By Sam Kingston (Associate) and Paul Betros (Partner)
A recent Queensland Supreme Court decision is a timely reminder that company directors need to act promptly and seek proper advice when their company is, or soon will be, insolvent. If they fail to take proper action, directors could be held personally liable for the company's debts.
Despite the moratorium preventing the enforcement of guarantee claims prescribed by the Corporations Act 2001 (CA), the decision in Bank of Western Australia Limited v Clift demonstrates that there is a risk that in some circumstances, creditors are still able to immediately enforce guarantees of liabilities of the company given by the director or a spouse, de facto or relative of the director.
Key takeaways from this case
- Directors must weigh their options very carefully difficulties.
- The decision in this case emphasises that the protection afforded to directors, spouses and relatives by the moratorium from guarantee claims imposed by section 440J of the CA may be much more limited than previously thought.
- The question of whether a company is insolvent is a complicated one. When faced with mounting debts and increasingly demanding creditors, directors need to take a proactive approach.
Background: the Corporations Act 2001
The CA encourages directors of companies that are facing financial difficulties to avoid the risk of insolvent trading liability by initiating a voluntary administration or members' voluntary winding up. There are a number of factors that directors need to consider before placing the company into voluntary administration.
Section 440J of the Act provides that during a company administration, a guarantee of a liability of the company cannot be enforced (except with leave of the Court) against a director, a spouse, a de facto spouse, or relative of the director. This section further provides that a proceeding in relation to a guarantee cannot be started against those people without the Court's leave. Importantly, this section does not prevent the enforcement of guarantees when the company goes into liquidation or executes a Deed of Company Arrangement, because the company is no longer under administration once the process has progressed to that stage.
It is important to note that the protection afforded by section 440J has always been of limited duration, and only exists for the relatively short lifespan of the voluntary administration itself.
Generally, the Courts have held that the rationale behind the moratorium is to encourage directors of insolvent companies to initiate an administration and to continue to co-operate with the administrator in carrying on the business of the company.
Timing is a very important issue for directors. Previous cases have confirmed that if a judgment has already been obtained against the director, it can be enforced even while the company is in administration. This is said to be because the creditor is enforcing the judgment, and not the guarantee. While this may seem to be an arbitrary distinction, the decision in Bank of Western Australia Limited v Clift demonstrates that the protection afforded to directors, spouses and relatives by the moratorium may have been even further eroded.
Bank of Western Australia Limited v Clift
In Bank of Western Australia Limited v Clift, Justice Margaret Wilson considered an application for summary judgment brought by Bankwest against a director of a company in administration. Bankwest had lent money to two companies, TDC Acquisition Pty Ltd and Medico Australia Pty Ltd. The defendant in the case was the sole director of each company, and had guaranteed both companies' liabilities.
Administrators were appointed to Medico and that company went into liquidation. At the time, TDC was not under any form of insolvency administration. Bankwest subsequently demanded that the defendant pay the loans due by TDC and Medico, and commenced Court proceedings. After those proceedings were filed, administrators were appointed to TDC. At the time of the summary judgment hearing, TDC was still in administration.
Her Honour considered whether leave for Bankwest to proceed to obtain judgment was required under section 440J. Her Honour concluded that leave was not required, and granted judgment in favour of the plaintiff.
The Judge's conclusions
In concluding that leave was not required in this case, and granting judgment in favour of the plaintiff, Her Honour held as follows:
- Her Honour referred to the decision in Re: Beham, in which default judgment had been obtained against a guarantor before an administrator was appointed. In that case, the Court held that the liability under the guarantee had merged in the judgment, meaning that the creditor was no longer seeking to enforce the guarantee, and the moratorium contained in section 440J did not apply. The Court also held that 'enforcement' would extend to steps taken before the commencement of the proceeding, such as serving a demand on the guarantor.
- Her Honour referred to the Explanatory Memorandum of the Act, which states that there was a concern that directors of insolvent companies would be discouraged from appointing administrators if guarantees become enforceable as soon as administrators were appointed. Her Honour noted that section 440J has been held to apply not only where the appointment of an administrator would actually trigger liability under a guarantee. Her Honour also noted that commentators suggest that the true rationale of section 440J is the administrator's need for continuing co-operation of the directors in carrying on the business of the company.
- Her Honour refers to the decision in Beham, which stated that the wording in section 440J differs from other sections of the Act that deal with the circumstances in which proceedings may not be started or proceed without leave. Her Honour concluded that the structure of section 440J may be an indication that the maintenance of a proceeding that has already started may not be intended to be caught within the prohibition.
- Her Honour noted that previous cases have drawn a distinction between establishing a liability and enforcing it. In particular, in Fraser v The Commissioner of Taxation, the Court saw a distinction between enforcing remedies and instituting legal proceedings and their continuance up to judgment.
- Her Honour concluded that there is a relevant distinction between the appointment of an administrator triggering liability under a guarantee on one hand, and continued maintenance with proceedings already underway on the other. Her Honour concluded that in the latter case, the potential for discouraging directors from assisting an administrator seems reduced.
- Her Honour concluded that in these circumstances, the plaintiff did not require leave to obtain judgment against the director. Her Honour acknowledged that this was not an easy question, but felt on balance that the plaintiff was entitled to judgment.
It appears that, while nominally legally represented, Mr Clift was not actually represented by a legal practitioner at the hearing, and his defence seems to have been poorly argued. Her Honour may have been able to reach the same outcome by granting the plaintiff leave to proceed, rather than drawing a fine distinction between continuing and commencing proceedings. Even so, Her Honour's comments about the continuation of proceedings against guarantors may have wide-reaching ramifications.
For more information about this case, please contact HopgoodGanim's Insolvency practice.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.