Law 11: Analysis of Insolvency, Director's Duties, and ASIC Role

This essay on insolvency delves into the legal definition of insolvency, highlighting the critical role of directors in recognizing and addressing signs of financial distress. It explores director's responsibilities, including measures to prevent liquidation and the liabilities they face under the Corporation Act 2001, particularly Section 588G. The essay contrasts voluntary and involuntary administration, as well as members' winding up, providing a clear understanding of different insolvency processes. It examines statistical trends in corporate insolvencies and discusses the role of ASIC. Furthermore, the essay critically analyzes issues within Australian insolvency law, such as the personal liability of directors and its impact, offering recommendations for reform. The essay concludes by emphasizing the importance of director's actions in protecting the interests of creditors and stakeholders during insolvency proceedings.

Running Head: Law 1
Law

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Introduction:
Insolvency is that state when company’s total liabilities exceed its total assets. Section 95 A1 of
the Corporation Act 2001 states, any organization or individual can be considered as solvent if
such organization or individual is able to pay all the debts and liabilities when they become due
and payable. This section further states, individual or organization is considered as insolvent if
they are not solvent.
In this essay, various terms related to insolvency are discussed such director’s role, ASIC role,
various methods of insolvency, and process of insolvency. This essay also defines the statistics
related to insolvency and observance. Lastly, brief conclusion is stated for concluding the paper2.
Meaning of insolvency & signs related to insolvency:
Insolvency is defined under section 95A of the Act, and it is considered as that situation when it
becomes impossible for organization or individual to pay its debts. In other words, organization
or individual does not have that much assets which can be used to pay the debts of the company.
Court determines primary method for the purpose of determining the company’s solvency in case
Bell Group Ltd (in liquidation) v Westpac Banking Corporation & Others3. In this case, court
held that solvency of company can be determined through the assets and liabilities of the
company.
Signs related to insolvency: There are number of signs which reflect the actual position of the
company such as profitability, goodwill, growth reflect the solvent position of the company. In
similar way unprofitability and excess debts reflect the insolvent position of the company. It is
necessary for directors of the company to determine the signs of insolvency at former stage for
1 Corporation Act 2001- Section 95A.
2 ASIC. Types of Insolvency. < http://asic.gov.au/regulatory-resources/insolvency/types-of-insolvency/>, Accessed
on 15th September 2017
3 Bell Group Ltd (in liquidation) v Westpac Banking Corporation & Others.

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the purpose of preventing the company to goes into liquidation. Some of these signs are stated
below:
 Cash flow of the company reflects more outgoing cash and less inflow of cash, which
means company incurred loss while trading.
 Company faces issue in arranging the capital for its day to day working.
 Company also faces issue in selling its stock.
 New limit is negotiated by the individual of organization with the current financier.
 Shareholders and creditors take or threaten to take legal action against the company4.
Measures taken by directors: after determining the signs of insolvency, it is the duty of
directors to take reasonable measures for preventing the company to goes into liquidation.
Following are some measures which can be taken by directors of the company:
 It is the duty of director to prevent the company from taking any further debt if above
stated signs are reflected. However, directors can incurred further loan if it is possible to
restructure or refinance the business, and funds in equity form is available for
recapitalizing the projects off the company.
 Board must pass resolution for the purpose of appointing liquidators and administrators
of the company.
 It is the obligation of the director to make sure that creditor’s and other stakeholder’s
interest has been protected if any risk related to the insolvency occurred.
 Directors of the company must not engage in any trading with the outsiders if any risk
related to the insolvency occurred or company becomes insolvent.
4 Australian Debt Solvers, Company Insolvency Survival Booklet, <https://australiandebtsolvers.com.au/wp-
content/uploads/2016/03/CompanyInsolvencySurvivalBooklet.pdf>, Accessed on 15th September 2017.

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Liabilities of directors in insolvency:
Corporation Act imposed number of responsibilities on directors of the company if any risk
related to insolvency occurred or company becomes insolvent. Section 588G of the Act imposed
this liability. According to Section 588G of the Act, it is the duty of the director to restrict the
trading at the time of insolvency5.
Applicability of section 588G- this section is applicable not only on the directors of the
company but o those individuals also who were not appointed as company’s director but they
were acting as the directors of the company. This section further state, obligation of director
arises in following situations:
 Organization becomes insolvent at that time when debt is incurred.
 Risk related to insolvency occurred if organization decided to take debt
 Such reasons are present which make the director’s believe that company face risk of
insolvency or becomes insolvent if such debt is incurred by the company. In case Kenna
& Brown Pty Ltd v Kenna6, Court stated that directors must conduct objective
assessment for the purpose of determining the insolvency.
Contravention of section 588G- there are two types of contravention related to this section, and
these contraventions are stated below:
 If directors of the company fail to prevent the company from incurring further debt, even
though sufficient reasons are present which make the directors believe that risk related to
insolvency is present or company becomes insolvent, then such failure can be considered
5 Corporation Act 2001- Section 588G.
6 Kenna & Brown Pty Ltd v Kenna.

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as contravention of this section and directors of the company are liable under civil
provision.
 Penalty under criminal provisions will be applicable on directors of the company if
directors of the company fail to prevent the company from incurring further debt, even
though sufficient reasons are present which make the directors believe that risk related to
insolvency is present or company becomes insolvent because of any dishonest reasons.
Consequences of contravention- following are the consequences of contravention of section
588G of the Act7:
 Court pass compensation order under section 1317E8 of the Act if director fails to
compile with this section and this order states that directors are personally liable to pay
the compensation to the company if any company suffered any loss.
 Court pass pecuniary order under section 1317G9 of the Act if director fails to compile
with this section, and this order states the amount of penalty imposed on directors up to
$200000.
 Court can pass disqualification order under section 20610 of the Act and as per this order;
directors of the company are disqualified to manage the company.
 If director fails to compile with section 588G because of any dishonest reason then
directors of the company are penalized under criminal provisions, and court can order
7 AICD. Insolvent trading, <http://aicd.companydirectors.com.au/~/media/cd2/resources/director-resources/
director-tools/pdf/05446-6-3-duties-directors_insolvent-trading_a4-web.ashx>, Accessed on 15th September 2017.
8 Corporation Act 2001- Section 1317E.
9 Corporation Act 2001- Section 1317G.
10 Corporation Act 2001- Section 206.

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fine up to 2000 penalty units or imprisonment for the period of 5 years (Corporation Act,
2001).
Alternative ways- if directors have sufficient reasons to believe that company face the risk
related to insolvency then directors can opt for these alternative ways also:
 Directors can take advice from professionals and experts.
 Directors can request secured creditors for appoint the receiver.
 Directors must cease the trading of the company.
 Directors must restrict the company for taking any other debt.
 Board can appoint administrator under section 436A of the Act11.
Difference between voluntary and involuntary:
If company opts for voluntary administration then company can choose reorganization. This
intervention is initiated by the directors of the company if directors have sufficient reason to
believe that company face risk of insolvency or becomes insolvent. In this director of the
company has power to exercise same level of control. This administration provides the hope of
business reorganization.
Under voluntary administration, external administrator is appointed by the company directors
and secured creditors. It must be noted that person who is appointed as administrator under this
method is known as voluntary administrator.
Investigation is conducted by the voluntary administrator, and in this investigation administrator
investigates the company affairs. Investigator sends report to the creditors of the company. In
11 Corporation Act 2001- Section 436A.

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this report investigator state clear views related to the conditions of the company and alternative
option available to creditors.
On the other hand, involuntary administration of the company occurred when administrator is
appointed by the charge holder, liquidator, and provincial liquidator. Under these method
directors of the company has power to exercise similar control. It must be noted that involuntary
administration is considered as that stage under which hope off business restructuring is almost
nil12.
Members winding up- If directors of the company does not opt for creditors winding up, then
also have one more option that is member’s winding up. Under this option, members of the
company pass special resolution for appointing the liquidator. This liquidator is appointed under
section 495 of Act13, which states that liquidator is appointed by passing special resolution in the
general meeting. Liquidator is appointed under this section for the purpose of wound up all he
operations of the company, and to discharge all the liabilities of the company.
Directors of the company can also opt for voluntary administration of the company, and under
this method directors appoint voluntary administrator for the purpose of investigating the matters
of the company.
Statistics related to insolvency:
ASIC quarterly statistics related to insolvency shows the result of the last quarter of 2016/17.
Result shows an increase of 28% in companies which opt for external administration. Total
12 Quinlan, M. (2005). Formal Reorganization in Australia.
https://www.allens.com.au/pubs/pdf/insol/pap15mar05.pdf, Accessed on 15th September 2017.
13 Corporation Act 2001- Section 495.

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appointments were 2198 as compared to 1717 in the previous quarter. This can be understood
through below stated table14:
Companies opt for EXAD:
Month 2016 2017 %change
April 793 590 -25.6%
May 735 792 7.8%
June 755 816 8.1%
Total 2283 2198 -3.7%15
Issue related to insolvency:
Australian insolvency law does not state any measures or steps through which directors of the
company can reorganize or restructure the business of the company. However, it also fails in
recognizing the long term gains of the company such as value of assets, goodwill, reasons of
closure at premature level, and liquidation. Law related to insolvency does not provide any
options which deals with the business restructuring or help in making the company profitable.
It also fails in providing the measures which protect the interest of directors as well. Making the
directors personally liable, while incurring further debt will reduce the capacity of directors to
conduct any step for restructuring the business of the company. Following are some issues
related to insolvency law in Australia:
14
15 ASIC, Corporate insolvencies: June quarter 2017, < http://download.asic.gov.au/media/4410590/201706-june-
qtr-2017-summary-analysis.pdf>, Accessed on 15th September 2017.

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 It will make the directors personally liable which reduce the capacity of directors to incur
any further debt.
 Talented people restrict themselves from holding the position of directors because of the
personal liability.
Some recommendations related to these issues are sated below:
 While taking the decision of premature liquidation, expert advice must be compulsory.
 Reduce the personal liability of the directors if they act in good faith16.
ASIC Role:
ASIC play very important role in the insolvency of the company, and ASIC has power to
deregister the company if ASIC has reason to believe that company ceased its trading and fees
and penalties due to ASIC and other authorities are not paid by the company. However, if
following reasons are present then ASIC can deregister the company:
 Company fails to submit its annual fee within the 12 months from the date on which fee
becomes due.
 ASIC issued compliance notice to the company and company does not submit any
response related to that notice within the period of 18 months from the date of issue of
notice.
 Processing related to the winding of the company is started and company fails to appoint
liquidator17.
16 ASIC, ( 2010). Duty to prevent insolvent trading: Guide for directors,
http://download.asic.gov.au/media/1241384/rg217-29july2010.pdf, Accessed on 15th August 2017.
17 ASIC. ASIC initiated deregistration of company. <
http://www.asic.gov.au/for-business/closing-your-company/deregistration/asic-initiated-deregistration-of-
company/#ReasonsforDereg>, Accessed on 15th September 2017.

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Observation:
There are number of legislations and case laws which clarify that director of the company are
personally liable if they breach their fiduciary duty. However, corporation Act fails to recognize
the interest of minority shareholders at the time of insolvency. In case law Kinsela v Russell
Kinsela Pty Ltd (in liq) (1986) 10 ACLR 39518, court held that if directors of the company breach
their fiduciary duty then members can rectify the action of the director in general meeting. In
case such rectification defrauding the minority then such rectification was considered as invalid.
Therefore it is necessary to consider the interest of the minority while making any decision;
otherwise such decision will be considered as invalid decision.
Conclusion:
In this essay, various terms related to insolvency are discussed and this discussion clearly states
that role of directors of the company is very important at the time of insolvency. As stated,
directors are personal responsible to ensure the interest of creditors and stakeholders.
BIBLIOGRAPHY
Website
ASIC. Types of Insolvency. < http://asic.gov.au/regulatory-resources/insolvency/types-of-
insolvency/>, Accessed on 15th September 2017.
Australian Debt Solvers, Company Insolvency Survival Booklet,
<
18 Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 10 ACLR 395.

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https://australiandebtsolvers.com.au/wp-content/uploads/2016/03/CompanyInsolvencySurvivalB
ooklet.pdf>, Accessed on 15th September 2017.
AICD. Insolvent trading, <http://aicd.companydirectors.com.au/~/media/cd2/resources/director-
resources/director-tools/pdf/05446-6-3-duties-directors_insolvent-trading_a4-web.ashx>,
Accessed on 15th September 2017.
Quinlan, M. (2005). Formal Reorganization in Australia.
<https://www.allens.com.au/pubs/pdf/insol/pap15mar05.pdf>, Accessed on 15th September 2017.
ASIC, Corporate insolvencies: June quarter 2017, <
http://download.asic.gov.au/media/4410590/201706-june-qtr-2017-summary-analysis.pdf>,
Accessed on 15th September 2017.
ASIC, ( 2010). Duty to prevent insolvent trading: Guide for directors,
http://download.asic.gov.au/media/1241384/rg217-29july2010.pdf, Accessed on 15th August
2017.
ASIC. ASIC initiated deregistration of company. < http://www.asic.gov.au/for-business/closing-
your-company/deregistration/asic-initiated-deregistration-of-company/#ReasonsforDereg>,
Accessed on 15th September 2017.
Case law
Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 10 ACLR 395.
Bell Group Ltd (in liquidation) v Westpac Banking Corporation & Others.
Kenna & Brown Pty Ltd v Kenna (1999) 32 ACSR.
Statute
Corporation Act 2001.