It is very common for insolvent companies, in particular, to
have deficient books and records. As a result of a recent Supreme
Court of NSW case there is potential for companies to pursue
directors for equitable compensation for the failure to keep proper
books and records in accordance with the Corporations Act
2001. The floodgates may open!
By section 286 Corporations Act 2001 a company is
obliged to keep written financial records that correctly record and
explain transactions, its financial position and performance. It
has been held by the Courts that records required to be kept under
section 286 include a balance sheet, profit and loss
statement, a cash flow statement and a general ledger. That
requirement is not met by merely keeping the source material from
which a set of books may be written up. The written financial
records must also enable true and fair financial statements to be
prepared and audited.
A breach of the section gives rise to a strict liability offence
under the Criminal Code (C'th). It has not been
generally considered that a failure to comply with the section
gives rise to damages or equitable compensation against directors
for a breach of duty. There is however a statutory duty on a
director to comply with the section and he/she commits an offence
if the contravention was dishonest (section 344. This section is a
civil penalty provision for which a director can be banned and/or
fined for contravention).
In the Matter of Lawrence Waterhouse Pty Ltd (In Liq) - Shaw v.
Minsden Pty Ltd  NSWSC 964, a company director breached the
statutory duty by failing to have in place a system where proper
books and records were kept. Accordingly, the liquidator of the
company could not determine whether monies were properly owing by
or to the company by or to its director and others. The liquidator
sought equitable compensation for the company by the director being
in breach of a fiduciary duty to the company, being the equivalent
of a trustee who was in breach of trust. It was argued that the
director was liable for funds paid out of the company which could
not be identified because of the failure to maintain adequate
financial records. The liquidator asserted that had proper accounts
been kept then the liquidator could have gathered up any debts
owing on the loan account and made a distribution to creditors.
Ward J of the Supreme Court of NSW did not dispute the ability
to claim damages or equitable compensation. She referred the
question to an Associate Justice or referee for a full audit. She
however made a declaration that the director had failed to keep
proper books and records as required by section 286.
Lessons to be drawn:
Insolvency practitioners appointed to companies, or the
companies themselves if incumbent director(s) is replaced, may now
have significant actions for monetary sums arising from a
director's failure to keep proper books and records if the
company's financial position cannot be properly determined.
This can have substantial financial implications to directors
and/or their insurers.
Directors bear responsibility, now including, potentially,
financial responsibility, for inadequate books and records. That
responsibility cannot be delegated away.
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.
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