Directors Duty

Directors’ duties in Australia are designed to promote good governance and ensure that directors act in the interests of the company – including putting the company’s interests ahead of their own (A Guide to Directors’ Duties and Responsibilities, 2008). In the case of OHS Solutions Pty. Ltd. in order to give advice it must first be known what are the duties and responsibilities of a director and officer.

There are three sources of law in which directors’ duties are enforced: the common-law (judge made), the Corporations Act 2001 (Commonwealth) (the “Corporations Act”) and a company’s constitution (A Guide to Directors’ Duties and Responsibilities, 2008). There are both general law and statutory law duties that are owed by the director to different persons General law duties are owed by the directors and senior executive officers, which are also regarded to as fiduciaries.

Statutory duties apply to directors, but there are some statutory duties that apply to company officers as well (Hanrahan, Ramsay & Stapledon 2011). The obligations and responsibilities that directors must follow include: duty to act bona fide (in good faith) in the interests of the company as a whole, duty not to act for an improper purpose, duties of care and diligence, duty to avoid conflicts of interest, duty not to make improper use of position, duty not to make improper use of information, duty not to trade while insolvent (A Guide to Directors’ Duties and Responsibilities, 2008).

As extensive as these duties and responsibilities are for the purpose of this paper the duty of focus is, duty not to trade while insolvent. Referring to section s588G of the Corporations Act 2001 (Commonwealth), directors have the duty to prevent their company incurring debts when the company is insolvent or would become insolvent (Corporations Act 2001 (Cth) s 588). Firstly, it needs to be sought as to when s588G applies.

It must be analysed whether the company was insolvent at the time or became insolvent by incurring that debt, whether the person was director when a company incurred debt and at the time debt was incurred there were reasonable grounds for suspecting insolvency. When a company incurs a debt for the purposes of s588G the type of debt must be identified as well as when the debt was incurred. There are two types of debts incurred, deemed debts and uncommercial transactions. Deemed debts are listed in s588G (1A) of the Corporations Act 2001 (Hanrahan, Ramsay & Stapledon 2011; Corporations Act 2001 (Cth) s 588)

To further define “debt”, Allan Topp of Sims Partners and Tim James, says, “debt” has been interpreted to bear its ordinary technical meaning as something recoverable by an action for debt and thus must be ascertained or capable of being ascertained. Therefore, a “debt” signifies an obligation for the payment of money or money’s worth. Many authorities suggest that the obligation must be for an ascertained liquidated sum (James & Topp 2000). Now it can be further discussed the types of debts companies can incur.

As previously stated before, one type of debt is uncommerical transactions; an uncommercial transaction is one that a reasonable person in the company’s circumstances would not have entered into having regard to the benefits and detriments to the company of entering into the transaction and respective benefits to other parties to the transaction. The liability of directors for insolvent trading therefore extends to circumstances where the company has not actually incurred a debt at the relevant time but entered into an “uncommercial transaction” (James & Topp 2000).

Drawing back to identifying insolvency within a company, to determine if a company is insolvent, a cash flow test must be used to determine if the company is able to pay all its debt as well as to determine what assets the company has (Hanrahan, Ramsay & Stapledon 2011). There are two presumptions of insolvency that will assist in providing a company was insolvent at the relevant time in s 588E, if the company is insolvent at any time during 12 months before winding up (closing down) and their failure to keep financial records (James & Topp 2012; Hanrahan, Ramsay & Stapledon 2011; Corporations Act 2001 (Cth) s 588).

Referring to the case of Quick v Stoland (1998), there are four factors taken into account: • All of the company’s debts as at the time in order to determine when those debts were due and payable; • All of the assets of the company as at the time in order to determine the extent to which those ssets are liquid or are realisable within a time frame that would allow each of the debts to be paid as and when they become payable;

The company’s business as at the time in order to determine its expected net cash flow from business by deducting from projected future sales the cash expenses which would be necessary to generate those sales; and • Arrangements between the company and prospective lenders such as its bankers and shareholders in order to determine whether any shortfall in liquid and realisable assets and cash flow could be made up by borrowings which would be repayable at a later time than the debts (James & Topp 2012).

Furthermore there must be an objective test applied for reasonable grounds for suspecting that a company is insolvent. Also identifying if the director was knowledgeable. It must be referred to what a reasonable director from a similar size company would do in the same situation. Referring to the case of Hall v Poolman (2007), two companies had wounded up owing a substantial amount of money to creditors. Both companies partake in the same type of business. A non-executive director who was the chairman of both companies argued that he has reasonable grounds to suspect that the companies were solvent.

The court rejected the argument stating that he was well aware of the following facts: • Both companies suffering a cash shortage (cash flow test), incurring substantial debts and creditors not being paid. • Cash shortage and only be relieved by refinancing with the sale of assets but there was no way of knowing if there was adequate time to sale assets to then pay off debts. • One of the two companies had a dispute with Australian Tax Office (ATO) in relation to a substantial amount of money the ATO claimed to be owed to them (Hanrahan, Ramsay & Stapledon 2011). There are several defenses that a director can have on their behalf so that they are not reliable on insolvent trading.

The defenses used are: “reasonable ground to expect solvency, reliance on information provided by others, absence from management, or applying reasonable steps of incurring debt (Hanrahan, Ramsay & Stapledon 2011). ” If the court does see the director reliable of insolvency there are fines and penalties accrued. There are cases where a company has been trading insolvent, the Corporations Act itself will then pierce the veil and make certain participants responsible for restoring the company to the position it would have been in if insolvency hadn’t occurred (Hanrahan, Ramsay & Stapledon 2011). In the case of OHS Solutions ‘ predicament it must me analysed if they have breached or about to breach the duty of preventing in solvent trading.

Referring to the case of Salomon v A Salomon & Co Ltd [1897], Mr. Aron Salomon was in the shoe business. Britain enacted a statute providing for the incorporation of businesses. A corporation then had to have at least seven shareholders. Salmon formed a corporation, with all seven shareholders being members of his family. The business of the corporation eventually went under, leaving considerable unpaid debts. The creditors argued in court that the shareholders should be liable for the debts of the corporation, because they were all related to Aron Salomon, and that the corporation was set up a mere sham. The court held in favour of the shareholders, Aron Salomon’s relatives.

The fact that the shareholders were all related to Aron Salomon was irrelevant in determining that the corporation legitimately existed as a separate entity, and thus the individual shareholders were not held liable for the corporation’s debts. This is a very similar case to the OHS predicament because of their pattern of falling into unpaid debits and still bringing on board other advertisers while not being able to pay off their current debts. In the case of Salomon the business was help accountable rather than the individual. An assumption must not be made on just one case. Referring to the case of Gilford Motor Co Ltd v Horne [1933], Mr. EB Horne was formerly a managing director of the Gilford Motor Co Ltd.

His employment contract stipulated (clause 9) not to solicit customers of the company if he were to leave employment of Gilford Motor Co. Mr. Horne was fired, thereafter he set up his own business and undercut Gilford Motor Co’s prices. He received legal advice saying that he was probably acting in breach of contract. So he set up a company, JM Horne ; Co Ltd, in which his wife and a friend called Mr. Howard were the sole shareholders and directors. They took over Horne’s business and continued it. Mr. Horne sent out fliers saying, The company had no such agreement with Gilford Motor about not competing, however Gilford Motor brought an action alleging that the company was used as an instrument of fraud to conceal Mr. Horne’s illegitimate actions.

The English Court of Appeal was satisfied that the company was formed for the purpose of avoiding liability under the agreement, the court noting that while a company usually has its own separate legal identity, if the company “was formed as a device, a stratagem” to allow Horne to evade the conditions of the agreement. Again in a second case were the individual was not held accountable even though a contract may have been possibly breach. In the case of OHS Solutions their concern of breaching their contract with their advertisers because the adverts are not working on the website is only a technological error, which they are seeking expert advice on fixing Trouble Shooters Pty. Ltd. A concern that OHS Solutions should have is the failure to maintain adequate financial statements.

As previously stated before according to section s 588E, “if a company has failed to keep proper accounting records or have improperly disposed of company’s books, there will be a presumption of insolvency (Corporations Act 2001 (Cth) s 588). ” In defense of OHS Solutions they can then refer to section s 588H and use the defense as “absence from management” in their favour due to the fact that their accountant isn’t available and no one was else has the professional expertise to manage their accounting books. Advice that should be given to the director is to find a replacement accountant to manage their books until their presentment accountant returns.

OHS Solutions must also stop taking on board new client until all accounts with current clients are paid off and finally to fix all technological dilemmas on their website. If accused with breach of duty if care through insolvency, Ying as the director may state that she took the necessary steps to prevent insolvency if she follows the previous advice given. Then the corporate veil will not be removed and the organisation will be accountable.