Company Law: Director Duties - Math Problem Example

Assignment Two: Directors Duties Question A In reference the Corporations Act 2001 (Cth)1, the directors of Coco Ltd have reasons to be concerned for not insuring the shipment of cocoa from Costa Rica. Being a director of a company entails various duties and responsibilities that if not exercised accordingly could subject directors to legal liabilities. Firstly, for not insuring the shipment of cocoa, the directors of Coco Ltd should be concerned whether they effectively exercised their statutory duty of care and diligence. Directors’ duty of care and diligence is featured in s180 (1) which stipulates that directors of a corporation must exercise their powers with care and diligence like reasonable person would if they occupied the position of a director2. Due to the serious risks associated with sea transport, the directors’ decision to ship goods from Costa Rica to Australia uninsured may be considered as a contravention of their duty of care and diligence3. The standards for determining whether directors breached their duty of care and diligence was applied in ASIC v Vines4. In this case standard of care and diligence was measured based on what a reasonable and prudent person would do and what an appointee with special skills would do in the given circumstances. In Wyong Shire Council v Shirt factors such as probability of risk occurrence, and magnitude of risks and losses incurred were used to determine what a reasonable director would do5 . These factors were also taken into account in Vines v ASIC6. It is expected that the directors should have diligently conducted a risk analysis and assessed factors that could jeopardize the financial standing of the company. Subsequently, they should have taken preventative or counter measures like insuring the shipment of cocoa in order to minimise the probability of the company becoming insolvent in case an accident at sea occurs. However, this was not the case thus as seen in AWA v Daniels where the directors we found liable for negligence, there is possibility that the directors may face legal liability for failing to effectively exercise their duty of care and diligence7. Under s1317E contravention of this provision may cause the ASIC to enforce civil penalties against the company’s directors once the court establishes a contravention8. In this case, the ASIC may enforce a pecuniary penalty order under s 1317G9 or a disqualification under s 206C10. Secondly, the directors of Coco Ltd should be concerned that their decision not to insure the the shipment of cocoa to Australia can be challenged as being in bad faith and not in the best interests of the company. As seen in ASIC v Adler where the director was found liable for breaching their duty of good faith, the directors of Coco Ltd could also be found liable11. Under s181, directors of a company are charged with the responsibility of exercising their duties and powers in good faith, in the best interests of the company and for a proper purpose12. According to Southgate and Glazer the term “good faith” and its antonym “bad faith” are used widely in different legal contexts. Good faith is commonly used to refer to honesty in purpose or belief. The term bad faith is used to refer to an intention to defraud or seek unwarranted advantage13. Evidently, the underlying reason why the directors did not insure the shipment was because they found the insurance costs too high to be sustained by the company. It may be questionable whether the decision not to insure the shipment was made in good or bad as seen in Regal (Hastings) Ltd v Gulliver14. Furthermore, under this provision it may be questionable whether the decision not to insure the shipment of cocoa was made in the best interest of the company. In reference to Sheahan v Verco making decisions or taking measures that can lead a company to incur more debts is not in the best interests of the company and can lead to legal liabilities15. Although the directors may not have foreseen the calamity, there were aware of the risks associated with shipping as a means of transportation. Baughen observes that, perils at sea such as bad weather and attacks can be unavoidable and as such it is important for shippers to take necessary measure to protect themselves from incurring losses. Thus not taking insurance may be termed as a decision that was not in the best interest of the company16. Consequently, directors could be subjected to legal liabilities provided under s 1317G or 206C 17.  Although, s 180 (2) on the Business Judgment rule can provide a safe harbor to protect the directors of Coco Ltd from personal liabilities for contravention of their duty18 just as in ASIC v Rich 19, there are certain provisions that may not be applicable in the case of Hugo. s180 (2) on the Business Judgment rule stipulates that a director who makes a business judgment is considered to meet the requirements stipulated under s180(1) if they do not have personal interest in the judgment made20. Based on this provision Hugo could be subjected to personal liabilities since he fails to meet the personal interest requirement of the Business Judgement Rule. For instance, in Cook v Deeks21 and Green v Bestobell Industries Pty Ltd , the court found that the directors had breached their duty for embarking on business under conflict of interest22. Question B The term “Insolvent” is used in the Corporations Act 2001 section 95A 23to refer to a person who is not solvent. According to this provision a solvent person one who is able to pay their debts as they become due and payable. Therefore, insolvency is used to refer to a person who is unable to pay their debt as they fall due. Similarly, under the Bankruptcy Act 1924 s 95 and s122, insolvency is defined as the inability of a company out of its own money to pays its debts as they fall due24. In reference to these provisions, Coco Ltd can be considered as insolvent since it incurred more debts and failed to meet its tax obligations. This shows that the company failed to meet to pay its debt as it fell due. Hence the company can be considered insolvent. In order to establish whether a company is insolvent, Goode recommends the use of two tests namely; the cashflow test and the balance sheet test25. Cash flow test involves assessing commercial solvency and whether a company’s assets exceed its liability on a balance sheet as seen in Leslie v Howship Holdings Pty Ltd 26. Using the balance sheet test a company can be considered as insolvent if its assets are not sufficient enough to take care of its liabilities. Despite the fact that the company may be able to take care of its current obligations, if the company’s total assets ultimately fail to meets its liabilities it can be considered insolvent27. Based on these two tests, Coco Ltd can be considered insolvent. It is apparent that the company’s total assets are not able to meet its liabilities since following the Suez Canal accident, the company incurred more debts and was unable to meet its tax obligations. In Sandell v Porter28, the question of insolvency under s 122(1) was put to test29. The Chief Justice observed that insolvency is the inability of the debtor from his own money to pay debts as they become due. However, the debtor’s money are not limited to the money or resources that are immediately available. They extend to money that can be gained through the sale of assets. A company cannot be considered as insolvent due to its temporary lack of liquidity. Thus the conclusion of whether a company is insolvent takes into account the overall financial position of a company30. In the case of Coco Ltd, the company did not get insurance because it could not sustain insurance payments. Following the accident the company drifted further into debt and was not able to meet its financial obligations. This shows that the company does not suffer from a temporary lack of liquidity rather its overall financial position is dire. Hence, Coco Ltd is insolvent. Question C By April 2013, Coco Ltd’s financial position had deteriorated however, it continued to incur further debts and continued to trade until the end of May 2013. Thus, in a case where the company would be found to be insolvent, the directors of the company would face a number of liabilities. Under s 588G of the Corporations Law, directors have a duty to prevent insolvent trading of their company. Failure to do so, liquidators can claim civil penalties against the directors who manage the company. In reference to this provision, liability can be imposed to a director as seen in Credit Corporation Australia Pty Ltd v Atkins 31if; they hold the position of a director when the company is incurs a debt, when there is reasonable doubt to suspect that the company is insolvent due to the debt incurred and when the directors are fully aware that there are reasonable grounds that the company could be insolvent32. Nonetheless, it is worth noting that, in order for the directors to face personal liabilities for insolvent trading under s588G(3)(c), it is important to prove beyond reasonable doubt that the directors “suspected” that the company was insolvent or would be insolvent due to the debts incurred. In Queensland Bacon Pty Ltf v Rees33 in reference to s95 of the Bankruptcy Act(1924), 34Justice Kitto established the meaning of the term “suspect” as a feeling that involves more than mere wondering whether something exists or not. It is an affirmative feeling characterised by real apprehension or mistrust but without sufficient evidence. Therefore, a reason to suspect that something exists is a good enough reason to look into the possibility of its existence. Since the directors of Coco Ltd were fully aware of the company’s financial position such that they decided not to insure the shipment of cocoa from Costa Rica, it is evident that they contravened s 588G. It is also plausible to argue that the directors of Coco Ltd breached s 588G mainly because although there were sound reasons to suspect believe that the company would become insolvent due to the debts incurred, they continued to trade. Contravention of s 588G can result to a number of penalties or liabilities. Firstly, under s 588M, the company’s liquidators can sue the director for compensation. If successful, the liquidator may obtain compensation that is equal to the loss or damage incurred when the company became insolvent35. The liquidator has the mandate to seek recovery of debts and losses incurred when the company was insolvent on behalf of creditors. Despite the fact that most claims for compensation are often filed by company liquidators, an individual creditor can also sue the directors for compensation for contravening s 588G36. In the case of Coco Ltd, the company in Costa Rica which supplied the company with Coco can seek for compensation. Other creditors can also seek for compensation from the directors. In addition to this, the court may order the directors to meet the company’s tax obligations. For instance, in ASIC v Plymin, Elliott and Harrison 37, the Victorian Supreme Court found that the directors failed to prevent the Water Wheel companies from incurring further debts when it was insolvent. It was established that the directors had breached s 588G38. Consequently, the company was placed into voluntary administration. Furthermore, the courts ordered that funds gained from selling part of the business would be used to pay the company’s creditor, ANZ Bank39. Since s588G is a civil penalty provision it can be enforced by the ASIC. Once the courts make a declaration that the directors breached this provision, under section 1317G the ASIC can seek a pecuniary penalty order of upto $200, 00040. Alternatively, under section 206C, ASIC can seek a disqualification order for the directors for a particular period of time41. For instance, in Commonwealth Bank of Australia v. Eise42 Mr Eise, a part-time director of the National Safety Council of Australia, was held liable and ordered to repay $97 million to the Commonwealth Bank. Mr Eise was found liable for failing to carefully assess the councils account and auditors’ reports thus failing to prevent the company for incurring more debt43. In Woodgate v Davis Justice Barrett found the director liable and observed that, Section 588G serve an important purpose of ensuring that director show case responsible conduct and attentiveness towards avoiding an increase in a company’s debt. The provision serves the purpose of protecting the welfare of creditors. It is also possible for the directors to face criminal liabilities. If it is established that the directors breached s588G and that their failure to prevent the company’s insolvency is established to be dishonest, the ASIC can impose criminal penalties on the directors. The criminal penalty may include the imprisonment of the directors for upto 5 years or a fine not exceeding $220, 000. In some instances, both forms of criminal penalties may be imposed44. Read More