Corporations Act: Prevention of Insolvent Trade
Part A
Write a brief explanation about why the directors’ duty to prevent insolvent trading exists & the circumstances and consequences of the “veil of incorporation” being lifted for insolvent trading.
The legal management of the corporations implements efforts in relation to the imposition of the higher level of liability on the directors as they execute their duties, roles, and obligations with the aim of achieving the goals of the business entities. This indicates that organizations have no right to trade while insolvent. This is ensured through the integration of the Corporations Act in the imposition of civil penalties and personal liability on the directors in case the business entity incurs debt or attains the aspect of insolvency. This imposition also occurs in relation to suspects of insolvency in the context of the business entity or company in accordance with section 588G of the Corporations Act (CCH Australia Limited, 2007).
There are several reasons why Corporations Act requires that the directors do not conduct business when the entities are insolvent. One of the reasons is to enhance the effectiveness and efficiency in the services and products delivery to the consumers. Insolvent trade relates to ineffective and inefficient products and services due to inappropriate funds or lack of sufficient resources. It is the duty of the director to ensure the achievement of the effective and valuable management of the business entity towards the achievement of the goals and objectives. The main aim of companies is to maximize profits while minimizing costs of production and distribution. In the case of insolvent trading practices, the business entity loses its objective due to much accumulation of debt thus unable to maximize its profits and revenues in the process of minimizing the cost of production of distribution. It is, therefore, effective and adequate for the directors to ensure that no business is transacted while the company is insolvent (CCH Australia Limited, 2007).
Another reason for the existence of the section 588G of the Corporations Act is to prevent the director to from being liable in the process of compensating creditors. In case the business entity accumulates debt between the period of insolvency and liquidation, the director is liable for the compensation of the creditors. This indicates that the business law is in place to protect the directors from personal liability thus the essence of ensuring no business transaction is conducted in the insolvency period. It is the role of the director to ensure that the company does not incur debts beyond its capacity to repay. In case the director fails to prevent trading during insolvency, he or she will have to incur the cost of compensating the creditors from personal resources.
Director’s duty to prevent insolvent trade exists to prevent breaching of the contract and duty of the director of any company. This is through ensuring that the directors offer quality management to the financial resources thus the ability to maximize profits while minimizing the cost of production and distribution. The main aim of the clause of the Corporations Act is to prevent directors to applying reckless tactics in the management of the resources of the company (CCH Australia Limited, 2007). The development of the law in relation to the duties of the directors in the protection against insolvent trade focuses on the prevention of the reckless act of incurring debts. This approach enables the directors of relevant organizations to prevent personal liability. This is because directors have the obligation to pay the creditors in case of accumulation of the debt beyond the capacity to repay of the company. The breaching of the contract will ensure that liquidators have the opportunity to make valuable claims for the credits thus pressure on the company. The law also exists to protect the image of the company within the market and industry. This is essential for transactions and interaction with suppliers, consumers, shareholders, and other relevant stakeholders.
Lifting of the ‘veil of incorporation’ refers to the process through which legislative or judiciary decides to separate the concept of personality of the organization and its members (Rush & Ottley, 2006). Several cases can make the judiciary to decide to lift the veil of incorporation. An example of the situation relates to the corporate form and group structures in the context of the process of merger. For instance, in case company Y owns the shares (capital) in four companies- K Ltd, B Ltd, G Ltd, and P Ltd as the parent or holding company, it has the authority and capacity to control the four subsidiaries. This is a reflection of several legal personalities subscribing to one business entity in economic reality. The organization and structures in this context ensures that the parent company to avail itself in relation to the benefits of the limited liability. In case the parent company executes any wrong transactions within the context of the any of its subsidiaries, the assets of company Y as the shareholder in the relevant organizations are out of reach. The legislative and judiciary aspects will prevent this to occur in most situations thus the benefits of the concept of limited liability to the parent company. This is an indication that the lifting of the veil of incorporation recognizes the structures and organizations of entities (Slorach & Ellis, 2012). Another situation for the lifting the veil of incorporations occurs when the directors breach the duty thus executing business in case of insolvency. According to section 213 of the Corporations Act, in the process of winding up of the business entity and it occurs that the transactions were conducted with the intent of defrauding creditors of the company, or any other individual is breaching of duty. This makes it essential for individuals or persons who participated in the process knowingly to be responsible or liable for the payment of the debt.
The courts also have the ability to lift the veil of incorporation in case the organization decides to pay dividends out of the capital even in the process of insolvency trade. The main consequence of lifting the veil is the ability to enjoy benefits of limited liability. This enables directors to enjoy limited liability in that they are not personally held accountable for the payment of the accumulated debt. There is a significant separation of liabilities and personality within the context of the organization. Parent organizations also enjoy benefits of limited liability in case of the transaction of trade during insolvency.
Part B
From what you of OHS Solutions’ predicament, discuss whether any of directors may be about to breach or have already breached the duty to prevent insolvent trading. (In order to do this, you will need to compare what is happening in OHS Solutions case with other precedent cases in relation to the appropriate sections of the Corporations Act). What will you advise Ying?
Section 588G aims at ensuring that the directors prevent interaction or business transactions during the aspect of insolvency. Four critical cases reflect on the breaching of the insolvent trading laws ensuring that the directors perform their roles and duties in the prevention of the insolvency trade. The first concept incorporates that fact that one is the director when the company or relevant business entity becomes insolvent while taking the debts (accumulating debts) or enters into insolvency because of obtaining of debts from creditors. This is an indication that the director must be in charge when the organization applies and attains debts for the execution of its duties and functions in relation to consumers and suppliers. If this scenario occurs within the company, then the directors are viewed to have breached the section of the Corporations Act aiming to prevent insolvent trading. Another element of the breaching of the section 588G of the Corporations Act entails the development of reasonable grounds or measures demonstrating suspicions in the context of insolvency or elements of insolvent trade. This indicates that there must be sufficient ground to enhance the suspicion on the case of insolvency or its essential elements (Loos & Pereira, 2006).
Another element of breaching the section 588G of the Corporations Act occurs when the director or any other executive authority is aware of the development of insolvency or potential concepts of insolvency within the business entity. This aspect indicates that the director must be aware of the events developing in relation to insolvency in order to be considered as having breached the contract of duty of protection or prevention of insolvent trade. In case other officials of the company identifies or recognizes elements of insolvency or potential insolvent trade and fails to report, the consequence will be a breach of contract of duty. This will ensure that the director or participants are personally responsible for the debts or insolvency of the company thus liable for the repayment of the debts during the liquidation process (Loos & Pereira, 2006).
The last aspect illustrating breach of contract indicates that the reason for the failure to prevent insolvent trade by the directors is dishonest (Loos & Pereira, 2006). This indicates that the director must have genuine and honest reasons for failing to prevent insolvent trade. In case the director of the company fails to prevent insolvent trade for personal gains, he or she is being dishonest in the process of executing his or her duties and obligations. This will contribute to the breaching of the contract of duty in the prevention of insolvency. In such situations, the director will be liable for the settlement of the debts accumulated because of the execution and failure to prevent insolvent trade in accordance with the directives of the Corporations Act. Another exception case of breaching of the contract of duty of the prevention of insolvent trade occurs when the holding company becomes liable for the accumulation of debts. This occurs when the directors of the holding company suspects that there are substantial grounds for the development of insolvency because of the accumulation of debt. For breach of contract of duty in relation to prevention of insolvent trade by the directors of companies, any of the breaching concepts or situations must reflect effectively (Loos & Pereira, 2006).
In the context of OHS Solutions, managing director Des is about to breach the contract of duty in relation to the prevention of insolvent trading. This relates to the process of transacting business amid the potential elements of insolvency surrounding the business transactions. The managing director just signed a $ 10,000 advertising contract with the Promotions Plus Pty. Ltd in order to advertise on the organization’s website. The managing director also organized for the execution of a trade show in conjunction with the Promotions Plus Pty. Ltd in the planned OHS conferences. This is a reflection of execution of duties or transactions in the presence of insolvency. The reasons for the failure to prevent insolvent trade might be honest. This is because according to the information available to the managing director, business is executing its duties to the consumers, suppliers, and shareholders. Des claims that Satish had informed him of the fixation of the technical problems through engaging of the Trouble Shooters. This indicates that according to information available to him, he had the duty to organize and negotiate on the business deals without any suspicion of the elements of insolvent trading.
Emma is about to breach the contract of duty in the prevention of insolvent trading activities. This is through failing to evaluate and monitor the financial records of the organization on an occasional basis. The source of the problem facing the organization seems to originate from the financial department. Emma proves to have neglected the duty as the financial director thus failing to recognize the overwhelming debt to the Trouble Shooters Company. As the financial director, Emma should have the valuable information relating to the debts and creditors transacting with the company. In this scenario, Emma fails to provide this information thus breaching the contract in relation to the duties and obligations of the financial director. In case the organization continues to transact under the influence or conditions illustrating elements of insolvency, Emma will be liable for the settlement of debts to the company’s creditors. This is because of the knowledge of the situation as the financial director.
Des has neglected the duties of the quality and effective management of the company thus the opportunity to ensure effective management of the business and its transactions. Ying is also about to breach the contract of duty in failing to prevent the act of insolvent trading. She is aware of ineffective management of the OHS Solutions through the Board meeting. In case the business continues to operate with the accumulated debts according to the examination of the financial results, Ying will be liable for the settlement of the debts obtained in relation to insolvent trading. As a member of the board because of the shares by Support Pty. Ltd, Ying is entitled to ensure quality management in the context of OHS solutions. She has the opportunity to ensure that other managers or directors such as Emma offer quality and adequate financial records to the suppliers, stakeholders, and shareholders in the business transactions.
Ying as the director of the Support Pty. Ltd is a personal guarantor through the role she played in assisting OHS Solutions to accumulate funds for its operations. Since this is an official guarantee concept from the aspect of Ying, she will be liable to the consequences creditors will suffer in the course of liquidation. This makes it critical for Ying to understand her role in the accumulation of the debt influencing the performance and management of the organization. This makes her to be vulnerable to the course of operations and management of events at OHS Solutions thus part of the potential insolvent trading. As the guarantor in this situation, Ying will lose more of her personal resources or assets in the course of liquidation. I would advice Ying to continue trading with the aim of preventing the crystallization of the personal liabilities and relevant subsequent enforcement in relation to debts. This will involve the company to execute trading activities in the course of insolvency thus the breaching of contract of duty. Ying should seek the direction of the courts in relation to lifting of the veil of incorporations thus the separation of the personality from liabilities. This will ensure that Ying is not liable for the whole aspect of the accumulated debt thus suffering during the liquidation process.
In the context of buying OHS Solutions, the holding of ordinary shares by the Support Pty. Ltd minimizes the possibility of buying the company demonstrating elements of insolvency. This is because she is a member of the board charged with effective management of the organization or OHS Solutions. This indicates that she is part of the wrongful trading in case the business decides to continue with transactions amid suspicion of insolvency. Despite this advice, Ying still has the opportunity to organize business friendly deals with the founders and directors of the OHS Solutions in relation to purchasing of the business. This process should be legal to enhance legality of the business in the context of its interaction with the suppliers, shareholders, consumers, and other stakeholders.
References
Rush, J., & Ottley, M. 2006. Business law. London, Thomson.
Slorach, J. S., & Ellis, J. G. 2012. Business law 2012-2013. Oxford: Oxford University Press.
CCH Australia Limited. 2007. Master OHS and environment guide 2007. North Ryde, N.S.W: CCH Australia Ltd.
Loos, A., & Pereira, M. A. 2006. Directors’ liability: A worldwide review. Alphen aan den Rijn: Kluwer Law Internat. [u.a..
