Corporations Law - Uniform Pty Ltd - Assignment Example

Susan &Co Certified Public Accountants 5thFebruary 2016 The Managing Director Harry Fine Outfitters Dear Sir, I hope this letter finds you well. Recently,you entered into a security agreement with uniform Pty Ltd to be supply the struggling retailer with uniforms. In that period Uniform Pty Ltd had been struggling to service its debt obligations. The problem became worse when Uniform Pty Ltd was locked out of its premises by the landlord over accrued rent. Following this incident Uniform Pty Ltd were unable to sell the stock of uniform supplied by Harry Outfitters on credit. Furthermore, you were unable to sell a stock of shoes obtained through a loan of $20,000 borrowed from a local bank. Specifically, you wrote to us requesting advice as regard the most preferable external administration option for Uniform Pty Ltd. You also wanted to know which one of Uniform Pty Ltdcreditors has priority over the assets of Uniform Pty ltd. In addition, you also sought advice over whether the actionsofUniform Pty directors in the circumstances breached any provisions of the Corporations Act. Uniform Pty Ltd is a limited company that supplies school uniforms. Gary and Steve are directors of Uniform Pty Ltd. Uniform Pty business has not been doing well since a new competitor opened two doors down. The company was already late in paying their utility, tax and lease payments by the time the busy season came around. However, Gary and Steve felt the company would be able to trade through the difficulties during the busy season. The directors were confident that the company would overcome the cash flow problems at the end of the busy season. Their confidence was increased by the fact that you had been able to trade through similar cash flow problems before. To obtain stock to sell during the busy season sale, they successfully negotiated a security agreementwith Harry Fine Outfitter’s to be supplied with uniforms on 5th January 2016. The agreement granted Harry Fine outfitters with a security interest in respect to all uniforms they had supplied to Uniform Pty Ltd. Unfortunately, Harry outfitters did not register the security interest. Gary and Steve also signed a loan agreement for $20,000 which was used to purchase shoes which they also meant tosell during the busy season. The bank registered a security interest over all present and after acquired property of Uniform Pty Ltd on 6 January 2016. Unfortunately, on the first day of the busy season, the Landlord locked Uniform Pty Ltd out of their premises and they were unable to continue trading. Currently, Uniform Pty Ltd has no funds to service the debts owing to the ATO, landlord, utility providers, Harry’s Fine Outfitters and Local Bank. According to my research and qualified opinion, the most preferable option forexternal administrationis for Uniform Pty Limited to be placed under voluntary administration1. Voluntary administration is an insolvency approach where the an independent and registered insolvency practitioner takes complete control of the insolvent business2. As a creditor with a charge over the stock of uniforms supplied to Uniform Pty Limited,Harry’s Fine Outfitterscan also appoint an administrator to take over Uniform Pty Limited3. Uniform Pty Limited is a business that has the potential for trading out of insolvency. Arguably, the interests of Harry’s Fine Outfitters would be best served by allowing an administrator to take over Uniform Pty Limited for a short period. It can be argued that Uniform Pty Limited would have been able to sell a substantial part of their stock if they weren’t shut out of their premises by the landlord. An administrator will serve the interests of Harry’s Fine Outfitters as he can supervise the business back to profitability or advise for liquidation of the company. An administrator will try his/her best to save the Uniform Pty Limitedor it businesses from liquidation. An administrators role is to investigate the viability of an insolvent company and advise its creditors of the options available for resolving its future4. As administrators, Harry’s Fine Outfitters can either5: End the voluntary administration and return the Uniform Pty Limited to the control of its directors. This is the appropriateoption, if the administrator believes that Uniform Pty Limited can trade out of trouble in the absence of his supervision. Execute a deed of company arrangement; DOCA. This is an arrangement where the company sets out plan to repay part or all of the debt6. It involves a comprise between the company and its creditors and varies the rights of the creditors as regard the debt owed to them. Liquidation: under the provisions of section 556 of the Corporations Act 2001, a resolution to dispose off the assets of the company to realize the debts owed to its creditors can be passed7. Liquidation would suit the interests of Harry’s Fine Outfitters, if there are sufficient assets to cater for all the debtors of Uniform Pty Limited. Arguably, youwill benefit greatly if you negotiate for a deed of company arrangement. Under the arrangement, Harry’s Fine Outfittersand other creditors can allow, Uniform Pty Limited to trade out of trouble and repay the amount owed for the uniforms purchased on credit8. Harry’s Fine Outfitters can also negotiate for a capital restructuring of Uniform Pty Limited and take an equity stake in the restructured company. If Uniform Pty Limited recover from the insolvency, the improved relationship with Harry’s Fine Outfitters will provide supply business to the garment wholesaler. You must acknowledge that various classes of creditors have differing priorities over the assets of a company under administration or about to be liquidated9. Secured creditors are the first priority when redistributing the assets of a company that has been liquidated. Moreover, creditors who have secured their debts through fixed charge assets have more priority over those whose interests are secured by floating charge securities10. For your interest to be prioritized,the floating charge interest will have to be a registered securities11. However, Harry's failed to register they had an interest in the stock of uniform supplied to Uniform Pty Limited. Moreover, interests over floating charge securities are given the least priority in the redistribution of an insolvent company’s assets at liquidation. Before crystallization, the holder of a floating charge has no recognizable Proprietary rights over the assets of the charger12. When the company goes into administration, receivership or is about to be liquidated, the charge fixes on the charged assets. Unfortunately, floating charge holders can only realizethe security after more preferential securities have been realized. After crystallization, a floating charge has among the least priority among secured creditors. In case a receiver takes over Uniform Pty Limited, he/she is obliged to pay out debts owed to priority creditors under section 433. Section 433 prioritizes payments owed to employees and insurance money owed to third parties13. Sometimes, a receiver may account forUnremitted tax revenue collected by chargorbefore floating charges as per section 221 of the Income Tax Assessment Act 1936 (Cth)14. However, as seen in Deputy Commissioner of Taxation v Chant, section 221P is ineffective against a chargee, if the receiver is not appointed over all the assets ofthe company15. The holders of floating charges are also among the least prioritized in case a liquidator is appointed to wind up the company. Under section 561, priority creditors including employee salaries and insurance money are accounted for first16. A floating charge may also be declared invalid under section 566, if it was created within six months of the commencement of winding up17. However, a floating charge remains valid, if the company was solvent at the time of granting the floating charge. Harry’s Fine Outfittersare at a great risk of being unable torecover the amount owed for supplying uniforms to Uniform Pty Limited. As seen in this analysis, an interest over a floating charge asset is a risky security option in case of insolvency. Harry's have no Proprietary rights over any of Uniform Pty Limited's assets beforea trigger event for crystallization occurs. For Harry's claim to fix on the supplied uniforms, Uniform Pty Limitedhas to either be under administration, receivership or be undergoing liquidation18. Unfortunately, Harry's claim would still be among the lowest priority for payment even when it fixes on the supplied uniforms. Other priority creditors like employees, the bank and the landlord will be considered before Harry's floating charge is considered. Under the section 588G, directors are liable if they fail to prevent their company from incurring further debt whilst insolvent, or if the company becomes insolvent by incurring the new debt at the time19. A director is also held liable, if their were reasonably sufficient grounds to suspect the company is insolvent or would become insolvent. Directors must therefore guard against insolvent trading at all times. The Corporation Act section 95Adefines insolvency as the opposite of solvency, meaning a corporation that is unable to pay all its debs when they become due and payable is considered to be insolvent20. A director who is found liable for failing to prevent insolvent trading can be held personally liable for losses incurred by creditors as a result of trading with the insolvent entity21. They may also be liable for a pecuniary penalty and be disqualified from managing companies. Gary and Steve breached their duty to prevent Uniform Pty limited from trading while insolvent. The two directors failed in carrying out the obligation to guard against insolvent trading as set out in section 588 of the Corporation Act. Uniform Pty Ltd was insolvent as it had fallen back on utility and rent payments by several months. The definition refers to insolvency as the inability to service debts when they become due and payable. Gary and Steve had a duty to ensure that Uniform Pty Ltd did not incur any new debt before servicing the debts that had accrued over several months. Instead, Gary and Steve acted in breach of Section 588G by including a new debt from a transaction where Harry's Fine Outfitters supplied them with uniforms. Gary and Steve also sought and obtained a loan from the bank to purchase shoes. At the time of incurring the new debts, Uniform Pty Ltd was already struggling to pay utility and rent payments. Directors who have been accused of beaching their duty to prevent insolvent trading can rely on several defences to avoid liability. The basis for these defences is establishing that there were reasonable grounds to expect the company would remain solvent22. The defences are23: 1. A plaintiff can rely on the first defence, if they have reasonable grounds to expect solvency. This defenceapples if it was reasonable for the director to be confident that the company would be able to repay their debts when they become due. 2. The second defenceapplies if the director relied on other competent persons in making the decision to allow insolvent trading. 3. Absence from management; directors who are not part of the management team at the time of the breach are not considered culpable for failure to prevent insolvent trading. However, the directors will have to prove their absence from management was caused by a good reason. 4. The final defence applies if the defendant took all reasonable steps to prevent insolvent the act of insolvent trading. Steve and Garyacted in breach of their duty to guard against insolvent but can still rely on one of the defences to avoid liability. Gary and Steve can argue that they had reasonable grounds to expect solvency at the time the debts became due. Under section 1317Sand 1318, Gary and Steve's breach of duty can be excused, as they had acted honestly and in regard to all circumstances24. It must be noted that the defencesdiscussed above do not prevent courts from finding plaintiff culpable of breaching their duty to prevent insolvent trading25. Instead, the defences provides grounds for courts to relieve directors of the consequences of breach. It is important to note that it is not a defence for a director to claim that he/she failed to prevent insolvent trading on the basis that the company’s and creditors' interests are best served by insolvent trading. However, courts will consider this a relevant factor in excusing the directors of the consequences of breaching section 588G26. In this case, Gary and Steve could argue that they were confident of trading out of trouble. By trading out of trouble, Uniform Pty Ltd would have been able to easily deal with it'sdebt obligation and continue trading. To summarize the advice, Harry Fine Outfitters should negotiate to have Uniform Pty Ltd placed under voluntary administration. Under this option, Uniform Pty Ltd would be able to trade out of trouble and repay the debt owed to Harry Fine Outfitters. Under other external administration options like liquidation, Uniform Pty Ltd security interest would be the least priority among all of Uniform Pty's creditors. There is a real riskthatHarry Fine Outfitters may never recover the amount owed. Finally, you can report Gary and Steve for failing to prevent Insolvent company trading as set out in the Corporations Act. I hope my advice is helpful, you can call me on my office number to discuss the matter further. Feel free to call for any clarification or to set up a meet to discuss the matter. Very truly yours, Susan Mcquire Bibliography A. Articles/Books/Reports Tomasic, Roman, Stephen Bottomley, and Rob McQueen.Corporations law in Australia ( Federation Press, 2002) Haque, A.K.M., 2006. Floating Charge as a Security Device, The UW Sydney L. Rev. 10 (2006) 25. B. Cases Tricontinental Corporation Limited v FCT [1988] 1 Qd R 474 Hall v Poolman (2007) 215 FLR 243; 65 ACSR 123  Deputy Commissioner of Taxation v Chant (1991) 24 NSWLR 352  C. Legislation Corporations Act 2001(cth), s. 433 Income Tax Assessment Act 1936 (Cth), s. 221 Read More