Directors' Liabilities in Australian Insolvency

This assignment delves into the complex area of directors' liabilities within the framework of Australian insolvency law. It explores the legal responsibilities placed upon directors when a company faces financial distress, including potential personal liability for debts incurred. The analysis incorporates relevant legislation like the Corporations Act 2001 (Cth), judicial precedents such as *Dempster v Mallina Holdings Ltd*, and insights from industry bodies like ARITA and ASIC. The document further discusses various insolvency procedures like voluntary and involuntary liquidation, shedding light on the directors' role during these processes.

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COMMERCIAL AND CORPORATION LAW
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Introduction
This paper briefly discusses various issues surrounding corporate insolvency. The paper
is divided into nine sub sections that highlight different aspects of corporate insolvency in
Australia and finishes with a conclusion.
Signs of Corporate Insolvency and the Duties of Directors in that Regard
There is no exact legal definition of insolvency and as such, it is a matter that is left to
judgement (Cabinet Maker 2008, p.24). It is a matter of argument as to when exactly a company
becomes insolvent. In general a company is insolvent when it fails to pay its liabilities as and
when they become due (Corporations Act 2001, s.95). The following is a list of signs of
corporate insolvency. Companies in financial distress will often forgo paying their tax liabilities
in order to ensure that they have sufficient cash flow to meet their important supplier payments
and pay wages. In the short term, this may be considered by many as an efficient use of cash
resources. However, after the accrual of interest and penalties of those taxed in the long term, the
tax liability imposed may grow to unmanageable levels. The Australian Securities and
Investment Commission, in its insolvency guide for directors, have outlined a list of signs
indicating that a company is becoming insolvent. These are as follows. Poor cash flow,
continuous losses, lack of business plans, absence of forecasts of cash flows and other budgets,
problems in debt collection and stock sales, increment in debt (more liabilities as compared to
assets), disorganization in internal accounting processes, and financial statements that are
incomplete. Other signs include loans that are unrecoverable to associated parties, creditors are
unpaid outside the ordinary terms, demand letters and legal warrants being issued against the

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company, issues with obtaining finance, increment in the number of complaints by suppliers, loss
of management personnel and director resignations, among many others (ASIC 2015, p.7).
Potential liabilities of company directors in the event of a company becoming insolvent
Directors of a company can be held liable in different ways when a company is declared
insolvent. The Supreme Court of Australia held the directors of a company to be personally
liable (Marsh, Roberts & Webb, 2017). The reason for this finding by the court was that the
directors were in breach of their duties hence incurring debts. The directors herein also made
unverifiable payments which could not be ascertained. Furthermore, according to McDonald and
Snead (2009, p. 3) courts have held that assets misappropriated by directors might be recovered.
However, such transaction of assets ought to have taken place prior to the insolvency. The court
continued to reiterate that the limitation period may be extended where fraud and breach of a
fiduciary obligation are proved on the acts of a director prior to insolvency. In most instances, as
discussed by Sellars (2001) p. 11, where directors are culpable, they are required to indemnify
the company for any loses accrued due to their breach of duty or to pay the creditors outstanding
debt.
Avenues Available to the Company, in Particular, to the Directors if the Company is Presumed
to be Insolvent
There are several available avenues that the directors to a company can take when the
company is presumed insolvent. According to the report prepared by Parliamentary Joint
Committee on Corporations and Financial Services (2004), a company or rather the directors can
agree with the creditors on how to settle the outstanding debts). Such arrangements should be set

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in a deed where which debts due would be settled. Additionally, the above report states that the
directors can set aside transactions that might seem to be the cause of such insolvency. In turn
the company would be restored to pre-insolvency stage. If at all a company is declared bankrupt,
it ought to be remembered that a company is a separate legal entity that can sue or be sued.
Therefore, if the directors duly discharged their obligations, the law protects them from being
personally held liable provided that in their obligation they did not engage in insolvent trading.
Finally, according to Rankin and Popkin (2004, p. 28) a director can demonstrate that they took
reasonable steps prevent insolvency by settling accrued debts, appointing administrators and
beginning winding up procedures. Furthermore, they argue that a director that seeks to disclaim
the responsibilities leading to insolvency must cite the above three defenses. A director cannot
allege that there were no reasonable steps that he could take to prevent the insolvency.
Difference between Voluntary and Involuntary Interventions by Different Parties
Concerned by the Potential Insolvency of a Company
Voluntary intervention or administration in this instance involves members and directors
placing the company to an independent person to assess the assets, cash and liabilities against the
potentially insolvent company (Sellars 2001, p. 2.) Consequently such an independent person
would recommend to the members whether a company ought to be wound up or not. In a
voluntary intervention, a director need not to vacate office since such an administration at time is
propagated by directors. However the court has held in the case of Dempster v Mallina Holdings
Ltd that whereas other directors might be found liable others may escape liability. Involuntary
insolvency involves an intervention by the Federal or Supreme Courts though an application by;

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the creditors, shareholders, directors or any other interested person. (Insolvency solution, 2017,
Voluntary & Involuntary Liquidation) indicates that creditor who is owed a debt may file an
application to declared a company insolvent due to its inability to pay the outstanding debt when
due. Shareholders, directors and other interested parties may file an application of their
respective interests in the company.
Good outcome for a company other than being wound up by the creditors,
and how might this be achieved
Instead of being wound up because of an insolvency, a company should consider several
options these include; receivership, voluntary arrangements, administration and provisional
liquidation. According to the Parliamentary Joint Committee on Corporations and Financial
Services inquiry into financial products and services in Australia (2009), in a receivership an
insolvency practitioner is appointed by the secured creditors in order to settle outstanding debts.
However it should be understood that receivership does not necessarily impute insolvency of a
company. On the other hand, administration involves appointment of administrators to carry
audits and determine the cash flow, assets and liabilities of a company. Administration would
usually result to a deed being entered and subsequently measures to prevent insolvency being put
down. Company voluntary arrangement involves an agreement being reached between creditors
being owed a debt not to claim their debt as against the company. This would allow the company
to rebuild its financial status or cash flow. Provisional liquidation is an alternative to winding up
of a company, because with the application of any party involved, the court may order a
provisional liquidation whereby assets of the company are placed into the hands of a provisional
liquidator who would in turn determine whether a company should be wound up or not.

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Insolvency Statistics in Australian Companies
The Australian market is mostly dominated by small as opposed to large businesses
(ARITA 2015, p.348). Between the years of 2013 and 2014, 92 percent of company exits
consisted of companies that employ less than five staff while 98 percent consisted of those that
employ less than 20 staff (ABS 2015). Although failures represent merely a miniature fraction
(below 10 percent) of all companies that exit,the available empirical data indicates that these
exists are dominated by small and medium sized enterprises. This is not surprising considering
that the economy is dominated by them, although it is also telling of the relation between their
nature and the failures.
With specific regard to insolvency, reports by the Australian Securities and Investment
Commission suggest that between 2013 and 2014, 81 percent of the over 9000 initial reports of
external administrators related to small companies of less than 20 staff (ASIC 2014). With
respect to liabilities, ASIC estimates that 43 percent of companies that failed had liabilities worth
approximately $250,000 and below, and 76 percent of fallen companies had liabilities amounting
to $1 million and below. Furthermore, 41 percent of the small companies at the time of
insolvency are usually without assets, while almost 80 percent of the remaining companies
usually have assets worth less than $50,000.
With respect to industry, retail trade (9%), food and accommodation industry (9%),
construction (23%) and ‘Other’ services altogether made up over half of the companies that were
insolvent during the year 2013 and 2014. By contrast, fairly huge industries such as education
and mining made up 1 percent of companies that ran into insolvency each.

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Topical Issues on Insolvency in Australian Companies
There are several topical issues in the Australian companies, and especially with respect
to reforms to the current insolvency law. The overarching objective of these proposals for reform
is to drive a cultural shift from stigmatizing and penalizing failure to a system that balances
between creditor protection and encouraging entrepreneurship (Law Society of New South
Wales 2016, p.1).The first topical issue discussed by the reform proposals is reduction of the
default bankruptcy period. This proposal has the overall aim of encouraging entrepreneurship
and innovation. The second topical issue is the introduction of a safe habour in insolvent trading.
The safe habour is aimed at operating as a carve-out to the section 588G of the Corporations Act
for directors in insolvency situations. The substance of this proposal is to protect directors from
personal liability in cases where a company enters into insolvency.
The Role of ASIC and other Statutory Authorities in Corporate Insolvency
ASIC: With respect to liquidation, the organization has the power to order the winding up
of a company, and also, liquidators are required to report to ASIC. Under voluntary
administrations, administrators also have various obligations for reporting to the authority.
Furthermore, the ASIC and the court generally supervise the activities of receivers and property
managers. The Court and ASIC also have powers of inquiry into the conduct of non-receiver
controllers (AFSA 2014, p.10).

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Australian Financial Security Authority (AFSA): with its establishment under the Public
Service Act 1999, AFSA registers all bankruptcies, personal insolvency agreements and debt
agreements; administration of bankruptcy estates as the Official Trustee; and ensuring
compliance by bankrupts, debtors and other related persons.It also maintains the National
Personal Insolvency Index (AFSA 2014, p.4).
Observations
It is notable from the foregoing that the proposal for providing a safe habour for directors
to shield them from personal liability is an important provision. The law of insolvency as is
currently constituted is draconian and harsh since they impose personal liability to directors who
many times make business decisions in good faith. The safe habour provisions will remove the
strictness in insolvency laws and allow restructuring efforts by directors during insolvency. This
will in turn encourage a turnaround culture that will enable rehabilitation of businesses,
especially considering the above statistics of business failure. The Governance Institute of
Australia has expressed in its submissions on this issue that of safe habour and has proposed
even further adjustments to the proposed law for its applicability in the Australian market.
Conclusion
In conclusion, this paper has discussed various issues in Australian Corporate Insolvency.
One of the key issues noted in this paper in general, is the need for reforms in the law that
governs corporate insolvency in the country as the available laws are quite harsh. This is with
particular regard to personal liability of directors during insolvency.

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References
ABS (Australian Bureau of Statistics) 2015, Australian Industry, 2013-14, 29 June, Cat no.
8155.0, Canberra
AFSA (Australian Financial Security Authority) 2014, Financial System Inquiry - Submission of
the Australian Financial SecurityAuthority in response to the Interim Report, August, AFSA
ARITA (Australian Restructuring Insolvency and Turnaround Association) 2014a, A
Platform for Recovery 2014, Discussion Paper, October
ASIC (Australian Securities and Investments Commission) 2014, Insolvency statistics - Series 1:
Companies entering external administration, viewed 19 September 2017
http://asic.gov.au/regulatory-resources/find-a document/statistics/insolvencystatistics/insolvency-

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statistics-series-1-companies-entering-external-administration/
Law Society of New South Wales 2016, Improving Bankruptcy and Insolvency laws - Response
to Proposals Paper, viewed 19 September 2017
http://www.lawsociety.com.au/cs/groups/public/documents/internetpolicysubmissions/
1176437.pdf
Australian Securities and Investment Commission August 2015, Insolvency: A Guide for
Directors, ASIC, viewed 19 September 2017
http://download.asic.gov.au/media/3337054/insolvency_guide_for_directors_42_1-amended-
aug-2015.pdf
Cabinet Maker 2008, ‘Directors Liabilities’, 18 April, p.24
Corporations Act 2001 (Cth)
Dempster v Mallina Holdings Ltd (1994) 15 ACSR 1)
Insolvency solution, 2017, Voluntary & Involuntary Liquidation viewed 20 September2017
(http://www.wais.com.au/corporate-insolvency/liquidations ).
Marsh,S, Roberts,S, & Webb,H 2017, The doubling up of insolvent debt: Personal liability of
directors and the concurrent liability of holding company viewed 19 September 2017, http://e
doubling up of insolvent debt: Personal liability of directors and the concurrent liability of
holding compa
Mcdonald, I, and Snead, J 2009, Reaching; The limit a recent court ruling gives rise to the
spectre of further claims against directors, just when they thought they were safe view 19
September 2017, http://Reaching The Limit court ruling

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Ripoll, B., 2009. Parliamentary Joint Committee on Corporations and Financial Services: inquiry
into financial products and services in Australia. Commonwealth of Australia.
Ripoll, B., 2009. Parliamentary Joint Committee on Corporations and Financial Services: inquiry
into financial products and services in Australia. Commonwealth of Australia.
Ripoll, B., 2009. Parliamentary Joint Committee on Corporations and Financial Services: inquiry
into financial products and services in Australia. Commonwealth of Australia.
Sellars, M.A., 2001, February. Corporate voluntary administration in Australia. In Forum for
Asian Insolvency Reform. Insolvency reform in Asia: An assessment of the recent developments
and the role of judiciary. Bali, Indonesia (pp. 7-8).