Answer :

Director’s duty to prevent insolvent trading

Part A

Duty for the prevention of insolvent trading as a fiduciary duty

A Director is an individual who is acting as a Director of any company. He bears a duty which is positive as per the section 588G in the Corporations Act of Australia as given in the case of Commonwealth Bank (1991). This is meant for the prevention of any insolvent company to engage in trading according to Harris, J. (2009). Although the role of a director is highly privileged but it carries unique responsibility for the company and its stakeholders. As per the Corporations Act 2001 in this country any director must be aware of his or her obligations in an insolvent company as was found in the case of Morley (1993) and Scott (2002). If the company is undergoing financial difficulty or is insolvent then the director has to be in compliance with rulings of the aforesaid section or else his or her duties will become under scrutiny.

The section 588G of this act entails that a director of an organization must prevent the company from the debt incurring if:

•The company has gone insolvent already at the time when the debt was incurred.

•By incurring a debt range or by taking any form of debt including the debt with which the organization had become insolvent. Also at the time when the debt was incurred there are reasonable ground to suspect that the organization was insolvent or that it would become insolvent if any more debt was taken by it as noted in the case of Sandell (1997).

This duty for the prevention of the company from trading while being insolvent is a fiduciary duty. As with fiduciary duty it is understood that the director must act honestly, loyally, and in good faith for the company. Therefore he has an obligation to prevent the company for doing any trading activity while it had gone insolvent as it is in the best interests of the organization or the businesses to stop it from further damages.

How does the safe harbour defense operate?

The recent changes in the law provided the directors a safe harbour from the provisions of trading given in the section 588G (2) for civil insolvency as noted by Nicols, P., James T. & Topp A. (2008). The protection granted by the safe harbor is for the directors however it does go move away from the civil liability which is given in the section 588G (2).  

In this safe harbor the directors have to continue to have compliance with all of their legal obligations like their duties as a director and this includes the part 2D.1 of the Act. And the safe harbor does not bear any impact on any of the obligations of a company and also on any of its officers to comply with the continuous obligations as maintained under this law which includes the section 674 of this Act. It also does not entail rules of continuous disclosure which is imposed by the market operator.

The safe harbor facilitate restructuring of the company outside the formal process of insolvency in order to attain better outcomes for the company in contrast to appointing any liquidator or the administrator as noted by James, P., Ramsay, I., & Siva, P. (2004). The safe harbor operates in a manner which encourages the monitoring of the organization’s financial position by the director. It also instructs for engaging early in cases of financial distress and take appropriate steps actively for either restricting the whole business. And if it is not possible then the directors are required to move to a quick formal insolvency.

Also it is to be noted that as per the safe harbour legal instrument the directors are only held liable and accountable for the debts of the organization which had been incurred while the company was insolvent. And it is also to be shown that the directors were not developing or took any course of action which at the crucial time was reasonable and would have led the company to enhanced outcome than earlier from the immediate liquidation or administration.

Who does it the s588GA grant protection, and is there a difference between this section and the business judgment rule s180 (2)?

Corporations Act 2001 had introduced a new section, which is the s588GA. This is for the protection of the directors from any personal liability for the business debts which have been incurred by any insolvent organization in case the director had taken a reasonable action course which was probable to generate an improved outcome for the creditors and the company as in contrast to the appointment of the liquidator or administrator as noted by Keay, A., & Murray, M. (2005). This section essentially allows the director to incur the debts of the company during the restructuring or turnaround phase without having any type of risk for being held personally responsible and liable for the organization’s debts which were not repaid.

This new safe harbour reform allows for the relief to the director as they can held for personal liability and they can continue the trading activities of the company which is still under financial distress however, it is to be provided that they have taken reasonable action course which have the probability of generating better outcomes for the company and its creditors. This legislation is only extended to the debts which are incurred in relation to the action course or in its development. This protection ceases when the reasonable action course ceases which was developed for generating enhanced outcomes for the organization and its creditors.

This legislation is a modified version of the business rule of judgement of the act of corporations 2001. This is in relation to the statutory duties of the director which are the duty of care and also diligence of the director as given in the section 180 of this act and also the equivalent duties mentioned in the law of equity and common law. The expansion of the business rule of judgement has taken place with this new section and this would operate for relieving the director from any personal liability to continue trading in an insolvent company according to Ramsay, I. (2000). However for this to be legal the following elements needs to be satisfied:

• The financial books, records and statements of the company were accurate and fair.
• The directors had taken advice for the business restructuring from a qualified professional who is having access to the accounts and records of the company, on the means and also feasibility for ensuring the continued company solvency.
• The business judgement of the director was to serve in the interests which is the best for the creditors of the organization by pursuing a restructuring.
• The restructuring of the company was diligently carried out by the company’s director.

Are there any restrictions given in the act on the possible operation of the s588GA defense?

There are restrictions on the operations of this legislation in the insolvent trading of the company and these are discussed below:

• The directors who have failed to implement any course of act or have not appointed any liquidator or the administrator with the specified time which was reasonable that was the time when financial difficulty was realized. Such directors are restricted to gain benefits from this legislation.
• This is meant for the protection of the directors who are competent and have acted diligently and honestly. Thereby the protection as per this section is only open to those directors who have ensured that the company was in line with legal compliances for instance it had fulfill the obligation of paying to the employees and had also fulfilled their obligations of tax reporting.
• This section allows for the restructuring of the company outside any formal process of insolvency. However, some company may still not be able to recover and will proceed to the voluntary liquidation or administration in spite of the best efforts of the director. It has to be provided for benefitting from the safe harbour legislation that the company’s director had developed or pursued a reasonable action course for leading the company to an improved outcome.
• It has restricted opening only to those directors who complies with some formal obligations during the phase of formal insolvency which would make the unable the company to turn around.
• The safe harbour will deemed to not have existed is the director fails to provide for a liquidator or an administrator with the certain needed information.
• When following the period of safe harbour the liquidator or the administrator is appointed, the directors who do not provide them access to the books or other secondary evidence of the company when followed with the appropriate request, then they will be prevented from using such materials as evidence for having taken the reasonable action course. Thereby the application of this legislation becomes restricted.

The above restrictions on the use of this legislation of safe harbour have been made to ensure that when company enters the administration or it is wound up the directors are not able to withhold the information or books of the company to prevent the administrator or the liquidator from carrying out an investigation of the activities of the company and thus they are prevented from taking appropriate action.  

Will the changes to Division 3 bear an effect on the number of voluntary insolvencies in Australia in the future?

Directors are not held as responsible for the debts of the company as they are acting as the when they undertake a contract or they act like a type of agent to the company. And the imposition of personal liability or responsbility for debts of the company shall only create a disincentive with the business of the company. Then only those debts which are likely to be paid are to be incurred in such scenarios. This is a conservative approach and this limits the entrepreneurial risk taking. Liability of insolvent trading needs to have a policy basis which could justify the possibility of restricting the business success because of the personal liability risk. 

The insolvent trading prohibition in the country of Australia is termed as one of the strictest in the world according to Harris, J. (2009). The provision of section 588G have thus been changed and thereby the directors who are competent in rescuing the company are allowed for certain measures which could assist them in restructuring or turnaround the company. This will have a decrease in the number of voluntary insolvency of companies in Australia as directors are made able to restructure the company and help it come out of the financial distress.

Part B

Directors’ duties breached by Mr Daly

Mr Daly is the executive director of Linchpin Capital and was in charge of $20 million fund which was investment capital of people was being found to have breached his duties as directors. His company serves like a linchpin for two different companies where one is an investment fund while the other is the financial advice business. As a director he had the duty in the financial advice business where he would decide where the money of investment fund and this is termed as the Investport Income Opportunity Fund, or IIOF. However, it is not only the single fund as there are two funds and one of them registered where the other is unregistered. The registered is the public facing fund while the unregistered is the bulk of the fund held by the company.

He had the breached the directors’ duties of honesty as he had used the retirement saving of people for expanding his own private interests of business. He had even borrowed money from the investor whenever he ran short of cash. He had allegedly breached his duties as a director by misleading the client and violated the rulings of Corporations Act. He also caused misappropriation of funds and played with the trust of the people. He also failed to maintain transparency in the business as all the information about the investment was not objectively shown in the financial reports which mislead the clients. He was even alleged to have tapped the money of the investors by borrowing huge sums for himself. He failed to follow his fiduciary duties for the investors of the company. It was also found that company was under huge debts which signaled a financial distressing situation still no rescue steps were taken by him.

Breach of duties of the directors by the other directors of the company

The two directors who were interviewed over the conduct of the business. One of the director was found to have accessed the funds for relieving himself of from his own financial distress. While the other director had also accessed the funds as he wanted to pay for his divorce settlement.

Both the directors had not maintain their fiduciary duties which was duty of care, honest and to act in good faith for the investors. As they had used the invested funds for their own personal benefits. They had not acted in a transparent manner as such acts were not mentioned in their diversified portfolio which was given in the public disclosure statement. The public was misled as to where their invested capital was going. And all the directors of the company instead of acting in good faith for the investors have only used the funds for their personal gains thereby they did not show the required care duty and honesty to the investors of an organization. And they had to incur losses of the company. Moreover, they had failed to analyze the financial reports of the organization and had to find the true financial position of their company which could have allowed for taking up of protection measures to restructure the company or even stop the company from taking funds from new investors.

Was the company involved in trading while being insolvent?

It is true that this company was trading while being insolvent. As it is clear from the interview of Mr Daly where even he was not sure that whether the investors will get their returns on maturity. The interests of their invested capital was not provided from the possible means of growing funds rather it was given by taking up more funds from the new investors. The invested funds of the people went to the unregistered funds which was only to expand the business empire of Daly and his other directors. It is shown in the financial reports that the registered funds have granted loans to the unregistered funds business and then it went to business entities. And the individuals who are associated with these business entities were for a range of purposes and it only appeared as the fund expansion in their business practice. This reflects that the company was not operating to increase the funds of the people rather was only channelizing the money for the private gains of the directors and allowed them to expand their business. They were paying the interest to the investors artificially which they had paid by adding up to the loan amount.

The defenses available to Mr Daly and his other directors

As a director Mr Daly had not acted in a manner to satisfy his duties as he did not revealed the true financial picture to the people who have invested capitals and to all other stakeholders of their company. And also the financial reports of the company were not maintained to provide objective information for the use of invested funds. The director also could not realize that the company was taking more loans and had become insolvent as he had not analyzed the financial reports or even maintained for ascertaining the true financial position of the company. Had this been done then he would have to take actions for preventing the company from becoming insolvent. However, neither of the expected actions were taken by him therefore he and his fellow directors does not have any defenses.

Safe harbour defense for the directors of the Mr Daly’s company

The application of safe harbour defense is restricted in its application and it can be only used by those directors who have been found to be competent enough to maintain the other legal obligations of the company. The legislation of Safe harbour allows such directors to protect the company from by restructuring or turnaround so that better outcomes can be generated. However, it is not available for the directors who have fulfill the legal obligations for their company and have not fulfilled their duties towards the different stakeholders of this company. As in this case, the company’s directors were not found to observe fiduciary duties which are based on common and equity law. They have not maintained trust, honesty and have also failed to behave in the good faith of this company and its investors. Also they have failed to observe the duty for the prevention of the company from doing any trading while being insolvent. Thus, this legislation is not available to them as they have been alleged for misleading their client, misappropriation of funds and failed to have transparency in the business