Fundamentals of Corporate Law - Assignment Example

Corporate Duties Institution Date Issue Did the directors of Coco ltd breach their duty of care and diligence in having the Cocoa shipped from Costa Rica uninsured? Was it good business judgement to result to importing Cocoa from Costa Rica uninsured? Relevant law The statutory law that guides these issues in Australian is found in section 180 (1) of the Corporations Act 2001 (Cth). In the section, a director of a company as reasonable person has a duty to act with due care and diligence while exercising his powers and discharging his duties. The statute provides two circumstances where this duty of care applies: first, if the person in question is a director or officer of the company in the present’s circumstance, secondly, if the offices held by the person in question bear the same responsibilities as those of a director or officer of the company In common law director’s duty to act with care and diligence is recognized in several cases. Directors duty to act diligently and with care are set out in City vs Equitable Fire Insurance company limited [1925] 1 CH 407. However directors and other officers can rely on the ruling in Asic vs Vines (2003) NSWSC 1116 which frees directors from liability if their business judgment is honest, informed and rational. Section 180 (2) of the Corporation Act 2001 (Cth) also provides directors with a safe harbour, if a director meets the following conditions in a business judgment, and is taken to have satisfied his duty under section 180 (1): a) If the decision is made in good faith and for a proper purpose. b) If the director or officer does not stand to make any material benefit from the decision. c) If he has informed himself on the subject matter and believes his action is appropriate. d) If he believes the business judgment is in the best interest of the corporation. Further section 180 (2) of the Corporation Act 2001 (Cth) states that the if an officer or director believes he is acting in the best interest of the company based on rational reasoning, the director is assumed to not have contravened se.ction 180(1). However it is required that the belief is one that a reasonable person would take if they were holding the same position. Section 180 (3) of the Corporation Act 2001 (Cth) refers to business judgment as a decision that takes into consideration relevant matters in the business’ operations. This definition limits the business judgment rule to matters of operational decisions only (Harris, Hargovan and Adams, 2013). In one case it was ruled that the director did not breach his duty to act with care and diligence as he proved he used good business judgment (ASIC v Maxwell and Others [2006] NSWSC 1052). Application The directors’ decision to import the Cocoa from Costa Rica uninsured can be presumed to be a contravention of Section 180 (2) of the Corporation Act 2001 (Cth). As directors of Coco ltd they are aware of the need to insure cargo that is transported by sea, as this is the normal way of conducting transportation business by sea. However, with a looming shortage of Cocoa in Australia the business decision made by the directors can be judged to be in the best interest of the company. The business decision made by the directors fulfils the condition of section 180 (2) Corporation Act (Cth) as: a) The decision to ship the Cocoa uninsured was made in good faith and for a proper purpose b) None of the directors or officers is using the opportunity to make material benefit. c) The directors have informed themselves on the subject matter and believes their action is appropriate; d) And the company stood to make a huge profit had the Coco arrived in Australia as envisioned. In most cases, Courts have abandoned a strict interpretation of Section 180 (1) Corporation Act 2001 (Cth) which would otherwise make the directors culpable for the loss of the uninsured cargo in the high seas (Harris, Hargovan and Adams, 2013). This interpretation aims at striking a balance between a director’s responsibility for business losses and entrepreneurial risk taking of directors. In Vrisakis v Australian Securities Commission (1993) 9 WAR 395, Justice Ipp argued that it can no longer be taken for granted that managing the operation of a company involves taking decision “which promise gains for the company on one hand, but at the same time they are fraught with risk on the other hand”. Similarly, the directors of Coco ltd downplayed the risk of importing the Cocoa uninsured as the benefits to the company would be worth the risk. Justice Ipp, in Vrisakis v Australian Securities Commission articulates this situation as “an act of balancing the foreseeable risk of harm against the potential benefits”. Under the argument in Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets (No 6), [2007] NSWSC 124, the directors of Coco Limited would escape liability for failing to insure the Cocoa, as the directors tried to reasonably balance the risk and reward the company would have gotten from the venture. Justice McDougall argues that the law must allow for directors to “display entrepreneurial flair and take on commercial risk” if any sufficient return on capital is to be realized. Clarke and Sheller JJA in Daniels & Ors v AWA Limited argue that failure of a venture that promised commensurate rewards to the company should not be taken as negligence on the part of the people who made the decision to pursue such as venture. In the present circumstances, the directors of Cocoa Ltd took an entrepreneurial risk by choosing to import the Cocoa uninsured from Costa Rica and it would therefore be unfair to allege they acted negligently. Conclusion Section 180 (1) of Corporation Act 2001 (Cth) is unusually harsh on directors or officers who take an entrepreneurial risk on behalf of the company. In this case however, the directors are not in breach of their duty of due care and diligence, as the decision to import the Coco uninsured was based on a good business judgement and it was in the interest of the company. Question 2: Is the company insolvent? Issue Has the Cocoa Company become insolvent? Relevant Law Section 95A of the Corporation Act 2001 (Cth) is concerned with determining whether a company is insolvent. The section states that; “a person is insolvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable”. According to Harris, Hargovan and Adams (2013), Australian law is very strict on insolvent trading. First, Australia uses a cash flow test in contrast to the balance sheet or net asset test used in other jurisdictions to test for insolvency. Therefore, bankruptcy in Australian companies is detected much earlier than in other countries. Secondly, the penalties for insolvent trading are very high in Australia; up to $220,000 in fines or a 5 year imprisonment (Harris, Hargovan and Adams, 2013). Application The financial position of Coco ltd indicates that the company is insolvent. When the Goods purchased from Costa Rica sunk at sea, Coco Ltd automatically made a loss of 25 per cent of the purchase price. This loss substantially depleted the company’s cash flow as they had ordered a large shipment of Cocoa. Furthermore, the company failed to pay insurance for the shipment; an indication the company was already experiencing cash flow problem prior to the shipment of the Cocoa. According to the Overland (2014), the common signs that a company is insolvent include cash flow problems, ongoing losses, overdue taxes and superannuation liabilities, expectation that the next big job/sale will lift the company out of the dire financial problems and defaulting on loans and credit payments. Cocoa limited expected the huge purchase of Cocoa from Costa Rica at a time when there was a biting shortage in the Australian market to save the company from financial ruin. The fact that the company was unable to clear the supplier’s debt when the Cargo got lost at sea indicates Cocoa Ltd intended to sell the coffee then pay the creditor. When the venture failed, the company was unable to raise additional capital to fund its activities or clear its debts. Despite this the company continued incurring more debt without bringing in any revenue. The final indicator that Cocoa ltd was insolvent came when the Australian Tax office (ATO) lodged a director penalty notice against the company, as it had failed to remit its taxes on time Australian Securities and Investments Commission v Rich (2009) 75 ACSR 1; 236 FLR 1, the ASIC accused the directors on One.Tel of contravening section 180 (1) of the Corporation Act 2001 (Cth) by failing to assess the true financial position of their company prior to the company being placed under administration. Similarly, the directors of Cocoa ltd have also failed to assess the financial position of their company and are therefore they cannot ascertain if the company is insolvent. Conclusion Company directors must assess the financial position of their company if they are experiencing cash flow and debt repayment problems to avoid attracting liability for insolvent trading. In this case Coco ltd continued trading while insolvent, therefore making the directors guilty of a civil and criminal offence. Question 3 Issue Can the directors of a company be held accountable for debts incurred if the company continues trading while insolvent? Can they attract criminal liability for breach of their duty to prevent insolvent trading? Relevant Law Section 588G of the Corporation Act 2001 (Cth) sets out a duty for directors of companies to prevent insolvent trading by their firms. A person has a duty to prevent insolvent trading if: he/she is a director or officer of the company at the time the company incurs the debt; if he is aware the company is insolvent, or would become insolvent by incurring the debt; if he has reason to believe the company is insolvent (it would be unable to clear its debts). In such a situation, failure to prevent the company from incurring further debt means the directors have breached their duty to prevent insolvent trading. A breach of Section 588G of the Corporation Act 2001 (Cth), triggers the compensation claims against a company’s director under section 588M. Section 588M of the Corporation Act 2001 (Cth) guides recovery of loss arising from insolvent trading and is one of the few instances where the corporate veil is pierced to find directors liable for debts incurred while acting on behalf of the company (Harris, Hargovan and Adams, 2013). Section 588M applies only when a director is in breach or Section 588G(2) or (3), and the creditor has suffered a loss due to the company becoming insolvent, the debt owed to the creditor is partly or wholly unsecured and the company is being wound up. Recovery of debt to from the director is not limited to cases where the director has not been convicted for an offence or civil order made in regard to the contravention. An amount equal to the loss or damage suffered by company is set as the limit of the amount recoverable from the director (Harris, Hargovan and Adams, 2013). Directors who breach their duty to prevent insolvent trading also attract criminal liability under section 588G (3) of the Corporation Act 2001 (Cth). A director is criminally liable for insolvent trading if; he was a director or officer of the company at the particular time the debt is incurred; if the company is insolvent, or the debt so incurred causes insolvency; if the person had reason to believe the company was insolvent or would soon become insolvent as set out in Credit Corporation Australia Pty Ltd v Atkins (1990) 17 ACLC 756; 30 ACSR 727; and if the person’s conduct in failing to prevent insolvent trading was dishonest. Section 588H provides grounds for directors to defend themselves against acquisitions of failing to prevent insolvent trading. A director may escape liability if: they reasonably expected the company would become solvent; they relied on advice or information from others: they were absent from active management of the business, for example through illness; they took reasonable steps to prevent the insolvent company from incurring debts (Harris, Hargovan and Adams, 2013). Application In this case, Hugo and his fellow directors would be liable for debts incurred when the company became insolvent. The supplier of the Cocoa would also be able to recover the loss suffered under Section 588M. It can be deduced from the case that the supplier’s debt caused Cocoa Ltd to become insolvent, as the directors speculatively ordered for the large quantity. Furthermore, the inability of the company to insure the cargo during shipping indicates the beginning of Cocoa ltd cash flow woes. Despite the knowledge that the company would not be able to pay the debt for within three month without first selling the Cocoa, the company went ahead to order the shipment. In Credit Corporation Australia Pty Ltd v Atkins (1990) 17 ACLC 756; 30 ACSR 727 mere suspicions that a company would become insolvent does not constitute reasonable belief that the company would become bankrupt. Since the directors of Coco Ltd knew that the company would not be able to pay for insurance, mere suspicion that the firm would become insolvent is ruled out (Harris, Hargovan and Adams, 2013). Secondly, the Cocoa supplier suffered damage; his debt was also wholly unsecured, therefore him recover the debt from the directors of Coco ltd. Moreover, the company continued trading despite being aware they could not clear their debt and would have gone on to attract further debts, if the Australian Tax office had not intervened. By continuing to trade the directors of Cocoa Ltd were acting dishonestly and thus they are criminally liable for insolvent trading. Criminal liability would be easy to proof as all the element of section 588G (30) of the Corporation Act 2001 (Cth) are present in the case: first, as all the directors were actively involved in running the affairs of the company at the time the debt was incurred; secondly, they were aware of the company’s insolvency as it hand been unable to clear the debt owed to the Cocoa supplier or clear its tax obligation; thirdly, the directors already knew of the company financial position as seen in their decision to import the cocoa uninsured, so suspicion as used in Credit Corporation Australia Pty Ltd v Atkins (1990) 17 ACLC 756; 30 ACSR 727 could not qualify as a defence; finally, the fact that the company continued trading until a tax penalty was imposed on the directors points to their dishonesty. Hugo and the other directors cannot rely on the defences against accusation of insolvent trading (s588H, Corporation Act 2001 (Cth)). The directors of Cocoa ltd reasonably expected the sale of the Cocoa ordered from Costa Rica would make the company solvent. However, this does not explain insolvent trading after the Cocoa venture failed. Furthermore, there is no mention of reliance on other people advice or absence from active management. Finally there was no effort on the part of the directors to prevent insolvent trading. Conclusion Therefore, director’s failure to prevent insolvent trading means they are liable for civil and criminal offences. References ASIC v Maxwell and Others [2006] NSWSC 1052. Asic vs Vines (2003) NSWSC 1116 City vs Equitable Fire Insurance company limited [1925] 1 CH 407. Credit Corporation Australia Pty Ltd v Atkins (1990) 17 ACLC 756; 30 ACSR 727 Daniels & Ors v AWA Limited Harris, J. ,Hargovan, A & Adams, M. 2013. Australian Corporate Law 4th Edition, Sydney: Lexxis Nexxus. Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets (No 6), [2007] NSWSC 124, Overland, J. 2014. Corporate Social Responsibility Reporting and Directors’ Duties: The Australian Experience. In Corporate Social Responsibility in the Global Business World (pp. 135-152). Sydney: Springer Berlin Heidelberg. The Corporations Act 2001 (Cth) Vrisakis v Australian Securities Commission (1993) 9 WAR 395 Read More