Understanding Directors' Duties in Insolvent Trading

This assignment delves into the complex area of directors' duties in the context of insolvent trading. It examines the legal framework surrounding a director's responsibilities to prevent and manage insolvency, including relevant legislation and case precedents like ASIC v Edwards. The assignment also explores potential defenses directors may have against claims of insolvent trading breach, shedding light on the complexities and challenges they face in this crucial aspect of corporate law.

ASIC v Edwards
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ASIC v Edwards
Introduction
The directors of the companies in Australia have the responsibility of governing the
company for the shareholders of this company. Section 198A(1) of the Corporations Act (CA)
puts forth the requirement of business of companies being managed under the directors of
directors of the company. Due to these reasons, certain responsibilities and duties have been
embarked upon the directors of the company in a general and legal manner. CA puts forth a
number of duties on the directors which include the duty of care and diligence, and also the duty
of acting in a manner showing good faith (Australian Institute of Company Directors, 2018).
The leading matter of ASIC (Australian Securities and Investment Commission) v
Edwards (No 3) (2006) 57 ACSR 209 proves to be an example of breaching duty of directors
provided under the CA. This was held by the Supreme Court of New South Wales. The
allegations made against the directors were that the provisions of CA had been breached, by
undertaking debts by company. This was deemed as insolvent trading later on (GML Consulting,
2018).
Background of case
The ASIC initiated legal proceedings against Malcolm Edwards. This led to the NSW
Supreme Court considering whether the company directors engaged in the project’s construction
phase, could be made responsible in order for the company indulging in insolvent trading. In this
case, the company was Murray River Limited (MR), which went by the name of Murray River
Pty Limited. Edwards was the director of the company from the period of 07/1998 to 03/2000. A
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ASIC v Edwards
joint venture had been entered on 22 December 1998 by the company with regards to the
development of apartment hotel on the Mulwala lake shores at Murray River. The contentions
put forth by the ASIC were that the director had been in breach of section 588G of CA owing to
his permission in the company to incur debts on six different accounts. This led to him failing in
preventing the company from undertaking such debts (Allens, 2006).
The situation which led to Edwards trading for the company, made the section 588G
apply on six different bases. Regarding these debts, Colin Joss & Co Pty Ltd (CJ) was creditor
who was the building contractor. The allegation was that the six debts had been owed as a result
of the undertaken contract between MR and CJ, to CJ by MR, based on the work done by CJ.
The debts which had been alleged for transactions undertaken on 1999, which includes 27 April
$390,000, 10 May $ 635,000, 20 May $ 1,340,000, 18 June $ 859,370, 22 June 1999- $ 183,889,
and 24 September $ 181,772 (GML Consulting, 2018).
A case was made against Edwards by the ASIC where the failure of Edwards was
highlighted in context of not preventing MR from taking more debts, more so a range of debts,
which led to the provisions of CA, particularly section 588G being breached. Reliance was made
by ASIC on subsection 2 of this section which is related to the individuals or the companies
violating this section where they fail in preventing insolvent trading resulting in debts being
incurred and which led to the company being insolvent. This is particularly for cases in which
the person has the knowledge that undertaking the particular trading would have the result of
company’s insolvency when the debts were undertaken; or where the person had reasonable
grounds of believing that this would happen (GML Consulting, 2018). By indulging in such
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ASIC v Edwards
debts when Edwards was director or MR, he failed in fulfilling the requirements laid down under
this section (Castle, 2015).
When these claims were made by ASIC, clarifications were made by Edwards regarding
the company being solvent at every material time period which had been highlighted by ASIC.
There were no reasonable grounds at any time frame regarding the company being insolvent or
that the company had the chance of becoming insolvent. Edwards stated that there were
reasonable grounds for excepting the solvency of the company, along with the solvency of MR to
be continued. Apart from the reasonable grounds for believing the same, he did believe that the
company would be able to meet their obligation when they became due on the company.
Edwards further believed that there were enough resources and assets in the balance sheet of MR
(Allens, 2006).
He further stated that the allegations of ASIC were not due and were not payable owing
to the conduct undertaken by CJ, which restricted them from enforcing any debts owed but the
company. This was along with the fact that the risk of going forward with continuing work on
the project was assumed by CJ. Lastly, the contract never meant that a debt had been incurred by
the company. There was a right of indemnity by the company where the debt had been occurred
from the other company for debt. As the company had been the beneficiary of the construction
trust that resulted, the right of indemnity and beneficial interest had to be deemed as the asset of
company. In all these replies, he went on to state that there were presence of genuine reasons for
having the faith in the company being able to meet their debts by making reliance on resource
which had been out of the balance-sheet of company (GML Consulting, 2018).
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ASIC v Edwards
Edwards raised the defence provided under section 588H of CA and repeated the
presence of genuine reasons at every time and for believing that competent and reliable
individuals providing him with the relevant information were giving him right information
regarding the company being solvent and that the company being able to comply with their
responsibility in a proper manner. Relying on this information, he had believed that the company
would have continued to be solvent at all time (GML Consulting, 2018).
Duties breached
Under section 588G of the CA, the directors are put with the duty of preventing insolvent
trading by the company. Where an individual is the director of a company when the debt was
incurred, and at that time the company was insolvent, or the result of undertaking the transaction
would be the company being deemed as insolvent, based on the reasonable grounds being
present for suspecting the insolvency of company, or resulting insolvency of company, this
section is deemed to be contravened. The section further provides that the view of a reasonable
person in similar situations has to be undertaken for holding the breach of this section, where it is
to be deemed that an individual in similar situation would have avoided taking of such debt or
transaction, resulting n insolvency of the company. It is deemed as an offence to prevent the
breach of this section where the elements of dishonesty are involved (Austlii, 2018).
Decision of the Court
In this case, the court analysed the facts in detail and stated that Edwards had failed in
preventing the company from indulging in insolvent trading as the company incurred a number
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ASIC v Edwards
of debts. This led to the court making a declaration of contravention based on section 1317E(1)
of CA (Justis One, 2018).
In doing so, the court stated that the success of ASIC claims was stemmed in showing the
quoted section being breached by Edwards. For this purpose, there was a need for the ASIC to
show that Edwards had been the company director when the debts were undertaken; the company
was already insolvent at such time, or the resulting of undertaking these debts was the company
becoming insolvent; there was presence of enough reasons during that time to show that the
company had been insolvent or that there were chances of the same happening by undertaking
this debt; there was a failure by the director in preventing the company from doing the same; and
that the director knew, based on the view of a prudent person, of the presence of such grounds,
resulting in Edwards breaching his director duty (GML Consulting, 2018).
Once the ASIC could show that these elements had been present in this case, the breach
of section 588G would have been established. Though, this would fail where Edwards is able to
satisfy the conditions laid down under section 588H of CA, even with satisfaction of section
588G. Thus, in the view of the court, where Edwards could show that at the debt incurring time,
there was presence of genuine reasons to believe that a competent person, other than Edwards
himself, had been liable for making the information available on solvency of the company and
this person has had fulfilled such responsibility; and that based on this available information, the
company was expected to stay solvent even with incurring of the debt (GML Consulting, 2018).
With this, Edwards also had to show that he had taken all requisite steps from restricting
the company from undertaking the debts which could make the company insolvent. For showing
this condition as fulfilled, the court undertook examination of the actions undertaken by different
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ASIC v Edwards
individuals and the result of these undertaken actions. In context of section 588G (1) of CA, the
judges stated that the debts had been undertaken by the company when Edwards had been the
director of company, on all six occasions (Harris, 2008). It was also established by the judges
that on all six counts, the company had been insolvent. This was due to the defendant raising the
point regarding condition of balance sheet and outside sourcing. This led to them holding that the
requirements of the quoted sections had been fulfilled (Lhuede & Alderman, 2009).
In the opinion of the court, there were reasonable reasons to doubt the solvency of
company (Chamberlains SBR, 2018). A reasonable person in place of Edwards, holding the
directorship of the company would have failed in establishing that there was enough sum to pay
the debts of the company, as was deemed by the defendant. Similarly, the court analysed
subjection 2 of this section where they stated that there had been a clear failure on part of
Edwards in stopping the company from being a part of insolvent trading (GML Consulting,
2018). Thus, section 588G was breached here.
The conduct of Edwards was not but immoral, wrong, not at all straightforward, and
showed elements of dishonesty and moral turpitude (Lewis, 2010; Wong, 2009). Edwards
indulged in such activities where the innocent creditors were embarked on a course of conduct,
which was detrimental for them in view of the court. Here, the sole purpose was Edwards
benefiting himself (BRI Ferrier, 2015). There had been noteworthy blunders undertaken by
Edwards, coupled with him being dishonest in his work (Australian Institute of Company
Directors, 2014). In view of the court, the company was insolvent when the project was started
and all throughout the project the company continued to be insolvent (Austlii, 2006). As per the
judges, Edwards clearly knew about the financial position of the company and also knew that by
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ASIC v Edwards
taking these debts the insolvency of the company would continue. There was a breach of the
quoted duties of CA based on this information (Austlii, 2005). This led to the court awarding
penalty to Edwards and also disqualified him from taking post of director, for ten years, of any
company (Mansor, 2011).
Conclusion
Thus, this case presents crucial insights on the role played by the directors in keeping the
company on right track in terms of not undertaking such activities which would result in the
company being deemed as insolvent. This case is a reminder for deploying proper governance of
the companies by directors. And also shows that not doing so is not only detrimental for the
company, but also for the directors indulging in such breaching conduct. The failure of Edwards
not only resulted in the company indulging in insolvent trading, but also led to him being
disqualified from being a director of any company. Thus, this case is guidance to the directors of
the other companies in the nation, to be sure of the solvency of the company before they incur
further debts, and to not incur debts when insolvency is a looming threat.
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ASIC v Edwards
References
Allens. (2006). Annual Review of Insolvency & Restructuring Law. Retrieved from:
https://www.allens.com.au/pubs/pdf/arir/2006/arirmain.pdf
Austlii. (2005). ASIC v Edwards [2005] NSWSC 831 (24 August 2005). Retrieved from:
http://www.austlii.edu.au/au/cases/nsw/NSWSC/2005/831.html
Austlii. (2006). ASIC v Edwards [2006] NSWSC 376 (5 May 2006). Retrieved from:
http://www.austlii.edu.au/au/cases/nsw/NSWSC/2006/376.html
Austlii. (2016). Corporations Act 2001 - Sect 588G. Retrieved from:
http://www.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s588g.html
Australian Institute of Company Directors. (2014). The Honest and Reasonable Director
Defence. Retrieved from:
http://fsi.gov.au/files/2014/09/Australian_Institute_of_Company_Directors_Attachment_
A.pdf
Australian Institute of Company Directors. (2018). What are the duties of directors?. Retrieved
from: http://www.companydirectors.com.au/membership/the-informed-director/what-are-
the-general-duties-of-directors
BRI Ferrier. (2015). Exoneration of directors from insolvent trading liability. Retrieved from:
http://briferrier.com.au/news/exoneration-of-directors-from-insolvent-trading-liability
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ASIC v Edwards
Castle, T. (2015). Developments in insolvent trading law in 2015. Retrieved from:
http://www.sparke.com.au/insights/developments-in-insolvent-trading-law-in-2015/
Chamberlains SBR. (2018). Insolvent Trading & A Directors Duty not to be in Breach. Retrieved
from: http://www.chamberlainssbr.com.au/PDF/Trade%20paper.pdf
GML Consulting. (2018). Australian Securities Investment Commission v Edwards [2005]
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Harris, J. (2008). Relief from Liability for Company Directors: Recent Developments and Their
Implications. University of Western Sydney Law Review, 12(1).
Justis One. (2016). ASIC v Edwards 2004. Retrieved from: https://app.justis.com/case/asic-v-
edwards/overview/c5Ctn4etm5Wca
Lewis, P.J. (2010). Insolvent trading defences after Hall v Poolman. Retrieved from:
http://sites.thomsonreuters.com.au/journals/files/2010/10/j04_v028_CSLJ_pt06_lewis.pd
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Lhuede, M., & Alderman, P. (2009). The Director`s Duty to Prevent Insolvent Trading.
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ASIC v Edwards
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Mansor, H. (2011). Solvency, Company Directors’ Duties and the Problem of Process and
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