Corporation Law and Insolvent Trading - Assignment Example

Insolvent Trading Name: Unit: Course: Supervisor: Date of submission: Introduction Insolvency trading takes place when the company directors permit the company to get into debts at a time when the books of accounts portray that the company cannot pay its debts (Levenstein 2010, p.2). In the Act of Corporations section 588G, insolvent is justified when a company incurs a liability or the debt leads it to being insolvent. The section 95A of the Corporations Act defines a company as being insolvent when it is in a financial situation where it cannot pay its creditors in the specified time for the debt payment. If a company is insolvent and engages in trade that risks its creditors business, this is legally wrong. In such a case, the creditors can instigate a legal process. The responsibility of ensuring that the company does not engage in insolvent trading lies on the directors (Grantham 2001, p. 3). This paper discusses a case study of OHS Solution and discusses if its directors are about or have already breached the responsibility to prevent bankrupt trading. Insolvent Trading The responsibility of the directors to thwart insolvent trading relies on various assumptions that can be used to deem the company insolvent. The assumptions are laid down in the section 588E of the Corporations Act. The first assumption is contained in section 588E (3) that assume that a company that is winding up and its financial records show that it was insolvent during the time of application of winding up. The second assumption is contained in the s 588E (4) and happens when the company for a substantial period of time as it is stated in section 286 does fail to keep records of financial matters, the company is treated as having been in debt during that time it contravened the section 286 (Ramsay 2000, p. 3). Having this knowledge in mind it is easy to determine the position of the OHS Solutions and the Directors. Liability of OHS Solutions Directors Des having already signed a contract worth 10, 000 with Promotions Plus PTY. Ltd implies that the company entered into trade. For a director to be deemed of breaching the Corporations Act section 588G, the grounds for the trading must be proved that there was a reasonable basis the director could have suspected insolvency. The reasonable grounds are assessed depending on the director’s competence and the basic knowledge of the financial status of the company1. In any company, executive directors are in charge of overseeing the operations of the company and thus are desired to have knowledge on the company’s financial status. The ability to “suspect” insolvency means that the director in charge has a positive apprehension of certainty of insolvency (Ramsey 2000, p. 12). In the case of Des, being a Managing Director means that he was responsive for the status of the company’s financial position, in addition the company had been in operation for only six months which implies the company financial status was no very complex for an executive director not to know the status. With such knowledge, engaging the company in a new contract infringed the duty to avert insolvent trade in reference to Des. This is due to the fact that he did so without having consulted the accounts. The company having been in trade for only six months and being the managing director, it could be assumed that he acted with negligence by assuming not to know the financial status of the company. In addition the Company had not settled its due debts with Trouble Shooters yet services had been provided. This could be assumed that the company had not retained its financial records for the specified time it was engaging in this new business. This means that Des was permitting OHS Solutions to incur more debts while it was still in a financial situation that could not pay earlier debts which deems it insolvent under the section 588G. Ying a non executive director of the company is also liable to the breach of duty to prevent insolvency trading. According to (ASIC 2008, p.2) the Corporations Act imposes duties on the directors which gives them responsibility to act with due diligence in execution of the responsibilities. Ying being a director of OHS solutions, friend to Des and at the same time a director of Support Pty Ltd, the two (Des and Support Pty Ltd are share holders of OHS Solutions) had the responsibility to exercise her powers and duties with a lot of care as it is expected from a reasonable person. This means that any director should take the necessary steps to be fully informed of the fiscal position of the company and ensuring that the specified company is not allowed to trade if it is insolvent (Mokal, 2000). Therefore being a friend of Des, though not an executive director, Ying ought to have known the financial position of the company and prevented the trade. The Corporations Act bestows the directors with the duty to ensure that they carry their duties in good faith that serves to the benefit of the company (ASIC 2008, p.4). Ying by speculating on the business opportunity that OHS Solutions was to lose and thinking of Support Pty Ltd taking over OHS Solutions means that he was not acting in good faith of the company and could be held legally responsible for allowing the company to engage in insolvent trading. Ying by just sitting and contemplating on the business opportunity it is assumable that he contravened the duties set out by the Corporations Act that prevent a director from using his position to gain advantage that could be to the detriment of the company, she was thus obligated to advice the fellow directors on matters relating to insolvency failure to which deemed her to having encouraged the company to engage in insolvent trading (Ramsay 2000, p 17). Ying and Des did not act in good faith and their actions were to the detriment of the OHS Solutions. It is thus evident having allowed the company to enter in a contract without carrying due diligence, they breached the duty to prevent their company solutions from insolent trading. In a similar case, The Stake Man Pty Ltd v Carroll [2009] FCA 1415 in which a director traded without consulting the financial capability of the company, the Federal Court of Australia, the Court found the director of The Man Stake Pty Ltd had breached section 588G by allowing the company to trade while it could not pay debts2. It can thus be assumed Des permitted OHS to trade while aware of the company’s financial status. This is compounded by the fact that he acted in desperation in a bid not to lose a big contract and was aware of the dissatisfactions from the contracts signed before. The company directors have a duty to ensure that relevant books and financial records are kept, this may be delegated the other employees but remains the mandate of the directors to ensure that the company has all its books in order failure to which surmounts to contravening the Corporations Act (Ford, Austin & Ramsey 2003, p.116). The duration of operation means that all the Directors must have been well informed of the financial status of the company. Satish was also aware of the $10, 000 debts and could have advised the fellow directors on trading precautions. Satish having been running the technological department where the debt was incurred puts him as having failed to prevent a breach in insolvent trading and hence liable of breaching the same duty. In a Metropolitan Fire Systems Pty v Miller the court on examining if the Director of Metropolitan Fire Systems had breached the duty to prevent insolvent trading, he relied on “suspect”3 issue which he stated that it requires a lower threshold or awareness, hence any small doubt by the director regarding the firm’s financial status could be used as a confidence measure that the company is insolvent. In the case of OHS Solution all directors must have had some knowledge that the company was doing well financially having just operated for six months. Furthermore, for Des to act in desperation and fear of losing big business which is based on failure of earlier satisfaction of clients means that he already suspected the financial status of the company. In relation to this case, it is arguable that Des and Satish were all aware of company being insolvent and their permitting the trade was infringe of obligation to prevent bankrupt trading. Conclusion The breach of duty to avert insolvent trading as laid down in the Corporations Act section 588 mandates the directors to act in diligence when transacting for a company. This is achieved by adhering to the statutory requirements and abiding by their duties which legally compel them to act in the favour of the organisation. The section 588G requirements that can make a director liable for the breach of his/her responsibility to avert insolvent trading is based on the director(s) having reasonable grounds to deduce that the company is insolvent and the fact that a reasonable person in the same capacity as the director could have the grounds to infer that the company was as well insolvent. The case of OHS solutions puts Des, Satish and Ying as having breached the duty to prevent insolvent trading. References ASIC. 2008. Insolvency: a guide for directors. Australian Securities & Investments Commission. Pp. 1-6. Ford, H.A., Austin, R. P. and Ramsay, I.M. 2003. Ford’s Principles of Corporations Law, Looseleaf, p.110-120 Grantham, R. 2001. The Judicial Extension of Directors’ Duties to Creditors. Journal of Business Law 1 (1), p.3. Levenstein, E. 2010. Director’s Trading in Insolvent Circumstances. Johannesburg: Werksmans Incorporating Jan S. de Villiers Mokal, R.J. 2000. An Agency Cost Analysis of the Wrongful Trading Provisions: Redistribution, Perverse Incentives and the Creditors’ Bargain. Cambridge Law Journal 59 (1), p.335. Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699; Ramsay, I.M. 2000. Company Directors’ Liability for Insolvent Trading. Melbourne: Centre for Corporate Law and Securities Regulation, pp. 2-23. Stake Man Pty Ltd v Carroll [2009] FCA 1415. Read More