A new reform package could exonerate directors from insolvency trading claims, among other things. Brisbane barrister David Topp writes
January is traditionally a slow news month. Perhaps this is why a comparatively dull topic such as corporate law reform generated much in the way of press on and around 20 January 2010. Even more so when one considers that perhaps the relevant minister, Chris Bowen, may have been able to have achieved what many might believe impossible: generating headlines on the same day in the national daily of “Directors can go for broke” and “Banks and insolvency practitioners are the big winners from recent decisions” [pages 31 and 40 of The Australian, 20 January 2010].
After all company directors and insolvency practitioners tend to gel as well as oil and water; ask any company director who has been on the receiving end of an unfair preference claim, or worse a personal liability lawsuit for insolvent trading, what their views of liquidators are. More than likely the response would employ language that would make even a sailor blush.
Firstly to the directors can go for broke angle. Primarily the Minister’s mooted corporate insolvency changes pertain to the well known “business judgment rule” [a creature of the late 1990’s CLERP reforms that is now enshrined in legislation [Section 180(2) of the Corporations Act 2001]]. Relevantly it requires business judgments to be made in the best interests of a corporation and without directors having any material personal interest in the subject matter of the business judgment.
Under Bowen’s reforms a modified version of the rule would in effect exonerate directors from insolvent trading claims if financial accounts and records of companies present a true and fair financial circumstances picture, and if directors are appropriately informed by restructuring advice based on those accounts and records.
This is also the case if their business judgment was that the interests of both a company's creditors and its members were best served by pursuing restructuring, and the restructuring was diligently pursued by the director.
The ‘restructuring advice’ angle was explained by the minister by introducing a notion of informal workouts: 'Informal work-outs play an important role in business rescue and therefore the protection of the shareholders, creditors and employees of distressed businesses. The use of formal insolvency reorganisation procedures is not always appropriate.’
While Section 588M of the Corporations Act 2001 exists, company directors always face a risk of a personal lawsuit against them for trading their corporations while insolvent. Any extending of the business judgment rule to such situations swiftly enters a grey area of best interests of their corporation versus the best interests of themselves, ie asset protection; when their own wealth is at stake how do directors prove that they had no material personal interest in the subject matter of a business judgment?
Needless to say many corporate liquidations concern thoroughly assetless entities in respect of which director claims for insolvent trading provide the only possible ground of recourse for a body of unpaid creditors. Therefore in this writer’s view any dilution of the practical effect of Section 588M should be approached with the utmost of caution. While the concept of directors obtaining restructuring advice, presumably from external sources, at least introduces some element of objectivity into what would otherwise be a very subjective [and hence litigiously difficult] analysis, it is to be hoped that the playing field between creditor interests and director interests does not transpire as tilting too far away from being at least partially level.
The aspects of the reforms which were adjudged beneficial to insolvency practitioners related primarily to streamlining of creditor meeting, notice and information provision procedures. Also the effective repeal of the High Court’s 2007 Sons of Gwalia decision [which promoted a sub-set of company shareholders to actual creditor status if they could prove their losses were due solely to misleading and deceptive conduct in corporate announcements] stands to at least relieve liquidators of having to adjudicate between actual creditor claims and those of the Sons of Gwalia “notional” shareholder creditors.
The reform package is at present just that – a package, not law. The division of Treasury which falls within Minister Bowen’s sphere will be accepting submissions until 2 March 2010.
David Topp is a Brisbane Barrister and The New Lawyer editorial contributor with a long held practice interest in insolvency litigation.