Australia: Insolvent trading claims – A cautionary tale for directors of corporations

Last Updated: 16 June 2012
Article by Kylie Hall

Most Read Contributor in Australia, July 2017

The law

Section 588G of the Corporations Act, 2001 (the Act) imposes a general obligation on company directors to prevent insolvent trading. In short, insolvent trading is said to occur in circumstances where, at the time the company incurs a debt, it is unable, or becomes unable, to pay its debts as and when they fall due.

Section 588M of the Act entitles a creditor who has suffered a loss as a result of a director contravening section 588G to seek to recover that loss from the responsible director. To satisfy a claim against a director for insolvent trading a creditor must prove:

  1. that they have suffered a loss because of the company's insolvency;
  2. that the debt was unsecured when the loss was suffered; and
  3. most importantly, that the company is being wound up. It is this final requirement which is the focus of this analysis.

On a literal interpretation of section 588M(1)(d), to be entitled to compensation a creditor must establish that the company which was the vehicle for the insolvent trading is being wound up. On its face, it would appear that this requirement is intended to refer to the status of the company at the time a proceeding is commenced by an aggrieved creditor. However, the decision of Barrett J in the Supreme Court of New South Wales in International Greetings UK Ltd v Stansfield [2010] NSWSC 1357 (International Greetings) set a precedent for the future interpretation of this section which is yet to be overruled or dealt with by amending legislation.

The facts

International Greetings centred around an insolvent trading claim against the directors of a company. Prior to judgment being delivered, but after the proceeding had been initiated, the liquidation of the company was finalised in accordance with the requirements of s.509 of the Act and the company was ultimately deregistered. The defendant directors submitted and Barret J held, that the plaintiff's right to recover under section 588M(3) was precluded because the company had been deregistered, and was non-existent, and was not being wound up as required by 588M(1)(d).

This finding lead to a decision by Barrett J, to dismiss the proceeding and to exclude the plaintiff creditor's right to seek compensation. His Honour held that "the words seem to me to be clear and unambiguous and I can see no basis on which their meaning can be affected by the practical considerations I have mentioned."

Overcoming the anomaly – reinstate the company

On a practical level, to prove all the elements of section 588M a plaintiff should request that the liquidator of the relevant company refrain from lodging the final company notice with ASIC pursuant to section 509 of the Act until after judgment has been handed down.

Whilst this statutory anomaly can be overcome by ensuring that the winding up process continues until judgment is handed down, a road block can be encountered in circumstances where deregistration of the company occurs prior to judgment being delivered or before proceedings are issued. This was an issue faced by one of our clients who is the plaintiff in a Section 588M claim. To overcome the problem, the solution for the plaintiff creditor is to make an application to reinstate the company pursuant to section 601AH of the Act.

Pursuant to section 601AH(5), the effect of reinstating a company is that the company is taken to have continued in existence as if it had not been deregistered. The pertinent issue to be considered is whether or not a company which has previously been wound up can be wound up again upon reinstatement or whether that process is finite and complete.

ACCC v ASIC [2000] NSWSC 316 involved an application by ASIC to reinstate a company which had been wound up and deregistered. Austin J held that even if the final account has been presented to ASIC by the liquidator pursuant to section 509 of the Act, an order by the court to reinstate the Company has the effect of countermanding ASIC's duty to deregister the company. His Honour went on to state that "the reinstatement must imply that the affairs of the reinstated company have not been fully wound up, even though the liquidator fully discharged the duties of winding up before the company was deregistered."

This reasoning has also been confirmed by Barrett J in Donmastry Pty Ltd v Albarran & Anor. [2004] NSWSC 632.

The cases above illustrate that by reinstating a company it is possible to satisfy section 588M(1)(d) even if the company has been deregistered or the winding up process is complete.

The lesson

Until the legislature takes steps to rectify section 588M(1)(d), when pursuing a claim against directors for insolvent trading it is crucial that the company which is the subject of the insolvent trading claim is in the process of being wound up until judgment is obtained. If the winding up process has not commenced or it has been completed in accordance with the requirements of section 509, plaintiffs face the risk of their claim being struck out or dismissed.

If deregistration has occurred prior to proceedings being issued or judgment being delivered then it is incumbent on the plaintiff to seek to reinstate the company pursuant to the relevant provisions of the Act.

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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