Under s588G of the Corporations Act 2001 (Cth) directors of a company can be held personally liable if the company incurs debt when insolvent and there are reasonable grounds to suspect the company is insolvent. Criminal and civil sanctions can be imposed on a director who breaches s 588G.
Whether a debt is incurred by entering into a lease has been considered in two cases. The facts briefly are as follows:
Russell Halpern Nominees Pty Ltd v Martin (1987) WAR 150; (1986) 10 ACLR 539 (Russell)
In Russell, the plaintiff company entered into an agreement to lease premises to two other companies in November 1980. The commencement or termination date of the lease was not pleaded during the proceedings. Counsel for the plaintiff company advised that the lease was for a term but could not disclose what the term was. In June 1982, the appellant obtained an order that the companies pay any arrears of rent. However, rent was not received and the companies remained in possession of the premises until May 1983.
The plaintiff commenced proceedings under the former Companies Code s 556 against directors of companies to recover the arrears of rent and further rent. The issue for the Court was whether a debt was incurred at the time the lease was entered into, or upon each and every rent day for the duration of the lease.
Bans Pty Ltd v Ling and Others (1995) 16 ACSR 404
The lessor commenced proceedings against two directors under Companies Code s 556 claiming they were personally liable for the amounts payable under the lease including interest on defaults.
The purpose of entry into the lease was to establish an English learning college, though the use stated on the lease was "commercial office space". The lease term was four years commencing on 19 June 1989, with rent payable at equal monthly instalments due on the first day of each month. The college commenced occupation of the premises in June, but the lease was not formally executed until October. A term of the lease was that rent fell due annually, which was not effective, as the lease was in fact a month to month lease.
To determine if there is a cause of action under s 588G the company must "incur a debt". Therefore, it is necessary to examine:
- what is a "debt"; and
- the circumstances when a debt is "incurred".
What is a Debt within s 588G ?
A "debt" is not defined within the Corporations Act 2001 (Cth), and not every liability that a company incurs is a debt. For a company to incur a "debt" it must come under an obligation to pay a liquidated/ascertained amount, being a fixed amount or an amount which can be positively calculated.
When is a Debt Incurred?
There is no general principle or rule which states when a debt is incurred1. Section 588G is concerned with the date which the company incurred the debt, not when the company became liable to pay the debt.
The time which a debt for rent under an agreement for lease is incurred was established in Russell. Burt CJ (Smith J agreeing) held that a debt is incurred from the act of entering into a lease, emphasising that a positive, voluntary act is required to establish a debt. A debt is not incurred each time rent falls due under a lease, because the company has not engaged in a positive act. To find otherwise would be "unacceptable"2. The Court in Russell found the company was not guilty of insolvent trading, as the positive act of signing the lease occurred prior to the business becoming insolvent.
Olney J in dissent3 held the trial judge had misconceived the effect of s 556(1) of the Code and found that the statement of claim did disclose a reasonable cause of action, although a pleading deficiency was capable of being remedied by amendment.
Bryson J in Bans v Ling, followed Russell, and found the directors personally liable for all rent from the date which the agreement to lease was signed until the date on which the company was placed into liquidation inclusive of interest on the defaults, because the leases were monthly. The directors were not liable for interest payable beyond the date when the company went into liquidation.
Insolvency and Leases
Property of an insolvent company often involves occupational leases, which contain clauses that enable the landlord to terminate the lease if the tenant company is placed into liquidation or other insolvency administration. However, the landlord need not formally terminate the lease.
If the insolvency appointee does not need the property, or it has no value, he/she may cause the company to vacate the premises. If the lessor accepts the repudiatory act of vacation, it must take reasonable steps to mitigate the loss to recover damages for unpaid future rent. However, at law the lessor is not required to accept a repudiatory act. At law a lessor is entitled to allow the lease to continue and sue for the rent while the lease continues, and there is no obligation at law to mitigate the loss i.e. rent accrues each month. That position may be qualified in the context of a liquidation, as companies in liquidation cannot continue trading except for beneficial realisations, or without appropriate approvals. In other words, there may be a surrender at law on the tenant vacation in a liquidation, regardless of the attitude of the landlord to seek to continue the lease.
Implications for Insolvent Trading
Liquidators are required to consider which debts remain outstanding at the date of liquidation, and of those, which were incurred at the relevant time.
The time the debt is incurred, i.e. the time the lease is entered into, on present law is the relevant time for when directors of a company may be liable for a company's inability to pay rent under the lease.
In Bans v Ling the lessee was holding over as a monthly tenant. In these cases, where the landlord is holding a tenant to the agreement, the rental debt arises on entering into the lease each month. The Full Court in Russell found that a tenant company cannot incur a debt whenever a present liability to pay rent is created by the tenant's covenant in the lease operating over time.
Russell, was a majority decision. It may not be upheld on an appeal today for a case in analogous circumstances. At some time a landlord will likely challenge Russell. If it is not followed, directors potentially are at serious risk for insolvent trading for ongoing rental obligations even though they caused the corporate tenant to vacate the subject premises if the landlord does not accept that repudiatory act. That potential liability for ongoing obligations would cease upon the appointment of an insolvency practitioner, because the directors are no longer in management of the company (see the defence in section 588H(4) of the Act if the company goes ultimately into liquidation). Thus if the repudiatory act of vacating the premises is not accepted by the landlord, company directors should seriously consider placing the company into an insolvency administration (voluntary administration or creditors voluntary liquidation) as soon as that attitude is ascertained. The position is different for directors of a company on a month by month lease as the act of vacation ie. non-renewal of the monthly lease, brings potential liability to an end on month end.
The assistance of Catherine Nguyen, Clerk, of Addisons in the preparation of this article is noted and greatly appreciated.
1Bans Pty Ltd v Ling and Others at
2Russell at 396.
3Russell at 546.
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.