TLAW 402 Company Law Assignment: Rags Pty Ltd Case Study, 2018

This assignment analyzes a case study involving Rags Pty Ltd, a small company with two directors, Susan and Mary. The case explores potential legal actions against the directors for breaches of the Corporations Act 2001 (Cth). The central issue revolves around Susan's financial mismanagement, including using company funds for personal gambling debts, and Mary's failure to adequately address the situation. The analysis examines the application of section 588G of the Act, concerning insolvent trading, and the potential liabilities of both directors. The assignment considers the roles of the liquidator and the Australian Securities and Investments Commission (ASIC) in pursuing legal actions against the directors, including potential civil penalties and disqualification from acting as directors. The analysis references relevant case law, such as Hall and Ors v Poolman and Ors, Westpac Banking Corp v Bell Group Ltd (in liq), and ASIC v Edwards (No. 3), to support the arguments and conclusions regarding the directors' responsibilities and potential consequences of their actions.

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Company Law

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Part (a)
Issue
The issue is what legal actions can be taken by the liquidator against Susan and Mary based
on their activities and chances of success?
Rule
The Corporations Act 2001 (Cth)1 (the Act) is the key legislation which governs the
companies operating in Australia. As per this act, a company becomes a separate legal entity
after its incorporation. Based on this right, the corporation has the right to hold property
under its name and sell property to third parties. Various rights and obligations are also
imposed on companies based on their actions. The company can sue third parties for violation
of contractual obligations, and third parties also have the right to sue the company for its
operations.2 The liabilities of a corporation cannot be imposed on its members, and they
cannot be held personally liable. This principle was recognised by the court in Salomon v
Salomon & Co Ltd3 case. It was ruled by the court that the shareholders cannot be held
personally liable for the debts of the company. However, this is not an absolute rule and
directors of a company can be held liable for violating the provisions given under the
Corporations Act. The obligations of directors may continue even after the corporation
ceased trading and has been deregistered. There are certain circumstances in which the
directors can be held liable for the company’s debts and other losses.
A good example is a liability which is imposed on directors if they incurred any debt when
the company is insolvent. This duty is recognised under section 588G of the Act. As per this
duty, the directors have to ensure that they avoid insolvent trading which means that they
must avoid trading when the company is insolvent and unable pay off its debts. In case the
director only suspects that the company will be insolvent based on their transactions, even
then they should avoid misusing their position to engage in any activities which could lead to
insolvency of the corporation. As per section 588G, there are four elements which must be
present to hold a person liable. The person must be acting as a director of the company while
the debt is incurred. The corporation must be insolvent at the time or by incurring the debt it
1 Corporations Act 2001 (Cth)
2 Jason R. Harris, Anil Hargovan, Michael Andrew Adams, Australian Corporate Law (6th ed., LexisNexis
Butterworths, 2017).
3 (1897) AC 22

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will become insolvent. There must be reasonable grounds available of suspecting the
company is insolvent or it is likely to become insolvent. This action must be taken after the
commencement of this Act. The liquidators have the right to hold the directors liable for
violation of section 588G at the time of liquidation of the company.
The judgement of Hall and Ors v Poolman and Ors4 case highlighted this liability. This case
was filed regarding the cause for concern regarding liquidators seeking to pursue directors of
liquidated companies for insolvent trading conduct by the directors of the company. This
claim was made in order to protect the right to preferential payment claims against unsecured
creditors in pursuant to liquidators who have entered into a litigation funding agreement.5 In
this case, the funds of the company were enough to fulfil the due payment of unsecured
creditors based on which the liquidators hold the directors liable to make such payments. The
court recognised the duty imposed directors based on the fact that insolvent trading is
considered as an actionable offense under the Corporations Act. Another example was given
in the ruling of Westpac Banking Corp v Bell Group Ltd (in liq)6 case. In this case, the court
provided that the directors of Bell Groups Ltd have violated section 588G by failing to
prevent insolvent trading in the company while engaging in transaction with the bank when
the company was almost insolvent. However, in this scenario, the bank had information
regarding the fact that Bell Groups Ltd is insolvent yet it involved in the transaction based on
which it committed equitable fraud.
Section 588G (2) provides that the person must be aware at the time and have grounds for
suspecting and a reasonable person in such situation will be aware regarding the fact that the
company has incurred a debt while being insolvent or likely to become, then a civil penalty
can be imposed under subsection 1317E (1). Moreover, defence against this provision is
recognised under section 588H of the Act. This section provides that the person must have
reasonable grounds to expect that the company is solvent at the time the debt is incurred at
the time. Moreover, subsection (3) provides that if the debt is incurred by a person who had
reasonable ground to believe that a competent and reliable person is responsible for providing
the information that the company is solvent and that the person has fulfilled his/her
responsibility, and he/she relied on the information provided by the first-mentioned person
regarding solvency of the company.
4 [2007] NSWSC 1330
5 Jason R. Harris, Anil Hargovan, Michael Andrew Adams, Australian Corporate Law (6th ed., LexisNexis
Butterworths, 2017).
6 [2014] HCATrans 75

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Application
In the given scenario, Susan is responsible for handling all the finance related matters in Rags
Pty Ltd, whereas, Mary handles staff, business marketing, and client relations. Susan has
been conducting fraud in the company by using its capital and assets to settle her personal
gambling debts. Mary learned about this situation of the company when she received a call
from the trade suppliers of the company who demanded their overdue monthly payment. She
confronted Susan regarding the same and relied on her expertise in this matter. However, the
concern is raised when she found out that the trade suppliers are still not paid. No actions
were taken Mary at that point in order to perform her duty as the director of the company to
get to the root of this problem. She continued to rely on the expertise of Susan who she knew
has a reputation of lying. A reasonable standard of care was not maintained by Mary even
when she received a call from the bank regarding the fact that the overdraft limit of the
company has been exceeded.
Susan has violated her duties given under section 588G by paying the trade suppliers through
the company’s credit card even when she knew that the company is insolvent and it is
surviving on credit for all 2018. In the case of Mary, she cannot rely on the defence given
under section 588H. She did not ask a third person to make comments on the financial
accounts of the company to determine whether Susan is conducting any fraud or not. She has
failed to maintain a standard which is expected from a person operating in her position as the
director of the company to ensure that the company did not engage in insolvent trading. As
discussed in the judgement of Hall and Ors v Poolman and Ors case, the liquidator of the
company has the right to hold both Susan and Mary liable for violation their duties
recognised under section 588G of the Corporations Act. The liquidator can also rely on the
judgement of Westpac Banking Corp v Bell Group Ltd (in liq) case to support the argument.
Civil liability can be imposed on the parties under section 1317E (1) of the act.
Conclusion
To conclude, the liquidator is more likely to succeed in the case filed against Mary and Susan
to hold them liable for violation section 588G since Susan payment trade suppliers through
credit card even after knowing that the company is insolvent. Mary did not act reasonably in
the particular situation based on which the liquidator is likely to also hold her liable along
with Susan to make payment regarding the debts of the company to secure the interest of
creditors.

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Part (b)
Issue
What legal actions can be taken by the ASIC against Susan and Mary for breach of the
Corporations Act?
Rule
The Australian Securities and Investments Commission (ASIC) is an independent regulator
which governs the companies which are operating in Australia. It regulates organisations
through the company and financial services laws to protect the interest of customers,
investors, and creditors. ASIC is responsible for administrating legislation which includes
Insurance Contracts Act 19847, National Consumer Credit Protection Act 20098 and
Corporations Act 2001 (Cth). ASIC has the authority to conduct investigation in the
operations of companies to impose penalties on them in case they violate their duties
mentioned under the Corporations Act.9 The ASIC can also impose obligations on directors
of companies to ensure that they take reasonable actions to ensure that they did not violate
their duties which resulted in adversely affecting the interest of creditors, customers, and
investors.
A good example was given in the judgement of ASIC v Edwards (No. 3)10 case. This case was
filed by ASIC in which it alleged the director for violating section 588G. The court upheld
the investigation and evidence provided by ASIC and charged the director for breach of his
duties. The director was disqualified for a period of 10 years after providing that he had
violated section 588G on many occasions. Therefore, the difference between the actions
taken by the liquidator and the ASIC is that the liquidator focuses on fulfilling the interest of
creditors of the company, whereas, the ASIC focuses on holding the directors liable for
violating their duties. The directors could face civil charges based on the charges imposed on
the ASIC on their actions based on which the court can disqualify them from acting as a
director for a specific period.
7 Insurance Contracts Act 1984
8 National Consumer Credit Protection Act 2009
9 Jason R. Harris, Anil Hargovan, Michael Andrew Adams, Australian Corporate Law (6th ed., LexisNexis
Butterworths, 2017).
10 (2006) 57 ACSR 209

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Application
In the given scenario, it is discussed in Part (a) that both Mary and Susan are liable towards
the creditors of the company and the liquidator is most likely to succeed in the claim against
both parties for violating section 588G. In case this claim is brought by the ASIC, then a suit
will be filed against Susan and Mary that contains evidence against the actions of the parties
that will be provided in the court based on the investigation of ASIC. In this case, the most
likely legal consequence which Susan and Mary will face is imposition of fine or penalty by
the court for failing to comply with their duties given in section 588G. They will be held
personally liable to pay off the debts of the company, however, Susan is more likely to held
liable than compared to Mary since she also used the company’s capital to pay off personal
debts and failed to keep proper records. As discussed in the judgement of ASIC v Edwards
(No. 3) case, both the parties are likely to become disqualified from acting as the director for
a specific period decided by the court.
Conclusion
To conclude, in case ASIC brought an action against Susan and Mary, then they are likely to
face legal consequences such as payment of fine and unpaid debt of the company. Moreover,
they are also likely to be disqualified from acting as directors for a specific period of time as
per the discretion of the court.

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Bibliography
A Articles/Books/Reports
Harris, JR, Hargovan, A and Adams, MA, Australian Corporate Law (6th ed., LexisNexis
Butterworths, 2017).
B Cases
ASIC v Edwards (No. 3) (2006) 57 ACSR 209
Hall and Ors v Poolman and Ors [2007] NSWSC 1330
Salomon v Salomon & Co Ltd (1897) AC 22
Westpac Banking Corp v Bell Group Ltd (in liq) [2014] HCATrans 75
C Legislation
Corporations Act 2001 (Cth)
Insurance Contracts Act 1984
National Consumer Credit Protection Act 2009