltd. She therefore can be held liable for the debt because of failing to prevent insolvent trading. c. The legal issue is to identify whether Alex and Betty breached any duty, under the Corporations Act 2001 that they owe to Smart Engineering Ltd. Do Betty and Alex owe Smart Engineering Ltd any duty? The area of law is company law. According to the Corporations Act (2001)5 the directors of a company have a number of duties to perform on behalf of the company. Section 180 indicates that directors are supposed to act with due care and diligence. In section 181, the directors are instructed to act in good faith. This involves the duty to act in the best interest of the company, the duty to avoid conflict of interest, the duty to avoid insolvent trading, the duty to act for a proper purpose, and the duty of fidelity and trust. Section 182 indicates that company directors should not use their position to benefit themselves or any other person to the disadvantage of the company (proper use of position). Finally, section 183 states that should properly use the information they have. The directors also have duties that relate to other laws, such as the occupational, health and safety law. In the case of Statewide Tobacco Services Ltd v. Morley [1990]6, Mrs Morley was a director and shareholder of a small family company. However, she was not involved in the daily running of the company activities over a long time. The company collapsed. The court held that she breached her duty of due care and diligence to the company. Mrs Morley's failed to monitor the financial progress of the company. Therefore, she did not have any reasonable cause to expect that the company would be able to pay its debts as and when they fall due. Even though she had been ill, it was held that her negligence was irrational. The judges indicated that a director is supposed to “take a diligent and intelligent interest in the information either available to him or which he might with fairness demand from the executives or other employees and agents of the company”. It was also argued that even if the director has no particular expertise, they are required to exercise reasonable diligence, which includes the duty to understand the company's financial status. Even under the common law, directors owe the company the duty of due care. In the AWA case7, it was held that “a director owes to the company a duty to take reasonable care in the performance of the office”. Directors are supposed to act whenever they note a problem. By accepting to become directors, people have got to take up the responsibility of making sure that they understand the nature of the duty they are called upon to perform. Of course, the duties will vary according to the size and business of the company as well as their experience and/or skills. The responsibilities of directors necessitate them to take reasonable steps to place themselves in a position to lead and monitor the management of the company. In this case Alex seemed to act recklessly by entering into dubious transaction on behalf of the company. Alex seems to understand the risks of the actions he is undertaking as a director of the company. In the first transaction, Smart Engineering Ltd lost $100,000 by delivering goods on credit to Shifty Sellers Pty Ltd, whose director was associated with credit risk and Alex knew that. In the second case, he goes on the secure a $500,000 loan from Eastpac Bank Ltd regardless of the poor financial status of the company. Betty, the non-executive director knew of that the business was in a poor financial status but failed to prevent the company from incurring the debt. Moreover, The circumstances of are further compounded by the reality that she failed to exercise a reasonable degree of care and diligence even with the full understanding of the foreseeable risk of harm against the potential benefits that could reasonably have been expected to accrue to the company from the conduct in question. In this case it may be argued that in their very nature, companies and their varying business endeavours may not allow equal treatment of directors and non-executive directors. However, there is satisfactory evidence to suggest that Betty knew of the facts regarding the business and therefore owed a duty of care to the company. In conclusion, Alex and Betty owed a duty of care and diligence to Smart Engineering Ltd. They have a case for acting negligently and therefore breached their duty of care and diligence. Bibliography Anderson, (2006) ‘Creditors’ rights of recovery’ 30 Melb Uni LR 1 ASIC RG 217 Duty to prevent insolvent trading: Guide for directors Daniels v AWA Ltd (1995) 16 ACSR 607 (AWA case) CAMAC, (2006), Personal liability for corporate fault Report Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115 Elliott v Australian Securities and Investments Commission (2004) 10 VR 369; 22 ACLC 458; 48 ACSR 621 James, Ramsay and Siva (2004), “Insolvent Trading: an Empirical Study” Keay, (2001), “Directors Duty to Take Into Account the Interests of Creditors” Melbourne University Law Review 11 Ramsay, I (2013, Corporate Governance & the Duties of Company Directors, CCH Australia Statewide Tobacco Services Ltd v Morley (1990) 8 ACLC 827 at 831 Read More