Corporate Law: Director's Duties, Safe Harbour Defence Analysis

This report provides a comprehensive analysis of corporate law, specifically addressing director's duties, the safe harbour defense under Section 588GA of the Corporations Act 2001, and insolvent trading. The report explores the fiduciary duties of directors, the operation of the safe harbour defense, and its restrictions. It examines the differences between the safe harbour and the business judgment rule (s180(2)). Furthermore, the report discusses the potential impact of changes to Division 3 on voluntary insolvencies in Australia. Part B of the report analyzes a case study involving Mr. Daly, assessing breaches of director's duties by him and other directors, and whether the company was trading while insolvent. It considers available defenses, including the safe harbour, and evaluates the impact of the new provisions. The report concludes with a summary of the key findings and references relevant legal provisions and scholarly articles.

Corporate Law

Table of Contents
INTRODUCTION...........................................................................................................................1
PART A...........................................................................................................................................1
1. Is the duty to prevent insolvent trading a fiduciary duty? Why or why not?.....................1
2. How does the safe harbour defence Section 588GA operate?...........................................1
3. Who does it (s588GA) protect, and is this different to the business judgement rule s180 (2)?
Give reasons...........................................................................................................................2
4. Are there any restrictions on the operations of s588GA defence? If so, what are they?....3
5. Do you think the changes to Division 3 will have an effect on the number of voluntary
insolvencies in Australia in the future? Why or why not?.....................................................4
PART B............................................................................................................................................4
1. Did Mr. Daly breach any directors' duties? If so, which ones and how?...........................4
2. Did any of the other directors breach their duties? If so, which duty and how?................5
3. Do you think the company was trading while insolvent? Give reasons.............................6
4. if the company was trading while insolvent-are there any defences available to Mr. Daly
and /or other directors? If so, what are they? Give reasons. ..................................................6
5. Would the new safe harbour defence assist the directors? If yes, how? If no, why not?...7
CONCLUSION................................................................................................................................7
REFERENCES................................................................................................................................9

INTRODUCTION
Corporate law is the body of rules and legal provisions that governs incorporation and
affairs of companies in a country. It regulates rights and obligation of individual engaged with
forming, owning and managing an entity1. A company comes into existence when it gets
registered under Corporate Law of a particular country. Also, it can be dissolved through law
only. It consists features which should be there in an organization to get the status of a company
in Australia. The report covers discussion on safe harbour defence in s588GA and number of
questions related to duties of directors on the basis of “The talented Mr. Daly”.
PART A
1. Is the duty to prevent insolvent trading a fiduciary duty? Why or why not?
According to Section 588G of Corporations Act, 2001, insolvent trading means if a
company has been become insolvent and direct giver permission to obtain or incur new loan or
debt, then defaulting director will be held personally liable for new debts. Corporate Laws in
Australia has gone through number of reforms whereby this amendment took place. A director is
under a duty to raise the alarm of financial difficulties so as to protect company as well as
investors who have invested in it. It is necessary to take suitable actions and decisions for
managing the assets in an efficient way for keeping the trust of investors and public2. Thus, it can
be said that, a director has fiduciary duty to inform internal management about condition of a
company so that appropriate measures can be taken to save it from dissolution. Also, no
additional debts should be incurred knowingly, when the corporate has already become
insolvent. The reason being, a director is fully aware about the most confidential data and
information which has not been made public and have potential to fluctuate prices of stocks and
other major aspects. Failure to exercise and make right decision regarding getting more funds in
the insolvency phase, the director who has taken such action will be held liable. Directors are
expected to act honestly and in good faith. Furthermore, this is about being ethical and
transparent about activities going within an organization. A director has huge responsibilities and
should always abide by legal provisions mentioned under Corporation Act 2001.
1
Allen, W. T. (2017). Our schizophrenic conception of the business corporation.
In Corporate Governance (pp. 79-99). Gower.
2 Baker, M. (2018). Translation and conflict: A narrative account. Routledge.
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2. How does the safe harbour defence Section 588GA operate?
Corporations Act, 2001 describes safe harbour as a protection to director from limited
civil incidents of insolvent trading. It is a defence which can be used in particular situations.
Section 588G(2) is new section for this safe harbour to be applied as a defence. A director will
not be held personally liable for a debt incurred by an insolvent company in the following cases:
 debt incurred after doubt of company might become insolvent has generated.
 Director establishes one or more alternatives.
 Debt obtained with a view to have improved situations with better outcomes.
 Debt incurred directly or indirectly with any such course of action3.
There is underlying requirement of this defence mechanism under which a director has to
take positive steps to develop and implement plan for restructuring of the company. This must be
done with the assistance of a qualified professional who is appointed once corporate insolvency.
There are two events in which a director cannot take the benefits of safe harbour defence
which are as follows:
 for the payment of employment entitlements
 fulfilling the taxation reporting requirements.
Within a prior period of 12 months.
However, before going for this option, a director must prove that:
 presence of reasonable grounds to believe the company was solvent.
 Had not been involved in management due to illness or for some other valid reason.
 All the reasonable steps were taken to avert incurring the debt.
In nutshell, it is a powerful defence which has the potential to save a director from
personal liability due to incurring of loan while company has become insolvent and director had
a plan to rescue the business from such situation4.
3 Bottomley, S. (2016). The constitutional corporation: Rethinking corporate governance.
Routledge.
4 McQueen, R. (2016). A Social History of Company Law: Great Britain and the
Australian Colonies 1854–1920. Routledge.
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3. Who does it (s588GA) protect, and is this different to the business judgement rule s180 (2)?
Give reasons.
Safe harbour as inserted under s588GA protects directors who has taken reasonable steps
to restructure or restore company's insolvency5. Further, this gives an opportunity to directors
save themselves from personal liability whereby a legitimate restructuring has been taken as
decision.
Whereas s180(2) of Corporation Act, 2001, a director or officer of a corporation has to
meet the below mentioned requirements as given in s180(1) and additional duties at common law
and in equity:
 judgement to be made in good faith.
Director must not have significant or material personal interest in the decision or subject matter.
 Information of the subject matter up to the extent which is appropriate.
 The decision is made in the best interest of the company.
Section 588GA is applicable only in the circumstances where the company has or may
become insolvent. It gives a chance to director to save himself from personal liability. It is an
amended version to protect directors who had honest thought to restructure the company to take
it out of financial distressing situation6. Whereas s180(2) applies in general context and in all the
activities irrespective of whether the matter is related to insolvency or not. There is no
involvement of personal liability, however, a director has to pay hefty fines and penalties.
Director in default is removed from the position and barred from holding the same post in the
same company or other for a specific period.
4. Are there any restrictions on the operations of s588GA defence? If so, what are they?
Section 588GA is for safe harbour defence which is a whole new transformation in the
reform history made in the favour of directors. It should be used wisely for people holding the
position of directors and has incurred debts for an insolvent company with a view to improve its
conditions.
1. In case the company has failed to comply with majority of obligations which includes
payment of entitlements to its employees or no returns, notices, statements etc. have bee
5 Carrera, S. and Guild, E. (2015). Safe Harbour Or Into the Storm?: EU-US Data
Transfers After the Schrems Judgment. Centre for European Policy Studies.
6 Cloots, E. (2018). Safe harbour or open sea for corporate headscarf bans? Achbita and
Bougnaoui. Common Market Law Review. 55(2). 589-624.
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filed. Provided, it has failed to do so twice or more within a period of 12 months ending
when the debt was incurred.
2. If debt has been incurred and afterwards, the director has failed to abide by any of the
below mentioned obligation:
 to prepare and give report regarding affairs of the company to the controller on the
control day.
 If an order for winding up has been made, there arise a requirement to provide a report to
liquidator about the affairs of the company on the date of winding up or at a prior date as
provided by liquidator.
 In case a company has been ordered or resolved to be wound up which gives rise to
requirements as given under Section 588GA.
5. Do you think the changes to Division 3 will have an effect on the number of voluntary
insolvencies in Australia in the future? Why or why not?
Voluntary insolvency refers to a process whereby the company itself or its director or
debtor file for winding up petition in a formal way7. There is no legal or situational pressure on
the management of a company. It is made voluntarily whenever the corporate becomes insolvent.
The Division 3 has been amended significantly by looking into the past cases of winding up.
Companies are great source of income for Australian government due to which it has emphasised
on restructuring of companies. Furthermore, the directors have been given a protection from
unnecessary dragging in the cases even when the decisions are taken to take the company out of
financial distress.
The modifications in division 3 will help in reducing voluntary insolvencies as help of
legal provisions will be taken. Especially, safe harbour defence will be used for saving extension
of personal liabilities. There is no such remedy available in voluntary insolvency and also, the
assets are managed by internal parties. There is increased chances of mistakes and risks which is
less majorly under s588GA and other sections in division 3. Also, the earlier scheme was time
consuming and expensive. Along with this, the provisions in the past were outdated which
needed reforms for effective implementation. Modifications have resulted in maximisation of
continuation of business, and in case its not feasible, then winding up would be the last option to
7 Welch, E. P. and et.al., (2016). Folk on the Delaware General Corporation Law:
Fundamentals. Wolters Kluwer Law & Business.
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be used. It provided flexibility and comparatively inexpensive procedure. Also, an automatic
transition will take place which will result into liquidation.
PART B
1. Did Mr. Daly breach any directors' duties? If so, which ones and how?
On analysis of “the Talented Mr. Daly” case it was found that, some major rules and
regulations were breached by Daly who was director of his company8. When a person holds the
position of a director, there are certain duties, roles and responsibilities which must be complied
in all the situations. Corporation Act, 2001 provides duties of a director . Section 5.3 contains
number of duties which are to be fulfilled as mentioned below:
 To act in good faith and in the best interests of the company.
 To manage things in a way to avoid conflicts and disputes between company and
directors.
 To exercise reasonable care and diligence in all the activities.
 To resume the operations of company in case it fails to pay its obligations.
 In case of proceeding with winding, an official liquidator must be informed and help the
liquidator out in providing records and documents for speedy realisation of assets9.
In the case given above, Peter Daly has misused the funds. The money of investors was
not utilised in for the purpose for which it was raised. When a company, invite investors to invest
funds, they are bound to disclose the purpose and avenues win which the money so raised will be
used. Pete Daly has paid the money for the settlement of personal financial distress and divorce
of one of his colleague's divorce. Also, the director himself accepted that legal provisions have
not been complied with. Both of the incidents have amounted breach of a directors' duties.
2. Did any of the other directors breach their duties? If so, which duty and how?
The company of Peter Daly had four directors who were questioned during the
investigation because of their involvement in the misleading the investors due to mismanagement
of funds. A corporate is an artificial person which cannot act by its own thus, it appoints
directors to make decisions and manage the affairs by complying with acts, which are applicable
to the company. Furthermore, the four people were in the possession of confidential data which
8 Dorresteijn, A. and et. al., (2017). European corporate law. Wolters Kluwer.
9 Means, R. C. (2016). Underdevelopment and the Development of Law: Corporations
and Corporation Law in Nineteenth-Century Colombia. UNC Press Books.
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were price sensitive information. It is absolutely right that other directors also breached their
duties which was to inform the shareholders and other interested people about mismanagement
of funds. Together with this, to act in good faith and in the best interests of the company has also
been contravened10.
All the directors are agents of a company, they should not involve in any of the act which
will give rise to legal consequence and force the company to wind up. Also, there is a fiduciary
relationship between company and parties who have invested their funds in the company. They
have every right to know about the activities in which their funds were being used. The other
directors must have given their suggestions and prevented Daly from going against Corporation
Act, 2001. Also, they broke the principle of fiduciary relationship as they are expected to act
within legal jurisdiction and in an ethical manner.
3. Do you think the company was trading while insolvent? Give reasons.
According to the result found in the investigation, it could be said that company did not
have sufficient funds to carry its operations due to which it raised funds. A company is defined
as insolvent when it has insufficient funds to pay its financial obligations. According to
Corporation Act, 2001, it is duty of director to prevent the incurring any debt when a company
has become insolvent.
In the case of Peter Daly, the company has mismanaged the whole funds which created a
situation, in which it might become insolvent. The prime reason for giving the status of insolvent
in that it raised approx $20 million which to which Peter and other directors had no access to it.
This was enough to term it an insolvent as they failed to pay the money which was raised for the
purpose of investing in multiple wide portfolio11. However, instead of using it into the main
objectives, Daly used in settling personal financial obligations. This put the focus, that Daly was
not having enough money to finance the operations. When the investors put questions about their
money, the answer from various financial advisors were that, their funds can be anywhere. Also,
there are no chance of the money being returned to them. The company failed to comply with
legal obligations which again added a step in becoming an insolvent company. People want to
10 Padova, Y. (2016). The Safe Harbour is invalid: what tools remain for data transfers and
what comes next?. International Data Privacy Law. 6(2). 139-161.
11 Tracol, X. (2016). “Invalidator” strikes back: The harbour has never been
safe. Computer Law & Security Review. 32(2). 345-362.
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see a company working in an ethical manner and when it fails to take required measures, the
chances of insolvency rises.
4. if the company was trading while insolvent-are there any defences available to Mr. Daly
and /or other directors? If so, what are they? Give reasons.
The company was trading while insolvent and there are number of defences available for
directors which are as follows:
 Reasonable grounds to except solvency: Section 588H (2) is a defence which states that
debt has incurred on the basis that director had reasonable grounds to assume that
company was solvent and continues to remain one12.
 Reliance on information provided by subordinates: This defence is available if it can
be proved that an eligible sub ordinate was reviewing company's solvency position and
providing information about it on a timely basis.
 Absence from management of the company: A director may raise defence, if they can
prove that there were away from the management of the company due to illness or for
other major reasons.
 All reasonable steps to prevent company incurring debt: If the director has done
everything to prevent company incurring debt. These actions should be reasonable.
The above mentioned defences can be used in one or more case, however, the onus to prove the
case along with evidence would be on the director.
5. Would the new safe harbour defence assist the directors? If yes, how? If no, why not?
Safe harbour defence has been newly introduced to protect directors from being held
personally liable for the debts incurred by the company while insolvent. This defence should not
be used by Peter Daly due to the reason that he has not taken reasonable measures to prevent
company from obtaining debt when it has become insolvent13.
This defence is for those directors who has complied with all the legal provisions and
taken care of activities. Furthermore, the debt was incurred for getting better outcomes and
12 Husovec, M. (2017). Holey cap! CJEU drills (yet) another hole in the e-Commerce
Directive’s safe harbours. Journal of Intellectual Property Law & Practice. 12(2). 115-
125.
13 Wang, J. (2015). Toward a more balanced safe harbour protection system for internet
service providers in China. Hong Kong LJ. 45. 881.
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improve the conditions of company. Whereas, in the case of Peter Daly, him and other directors
have raised the funds for settling personal financial problems and divorce of colleague.
Hence, this defence is not suitable and Peter Daly has breached major requirements
which are sufficient to conduct in-depth investigation and find out all those involved in the
offence, so that punishment or penalties can be awarded.
CONCLUSION
From the above report, it has been concluded that Corporate law is the essence of whole
business activities and practices which provides number of legal provisions applicable on
formation, management and winding up. In order to operate companies in Australia, Corporation
Act, 2001 has been enacted which gives meaning of insolvency and various defences available.
Furthermore, a director has duties as provided under the act which should be followed in all
circumstances in order to carry business activities without any scope of mistake. Any
contravention of such duty, legal consequences will be provided which may bar director to hold
to hold the position for a certain period.
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REFERENCES
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