At Work

Insolvency Tsunami or Not, Don’t Breach Your Duties As a Director

As a director, you can be under quite a lot of pressure when your company is in danger of being insolvent or is already insolvent. However, you need to keep your cool.

When your company is at risk of insolvency, it’s important to remember your duties as a director’s breach of duty given the risks of insolvent trading and the potential for personal liability. After all, if you, the manager of a company, didn’t have duties, it would be a free for all with very little to protect anyone against self-dealing or inappropriate management.

The Current Insolvency Laws

As it stands, the insolvent trading laws provide limited breathing space and only if specific conditions are met. Generally, you are supposed to stop trading as soon as you become aware of the insolvency of your company unless you can bring your position within the temporary relief or safe harbour regime that may apply to your circumstances. Those who are found to be trying to dig their way out of this situation by continuing to trade are swimming in dangerous waters (i.e. you’ll have to pay a lot of money).

The good news is that the government has provided significant support of business and that may have enabled you to trade your way out of any temporary problems! If, however, you liquidity problems as a company are more than temporary then it may be necessary to get insolvency and legal advice to understand your options.

You may well need a refresher, and that’s okay! Let’s take a look at everything you should be doing if the insolvency tsunami is threatening to hit.

Your Duties As a Director

#1 Be Aware of The Corporations Act 2001 (Cth)

In the normal, day-to-day running of your company, you will hopefully be adhering to this Act anyway. But, if your company is moving to insolvency, there may be an obligation to consider what duties are owed to creditors, and what the Act will require of you.

We suggest that you take some time out to get proper legal advice. Such advice may be able to tell you what needs to happen to discharge yourself of the duties. Usually, you should hire a professional to help you with this (it’s a lot easier than attempting to muddle through on your own).

#2 Always Consider Whether Your Company Is Still Solvent

Your focus should be on cash flow (and to a much lesser extent the balance sheet test). Ask yourself if your company can meet its debts as and when they full due and payable. If not, targeted advice is necessary. 

#3 Decide Whether To Continue Trading

We mentioned earlier that wrongfully trading may lead to personal liability and maybe even a penalty. To keep yourself “safe”, you’ll need to decide whether you should still operate so you aren’t breaching your duties as a director. It may be necessary to consider going into voluntary administration. 

#4 Transactions Leading to Insolvency Can Be Challenged

Be careful if you’re about to take assets out of your company heading toward insolvency. Why? Because they are generally challenged by the court! Again, this leads to the possibility of a liquidator seeking to claw them back or you may be guilty of illegal phoenixing. 

#5 Directors have a range of other duties

Keep in mind that a director can be someone appointed to that position or even someone who has not been appointed but that acts as a director (de-facto director) or even someone in accordance with whose wishes the directors are accustomed to act (shadow director). 

Specific duties are wide ranging and cover matters such as:

Duties to the company – Most of the director’s duties are owed to the company and not to the shareholders. There are some limited common law exceptions such as when the company is in or approaches insolvency in which case there is a need for directors to also have regard to the interests of shareholders. 

Duties of care and diligence – Under the Corporations Legislation there is a need for directors to exercise their duties properly so in that sense the obligation is similar to common law duty not to act negligently. Simply put the directors need to take in the exercise of their powers. Where this obligation is breaches it may in some cases be possible to rely on the business judgments rule. 

Duties of good faith – Directors also need to exercise their powers appropriately and honestly for the benefit of the company. 

Duties of loyalty – Directors often need to take care to avoid a conflict of interest. That means they should not self deal or cause detriment to the company. 

Avoid illegal phoenixing – Some of the new obligations placed on directors relate to the need to avoid depriving creditors of the benefits they would otherwise be entitled to if directors did not dispose of assets at or near to insolvency. Such creditor defeating dispositions are only allowed in very limited circumstances. 

Apart from this directors may have a range of other obligations worth being reminded of that include the need to disclose person interests when voting. There may also be specific obligations under the OH&S Legislation, the Superannuation Laws and so forth. 

The Bottom Line

Insolvency is no joke. But if you don’t abandon your duties, you’ll be doing right by yourself, your company, and everyone around you.

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