Insolvency and directors' duties in Australia: overview
Q&A guide to insolvency and directors' duties in Australia.
The Q&A global guide provides an overview of insolvency from the perspective of companies that are operating within a domestic and/or international group of companies, and considers the various complexities that this can introduce into insolvency procedures. It also has a significant concentration on duties, liabilities, insurance, litigation, and subsequent restrictions imposed on directors of an insolvent company.
To compare answers across multiple jurisdictions, visit the Insolvency and Directors’ Duties Country Q&A tool.
This Q&A is part of the Insolvency and Directors’ Duties Global Guide. For a full list of contents, please visit www.practicallaw.com/internationalinsolvency-guide.
Corporate insolvency proceedings
The most common insolvency proceedings involving a liquidation of an insolvent company's assets are:
A creditors' voluntary liquidation which is, essentially, an out-of-court process (Part 5.5, Corporations Act 2001 ( Cth) ( Corporations Act)).
A court ordered or compulsory liquidation (Part 5.4B, Corporations Act).
In Australia, the terms "liquidation" and "winding-up" are synonymous.
Creditors' voluntary liquidation
In a creditors' voluntary winding-up the appointed liquidator assumes control of the company's affairs, realises its assets and discharges its liabilities in preparation for its dissolution.
Unless the court orders otherwise, once a company is in liquidation, a stay operates to prevent court proceedings against it or execution against its property. That stay does not prevent secured creditors, or landlords or owners of property from exercising their rights.
In a compulsory liquidation, the court orders that the company be wound up. The functions of a court appointed liquidator are similar to those of a liquidator appointed in a creditors' voluntary winding-up, and a similar moratorium applies.
There are two statutory proceedings allowing for a rescue/restructuring of a debtor company's operations and debts:
Administration (Part 5.3A, Corporations Act).
Scheme of arrangement (Part 5.1, Corporations Act).
It is also possible to achieve that objective through a receivership (Part 5.2, Corporations Act).
In an administration, the company comes under the control of the appointed independent insolvency practitioner, the administrator, who has the power to conduct, terminate or sell the business of the company.
In consultation with the company's creditors, it is the administrator's role either to:
Work out a recovery plan for the company (in the form of a deed of company arrangement that is administered by a deed administrator, usually the former administrator); or
Ensure an orderly transition to winding-up (with the object of securing a higher return for creditors than would be the case if the company were forced to engage in a fire sale of its assets).
A moratorium applies while the company is in administration (subject to certain exceptions), preventing actions against the company or its property by creditors, including secured creditors and lessors of property.
A deed of company arrangement, if approved by creditors of the company, can be used as the vehicle for effecting the sale of the company's business or assets, or restructuring the company's debt and equity.
Scheme of arrangement
A scheme of arrangement is a binding, court-approved agreement that varies the rights of a company's creditors (or a class of creditors). In an insolvency context, a scheme can, for example, take the form of a proposal for the release of claims against the insolvent company and/or third parties, in exchange for distributions to creditors or a particular class of creditors.
This statutory mechanism, under section 411 of the Corporations Act:
Enables a company to overcome any impracticality connected with obtaining individual consent from each and every creditor intended to be bound.
Prevents, in appropriate circumstances, minority creditors from frustrating what might otherwise be a beneficial arrangement between the company and its creditors.
A security agreement between the company and its secured creditor usually provides that, on the occurrence of an insolvency event or other event of default, the secured creditor can appoint a receiver or receiver and manager to the company's property.
The receiver's role is to take possession of and sell the secured property, with the objective of recovering the appointing creditor's debt. A receiver and manager has the power to manage the business and usually endeavours to sell it as a going concern. In this way, receivership can be a vehicle for achieving the survival of the company's business.
When the receiver has realised the security, control of the company reverts to its directors. In practice, receivership is often followed by the winding-up of the company.
Creditors' voluntary liquidation
A creditors' voluntary winding-up can be initiated in one of two ways:
If the company is insolvent, it can convene a meeting of shareholders, who then appoint a liquidator (whose first responsibility is to convene a meeting of creditors).
If a company is in administration, the creditors can vote to terminate the administration and appoint a liquidator.
An application to court to wind up a company can be made by various persons, but is most often initiated by a creditor. Typically, such an application is based on the insolvency of the company. This is usually established by the failure of the debtor company to comply with a statutory demand (which is a demand served on the company by a creditor requiring payment of a debt within 21 days of service).
An administrator can be appointed:
By the company if its board resolves that the company is insolvent or likely to become insolvent.
By a liquidator of a company if he thinks that the company is insolvent, or is likely to become insolvent.
By a secured creditor which has an enforceable security interest in the whole, or substantially the whole, of the company's property.
Scheme of arrangement
Part 5.1 of the Corporations Act prescribes a three-stage process for initiating a scheme of arrangement in relation to a company, comprising:
First, an application to the court by the company or any creditor or member of the company (or in the case of a company being wound up, by the liquidator) for leave to summon a meeting or meetings of the company's creditors.
Second, the holding of the meeting(s), during which creditors vote on the scheme.
Third, assuming creditors have voted in favour of the scheme at the meeting(s) of creditors, a second application to the court for its approval of the scheme. This approval, if granted, renders the arrangement binding as between the company and its creditors.
The appointment of a receiver or receiver and manager by the secured creditor is usually made by a deed of appointment supported by an indemnity from the secured creditor in favour of the appointee.
Insolvency of corporate groups
Each company in a corporate group is a separate entity, and will separately appoint, or have appointed to it, an insolvency practitioner. There is no formal legal mechanism for initiating proceedings on a group basis, irrespective of whether the proceedings are out-of-court or court sanctioned. However, once insolvency proceedings have been commenced in respect of individual group companies, "pooling" of those proceedings may be available in certain circumstances. See Questions 10 to 13.
There is no requirement that all companies within an insolvent group must be subject to the same type of insolvency proceedings. However, in practice, it is relatively rare to find that only some companies within a group are placed in external administration. Considerations of commercial reputation generally mean that solvent members of a group will support an insolvent member. Where this does not occur, it is usually because all of the group members are insolvent (or are rendered insolvent by inter-company loans, guarantees and transactions). It follows that all of the members of a group typically enter external administration either at the same time or within a short period of time.
Affiliated companies based in different states within Australia are not required to commence insolvency proceedings in one central location. However, where the insolvency proceedings of affiliated companies are initiated by way of court applications, as a matter of convenience, those applications are typically filed with the same court in the same state.
The same insolvency practitioner can be appointed to all of the companies within a group. However, subject to a pooling determination/order, the assets and liabilities of each company within a group must be administered separately.
For those forms of external administration which are non-curial (creditors' voluntary liquidation, administration and receivership), generally, no court hearing or determination is required to appoint a single insolvency practitioner to multiple companies in a corporate group.
Where an application is made for the compulsory winding-up of multiple companies in a corporate group, the court will consider whether the appointment of a single insolvency practitioner to all those companies is appropriate, having regard to any potential conflict of interest.
In a scheme of arrangement, the Corporations Act prohibits an officer of the company or of a related company from being appointed as a scheme administrator for the company, unless the court grants leave, or the Australian Securities and Investments Commission (ASIC), being the relevant regulator, confirms an exemption permitting a particular appointment. Since a liquidator is, by definition, an officer of a company, where a liquidator of multiple companies in a group is seeking to be appointed as the administrator of a scheme of arrangement in relation to the group companies, he requires leave from the court or exemption by ASIC.
Where the appointment of a liquidator or a scheme administrator is the subject of a court application, notice to creditors is not required. However, insolvency practitioners may provide this notice as a matter of good practice, and creditors or other interested parties may seek leave to be heard.
The requirement to administer each insolvent company separately can sometimes place the insolvency practitioner in a position of conflict, where it emerges during the course of the external administration that the interests of one company in the group conflict with the interests of another. Where the conflict is restricted to a discrete matter, the court can appoint a "special purpose" or "conflict" external administrator to manage that matter. However, it is more common for the practitioner or a person with a real interest in the insolvency proceedings (for example, a creditor) to obtain a court order removing the practitioner from the position of conflict and appointing an independent replacement to one of the companies in the group.
If one insolvency practitioner is appointed to all members of the group and there is no conflict of interest, there is nothing to prevent a professional firm providing services to all members in the group. If a conflict exists and an independent external administrator is appointed, he will obtain separate and independent advice.
In certain exceptional circumstances, conflicts of interest can be managed by one insolvency practitioner obtaining advice from separate firms, together with an application to the court for approval of the proposed course of action.
The transfer of assets between companies within a group is generally governed by the same rules that govern any corporate transaction. The Corporations Act does not recognise a group of companies as having any separate existence from the individual companies in the group (with a few exceptions, for example financial reporting).
There are two sets of principles that govern intra-group transfers and transactions that occur before the commencement of external administration:
The duties of directors.
The "claw-back" rules.
Duties of directors
Directors owe their primary duty to their company, not to the group. In general, their duties as directors prevent them from entering into a transaction unless they reasonably believe that the transaction is in the company's best interests. Therefore, it would be a breach of duty for the directors of a solvent member of a group to transfer its assets to an insolvent member, unless the directors of the solvent company reasonably believed that the transfer was in the best interests of the solvent company.
It would not be sufficient for the directors simply to believe that the transfer was in the best interests of the group, unless they also believed that their own company's interests coincided with or were dependent on the interests of the group.
There is a specific statutory provision which, subject to the company's constitution, allows directors of a wholly owned subsidiary to act in the best interests of the holding company (section 187, Corporations Act). However, this is extremely limited as it does not apply where the subsidiary is insolvent or becomes insolvent because of its directors' actions.
If a company is being liquidated, certain transfers of company property in the "relation back" period leading up to the commencement of the winding-up (often referred to as voidable transactions) can be recovered by the liquidator on behalf of the company from the transferee (Part 5.7B, Corporations Act). The "relation back" period varies depending on the type of transaction.
The principles and rules governing voidable transactions do not generally take account of whether the transferee and the transferor are members of the same group.
Voidable transactions would include uncommercial transactions that were entered into when the company was insolvent. An uncommercial transaction is one which a reasonable person (in the company's position) would not have entered into, having regard to any relevant matter, including the transaction's (section 588FB( 1), Corporations Act):
Benefits (if any) to the company.
Detriment to the company.
Benefits to other parties.
The relation back period for an uncommercial transaction that was entered into when the company was insolvent is two years (section 588FE( 3), Corporations Act).
Where the transaction was entered into with a related company, the relation back period is four years (section 588FE( 4), Corporations Act).
Companies are related if either (section 50, Corporations Act):
They are subsidiaries of the same holding company; or
One is a subsidiary of the other.
There is a statutory defence to a claw-back action, elements of which are that the transferee acted in good faith and had no reasonable grounds to suspect that the transferor company was insolvent (section 588FG, Corporations Act). Where the transferor and transferee are members of the same corporate group, it is likely that the transferee would have difficulty in establishing this defence.
The Corporations Act does not generally attribute any separate legal identity or recognition to a group, as distinct from its corporate members. As a result, claims by one group company against another rank equally with claims by any third-party creditor. One example of an exception to this general rule is that, where the outcome of voting at a key creditors' meeting was determined by the vote of one or more related creditors, and the passing of, or failure to pass, the relevant resolution was contrary to the interest of creditors as a whole, then the court may make orders setting aside the resolution (section 600A, Corporations Act).
If a related creditor holds security, it ranks above unsecured creditors (provided the security itself is not susceptible to a claw-back action by the liquidator). As a matter of practice, intra-group transactions are usually subject to a high level of scrutiny by insolvency practitioners.
The Corporations Act does allow voluntary subordination of debts (see, for example, section 563C of the Corporations Act, which applies in a liquidation). Debt subordination is also common in administrations where creditors related to the insolvent company agree to postpone their claims if unrelated creditors agree to a restructure (contained in a deed of company arrangement).
There are statutory provisions that specifically allow for the pooling of the assets and liabilities of the members of a corporate group if the member companies are in liquidation (Part 5.6, Division 8, Corporations Act). Pooling can be achieved in one of two ways:
The procedure for voluntary pooling requires the liquidator(s) of the companies to make a pooling determination, which becomes operative if approved by the requisite majority (75% by value and 50% by number) of the unsecured creditors of each company.
A dissenting creditor can challenge the pooling in court on a variety of grounds, including asserting that:
Material information provided to creditors in advance of the vote was misleading.
The pooling determination would materially disadvantage the applicant creditor.
An alternative method of achieving pooling is for the liquidator to bypass the creditors and apply to the court for a pooling order on the basis that the order is just and equitable. In determining whether the order is just and equitable, the court must consider a number of specified matters, including the extent to which creditors of any of the companies in the group may be advantaged or disadvantaged by the making of the order.
Where the companies in a group are in administration, the creditors can enter into a pooling arrangement by agreeing to a deed of company arrangement to that effect. The administrator can also seek the comfort of a court order (for extra caution) (section 447A, Corporations Act).
Scheme of arrangement
Subject to the court granting approval under section 413 of the Corporations Act, a scheme of arrangement may provide for the transfer of one company's property and liabilities to another company. Typically, this involves one or more subsidiaries transferring their property and liabilities to the holding company.
Where there are a significant number of subsidiaries and a proposed scheme of arrangement provides for the transfer by each subsidiary of all of its property and liabilities to the holding company, the court can order that the meetings of creditors (of the holding company and of the subsidiaries) be held on a consolidated basis, so as to facilitate the timely and effective consideration by creditors of the scheme (sections 411(1A) and 411(1B), Corporations Act).
See Question 10.
Partial pooling is permitted under the Corporations Act. In Walker, in the matter of ZYX Learning Centres Limited (formerly A.B.C. Learning Centres Limited) (Receivers and Managers Appointed) (in Liq)  FCA 146, the liquidators sought, and the court made, a pooling order under section 579E of the Corporations Act in respect of two group companies out of a group of 39.
In a voluntary pooling of group companies in liquidation, the liquidator can, under section 571 of the Corporations Act, modify one or more prescribed provisions of a pooling determination, provided that the liquidator considers the modification to be just and equitable as between the various creditors of the group companies. For example, the liquidator can achieve partial pooling by excluding one or more group companies from the application of subsection 571(2)(a) of the Corporations Act, which provides that each company in the pooled group is taken to be jointly and severally liable for each debt payable by, and each claim against, each other company in the group.
Similarly, when making a pooling order, the court can, among other things, make ancillary orders under section 579G of the Corporations Act:
Exempting specific debts from the pooling order.
Transferring specific property from one company in the group to another.
Modifying the application of the Corporations Act in relation to the winding-up of the companies in the group.
Such ancillary orders can only be made if the court is of the opinion that it is just and equitable to do so.
In relation to group companies that are subject to administration, partial pooling can be achieved by way of deeds of company arrangement to that effect.
Scheme of arrangement
Partial pooling can also be achieved by way of a scheme of arrangement and an order under section 413 of the Corporations Act, permitting the transfer of the whole or any part of the property or liabilities of a company to another company. There is no requirement that an order under section 413 must apply to all of the companies in a group.
The position of secured creditors is (in theory) unaffected by pooling, because the secured creditor should be able to identify specific secured property to which it can have recourse. Any pooling of assets would not remove the secured creditor's security over the property.
Where a deed of company arrangement provides for pooling (and, in doing so, purports to affect secured property), a secured creditor is not bound by the deed unless:
It has voted in favour of the deed at the relevant meeting of creditors; or
The court makes an order under section 444F of the Corporations Act limiting the secured creditor's rights to deal with its security interest.
The court can only make such an order if it is satisfied that both:
Permitting the secured creditor to deal with its security interest would have a material adverse effect on achieving the purposes of the deed of company arrangement.
The interests of the secured creditor are adequately protected.
A secured creditor of one company cannot generally enforce its security interest against the property of another company within the group.
If a creditor has security over the assets of one member of a group and has a guarantee of the same debt from another member of the group, both the security and the guarantee are valid and, subject to restrictions on enforcement (such as the stay on enforcement actions against a company during its administration), can be separately pursued in the insolvency proceeding of the relevant company. For example, if the property of the first company is insufficient to discharge the liability, the secured creditor can prove in the winding-up of the guarantor company for the balance.
Insolvency proceedings for international corporate groups
UNCITRAL Model Law on Cross-Border Insolvency 1997 (UNCITRAL Model Insolvency Law)
Australia has adopted the UNCITRAL Model Insolvency Law through the Cross-Border Insolvency Act 2008 (Cth) (effective 1 July 2008). The UNCITRAL Model Insolvency Law does not apply to a receivership or a winding-up by the court on grounds other than insolvency. It also does not cover authorised deposit-taking institutions (that is, bodies corporate licensed by the relevant Australian regulator to carry on banking business in Australia), general insurers or life insurers (each of which has a particular insolvency regime that applies to them).
Under the UNCITRAL Model Insolvency Law, the Australian court can recognise:
A foreign proceeding that was commenced in the country in which the debtor has its centre of main interests (foreign main proceeding). Any Australian proceeding against the debtor or execution against the debtor's assets is then immediately stayed, third parties' rights to deal with the debtor's assets are immediately suspended, and the court may make further ancillary orders for the protection of the company's property in Australia.
A foreign proceeding that was commenced in a country where the debtor does not have its centre of main interests (foreign non-main proceeding). The court can then make orders staying any Australian proceeding and/or execution against the debtor or affecting the right to deal with the debtor's assets.
Once the Australian court has recognised a foreign main proceeding or a foreign non-main proceeding, the foreign representative can take advantage of certain remedies available under Australia's insolvency regime, such as the ability of a liquidator to initiate proceedings in Australia under Part 5.7B of the Corporations Act, including actions dealing with "claw-backs" (see Question 8).
Before the introduction of the UNCITRAL Model Insolvency Law, the Corporations Act contained three (limited) procedures for dealing with cross-border insolvency issues. Those procedures remain available. In summary, they provide for:
The winding-up of foreign companies that are either registered in Australia or, if not registered, carrying on business in Australia (Part 5.7, Corporations Act).
Ancillary liquidations of registered foreign companies (section 601CL, Corporations Act).
A procedure under which Australian courts can render assistance when requested by foreign insolvency courts (Part 5.6, Division 9, Corporations Act).
Winding-up under Part 5.7. Jurisdiction to wind up a foreign company in Australia under Part 5.7 of the Corporations Act depends on that company's classification not only as a foreign company but also as a "Part 5.7 body" (see below). A foreign company (which is defined as including a body corporate incorporated outside Australia) is also a "Part 5.7 body" if it is either:
Registered with ASIC under Division 2 of Part 5B.2; or
Not registered with ASIC, but carries on business in Australia.
Section 583(c) of the Corporations Act specifies the circumstances in which a foreign company (that is a Part 5.7 body) can be wound up. This includes the company's dissolution, deregistration, ceasing to carry on business in Australia and inability to pay its debts. The most common is the company's inability to pay its debts, including circumstances where there is a failure to comply with a statutory demand or the unsatisfied return of execution or other enforcement of an Australian or foreign judgment (section 585, Corporations Act).
The Australian court has jurisdiction even if the foreign company (which satisfies the Part 5.7 criteria) is being wound up, or has been dissolved, deregistered or has otherwise ceased to exist under the laws of its country of incorporation (section 582(3), Corporations Act).
In addition to the statutory requirements, the making of a winding-up order under Part 5.7 may also depend on other discretionary considerations. The presence of local assets, or creditors within the jurisdiction who would benefit, are of significance to the determination of a winding-up application under Part 5.7.
The Part 5.7 mechanism establishes a separate insolvency administration in Australia. It does not give recognition to any foreign insolvency proceeding. It provides for a local winding-up to be undertaken in accordance with Australian insolvency law, with any adaptations as are necessary. Part 5.7 does not enable the placement of Part 5.7 bodies into other forms of external administration, such as creditors' voluntary winding-up or administration.
In the event of an inconsistency between the UNCITRAL Model Insolvency Law and Part 5.7 of the Corporations Act, the UNCITRAL Model Insolvency Law prevails.
Ancillary liquidation of foreign registered company under section 601CL. If a registered foreign company is wound up, dissolved or deregistered in its place of origin, the local agent must lodge a notice with the Australian Securities and Investment Commission (ASIC). Subsequently, the court must, on application of the foreign liquidator, appoint an Australian liquidator to the company.
The Australian liquidator of the foreign company must:
Invite Australian creditors to make claims, before making any distribution of the foreign company's property.
Remit the net amount of property realised and recovered in Australia to the principal liquidator overseas (subject to any order to the contrary).
Unless the court orders otherwise, the Australian liquidator must not pay out a creditor of the foreign company to the exclusion of another creditor of the company. Therefore, local and foreign creditors are generally entitled to share in the proceeds from the winding-up pari passu.
The UNCITRAL Model Insolvency Law is in addition to, and not in derogation of, section 601CL.
Co-operation between Australian and foreign courts. Division 9 of Part 5.6 of the Corporations Act contains the original statutory scheme for co-operation between Australian and foreign courts in "external administration matters" (see below). The UNCITRAL Model Insolvency Law prevails if there is an inconsistency between the original statutory scheme and the UNCITRAL Model Insolvency Law.
An "external administration matter" means a matter relating to the:
Local winding-up of a company or Part 5.7 body.
Winding-up, outside Australia, of a body corporate or a Part 5.7 body.
Insolvency of a body corporate or a Part 5.7 body.
Under section 581(2) of the Corporations Act, an Australian court must act in aid of, and auxiliary to, the courts of prescribed countries that have jurisdiction in external administration matters. However, it retains discretion regarding the nature and extent of the aid to be given. Prescribed countries include the UK, the US, Malaysia, Singapore, Switzerland, Canada, New Zealand, Papua New Guinea and Jersey (Corporations Regulations 2001 (Cth), regulation 5.6.74). In the case of requests from the appropriate courts of other countries, the Australian court has discretion whether to assist and as to the nature and extent of the aid.
A request for assistance is usually in the form of a letter of request from the foreign court. Where the Australian court is required or elects to assist, it can exercise the powers it would have had if the matter had arisen in its own jurisdiction (section 581(3), Corporations Act).
Section 581(4) of the Corporations Act is the reciprocal provision which permits the Australian court to request assistance from a foreign court with jurisdiction in external administration matters. In considering the issuance of a request, an Australian court examines whether there is a good substantive reason for the request and the utility in issuing the request (in addition to whether it is in respect of an "external administration matter").
Section 581(4) can also be invoked in the context of an administration if orders of an Australian court are made which attract the need for the foreign court to act in aid of, and auxiliary to, the Australian court.
See Question 15.
Overseas property is commonly regarded as contemplated by an Australian liquidation. This is despite the fact that section 9 of the Corporations Act does not specifically mention overseas property. However, the availability of overseas property can be restricted by specific provisions of the Corporations Act and those principles of Australian private international law that require the Australian court to defer to the laws and the courts of the jurisdiction where the property is located.
The first consideration as to whether the court will attempt to exercise jurisdiction over foreign assets is whether the assets are comprised of movable or immovable property. Title to immovable property is governed by the lex situs (that is, the laws of the jurisdiction where the relevant asset is situated). Therefore, it is up to an Australian liquidator to apply for an order from the foreign court to deal with title to immovable property or the proceeds of its sale.
Movable overseas property of a company filing domestically is normally treated by the court as being under the control of the Australian liquidator. However, if third party rights over those assets have already been created under the lex situs (such as foreign securities), the liquidator can take subject to those rights.
In the context of a winding-up, whether an Australian court will enforce a foreign court order attempting to exercise jurisdiction over local assets depends on:
The application of the provisions of the UNCITRAL Model Insolvency Law.
The application of the aid and auxiliary provisions in section 581 of the Corporations Act or, alternatively, the existence of an ancillary liquidation either under Part 5.7 or section 601CL of the Corporations Act.
The jurisdiction of the Australian court to order the requested remedy.
Local laws affecting creditors' rights,
See Question 15.
The Australian courts may recognise either:
The administration of a company in a foreign jurisdiction as a "foreign proceeding" under the UNCITRAL Model Insolvency Law; or
The appointment of the overseas administrator, under the aid and auxiliary provisions in section 581 of the Corporations Act.
The effect of recognition is to enable the overseas administrator to exercise powers over the company's assets in Australia.
Although recognition and relief under the UNCITRAL Model Insolvency Law are not available to an overseas receiver, the Australian courts can nevertheless recognise the appointment of an overseas receiver under section 581(2) of the Corporations Act, if both:
There is a sufficient connection between the company in receivership and the jurisdiction in which the receiver is appointed.
The relevant charge is valid and enforceable under Australian law as well as the laws where the debtor company was incorporated.
See Question 15, Other procedures: Co-operation between Australian and foreign courts.
The Federal Court of Australia and the Supreme Court of New South Wales have issued practice notes encouraging parties to consider the Guidelines Applicable to Court-To-Court Communications in Cross-Border Cases as adopted and promulgated by the American Law Institute and the International Insolvency Institute, when developing the framework or protocol for co-operation with a foreign court or foreign representative.
A company must have its own board. This does not mean that the board of each company in a group cannot be composed of the same individuals. However, each board must function separately in relation to each company. The law generally prohibits the board of a company within a group from preferring the interests of the group ahead of the interests of the company.
There is no legal requirement that each company within a group must have a separate management team, and it is quite common for companies within a group to share management teams.
A person (an individual or a company, including a parent company) that is not validly appointed as a director can be subject to the same duties as a formally appointed director (see Question 22), including, for example, the duty to prevent insolvent trading, if (section 9, Corporations Act):
The person acts in the position of a director; or
The board of the company (or the governing majority of directors) is accustomed to acting in accordance with the person's instructions or wishes.
Such a person is commonly known as a "de facto" director or a "shadow director".
The duties of directors in Australia are governed by both the Corporations Act and common law.
The main provisions governing the duties of directors and other officers are contained in Part 2D.1 Division 1 of the Corporations Act. There are two fundamental concepts underlying these provisions and the duties of directors at common law:
The duty is owed to the company (as a legal entity) rather than to individual shareholders.
There is no actionable duty owed to creditors (collectively or individually).
The key duties of directors and other officers include, but are not limited to the:
Duty to exercise reasonable care and diligence.
Duty to act in good faith in the best interests of the company and for a proper purpose.
Duty to not improperly use their position, or information obtained by virtue of their position, to gain an advantage for themselves or someone else or to cause detriment to the company.
Duty to prevent insolvent trading (for directors only).
The duties and responsibilities outlined above apply whether the company is solvent or insolvent.
When the company is insolvent or nearing insolvency, directors and officers must have regard to the interests of the company's creditors when discharging their duties to the company. However, the requirement does not give rise to an actionable duty owed to creditors.
In addition, directors also become subject to a positive duty to prevent insolvent trading (section 588G, Corporations Act).
Directors (and other officers) owe their duties to the company to which they are appointed and not to any other company in the corporate group (at least where the group companies have independent boards). Where a director is on the board of more than one company in a corporate group, he can be required to abstain from voting on certain matters or even resign from his position if an irreconcilable conflict of interest arises between the two group companies.
Special provisions are made for the directors of a wholly-owned subsidiary, allowing them to act in good faith in the best interests of the holding company (instead of the subsidiary), provided that both (section 187, Corporations Act):
The constitution of the subsidiary expressly authorises the directors to act in the best interests of the holding company.
The subsidiary is not insolvent at the time and does not become insolvent because of the directors' act.
Examples of conduct that may be in breach of the duties and responsibilities of officers and directors include:
Failure to take reasonable steps to minimise losses to creditors. This is potentially a breach of the duty to act in the best interests of the company, particularly if the company is insolvent or is nearing insolvency. It may also contravene the duty to prevent insolvent trading.
Misappropriation of corporate assets. This would constitute a breach of the directors'/officers' duties to the company (whether the company was solvent or insolvent at the time).
Undervaluation of corporate assets in a preference or other transaction to the detriment of creditors. By allowing or causing the company to enter into such transactions, directors/officers may breach their duty to exercise reasonable care and diligence and their duty to act in the best interests of the company. In addition, such transactions are likely to constitute "uncommercial transactions", which are considered "debts incurred" for the purposes of the insolvent trading provisions and, if entered into while the company is insolvent, would amount to a breach of the director's duty to prevent insolvent trading.
Failure to inform creditors of insolvency. This failure could constitute a breach of the duty to exercise reasonable care and diligence, particularly if it exposes the company to the risk of being sued for misleading or deceptive conduct. For public companies listed on the Australian Stock Exchange (ASX), ASX Listing Rule 3.1 requires companies to immediately disclose to the market any information likely to have to have a material effect on their share price (which would certainly include information about the company's insolvency). A failure to disclose would amount to a breach of the rule and also a breach of section 674(2) of the Corporations Act. An individual who is involved in a listed company's contravention of section 674(2) of the Corporations Act (including directors of the company) will also contravene the section.
Preferring payment to one creditor as opposed to another when insufficient monies are available to pay both. Such a preferential payment could potentially be a breach of the duty to act in the best interests of the company if that payment is made at a time when the company is insolvent or is nearing insolvency.
Continuing to trade when there is little prospect of being able to pay when due. This is likely to amount to a failure on the part of a director to prevent insolvent trading, if the company subsequently goes into liquidation.
If a director or an officer of a company contravenes particular statutory duties (described as civil penalty provisions), the Australian Securities and Investments Commission (ASIC) can apply to the court for a declaration of contravention, a pecuniary penalty order or a compensation order against the director/officer personally (section 1317J(1), Corporations Act). The company itself can also apply to the court for a compensation order (whether or not a declaration of contravention has been made). If, on application by ASIC, a declaration of contravention is made, the court can order the director/officer to pay the Commonwealth Government a pecuniary penalty of up to A$200,000. In addition, the court can order that the director/officer compensate the company for the damage it has suffered.
The company itself can sue a director or an officer for damages in respect of his breach of duty. After the company is placed in liquidation, the liquidator can bring a similar claim on behalf of the company.
The Director of Public Prosecutions can commence criminal proceedings against the director/officer in relation to a contravention of a relevant statutory duty that is committed with dishonest intent. The maximum penalty for the offences varies. A criminal contravention of section 184 (duty of good faith and proper purpose) or section 588G (duty to prevent insolvent trading) can attract a fine of up to AU$360,000 and/or imprisonment for up to five years.
The existence of potential personally liability for debts incurred by a company while insolvent will inevitably be a consideration taken into account by directors when deciding whether to put the company into external administration.
Although section 95A of the Corporations Act expressly provides that a company is solvent if and only if it is able to pay all its debts as and when they become due and payable, and a company which is not solvent is insolvent, there remains a lack of precision under case law regarding the application of that statutory test. As a matter of practice, it is often difficult to determine when a company is solvent and when it becomes insolvent. In such circumstances, directors may prefer to avoid the issue altogether, by appointing an administrator to the company before it becomes clearly insolvent.
It is not uncommon for Australian companies to indemnify and insure their directors and officers against personal liability. However, a company's ability to grant indemnity or take out indemnity or insurance policies is subject to certain statutory restrictions.
A company is specifically prohibited from indemnifying its directors and officers for certain liabilities (section 199A( 2), Corporations Act) including liability:
Owed to the company or a related body corporate.
For a pecuniary penalty order or a compensation order.
Owed to a third party that did not arise out of conduct in good faith.
A company cannot indemnify its directors and officers for civil or criminal liabilities resulting from breaches of the following duties associated with the operation of a financially distressed company:
The obligation to consider the interests of creditors when the company approaches insolvency.
The (directors') duty to prevent insolvent trading.
Companies are prohibited from paying, or agreeing to pay, a premium for a contract insuring a director/officer of the company against a liability arising out of:
A wilful breach of duty in relation to the company.
Improper use of position or information by the director/officer.
The company can pay the premium on an insurance policy taken out to cover other liabilities of directors and officers. The amount of premium payable on the policy is determined on a case-by-case basis and depends on the type of business operated by the company, the amount of cover purchased and the level of risk involved.
As a general rule, there is nothing to prevent a director or officer from resigning his position. However, the director's positive duty to prevent insolvent trading (if interpreted broadly) may arguably require him to take "all steps practicable" before resigning. This is to prevent the company from incurring debts while insolvent, even if that means putting the company into external administration.
When a company is placed into liquidation, the liquidator takes possession of the company's books, and can subject directors and officers to compulsory examinations under court supervision. The information taken from the company's books and examinations can be used as the basis for civil court proceedings against the directors and officers for insolvent trading as well as other breaches of duty. This is a means by which the liquidator may recover compensation for losses suffered by the company.
The fact that a liquidator identifies a viable cause of action against an officer or director does not mean that court proceedings are inevitable. It is often the case that the liquidator simply does not have sufficient funds to begin court proceedings. In that case, a liquidator may ask a professional litigation funder to fund the proceedings or invite creditors to contribute to the cost of the proceedings.
Creditors (whether individually or collectively) generally have no standing to bring actions against directors of an insolvent company, unless there are special dealings between them and the directors directly. The ability to bring such actions resides with the liquidator. However, individual creditors may provide funding to the liquidator to commence such proceedings, and subsequently seek an order from the court permitting the liquidator to make priority payments to those funding creditors from any judgment sum or settlement proceeds recovered as a result of the proceedings (section 564, Corporation Act).
Proof of good faith on the part of a director/officer is generally an effective defence against criminal liability in respect of any contravention of his statutory duties. This is because the establishment of criminal liability always requires the proof of dishonest intent.
Good faith is also an element in most of the major defences against civil claims, including:
The defence available to directors of wholly-owned subsidiaries under section 187 of the Corporations Act.
The "business judgement rule" defence that exempts directors from liability for a breach of their duty to exercise care and diligence.
Invocation of the court's discretionary power under sections 1317S and 1318 of the Corporations Act to grant relief from civil liability for contravening a statutory duty or for negligence, default or breach of trust.
However, good faith itself is not a defence against civil liability for insolvent trading.
There is no general due diligence defence under the Corporations Act or the common law that applies across all breaches of duty. However, due diligence is one of the elements in the statutory "business judgement rule" defence (see above).
A director has a statutory defence against insolvent trading liability if he had reasonable grounds to expect and did expect that the company was solvent at the time the debt was incurred. Almost inevitably, this would require the director to carry out some form of due diligence to determine the company's financial position.
Reliance on outside consultants or professionals
In the context of determining whether a director has performed his statutory duties, and where the reasonableness of his reliance on information comes into question, section 189 of the Corporations Act provides that a director's reliance on information or advice provided by professional advisers is reasonable if made in good faith and after independent assessment of the information or advice. In practice, this statutory presumption is of very limited scope, and does not assist directors to avoid liability for breach of any of their statutory duties, except for the duty of reasonable care and diligence.
Section 588H(3) of the Corporations Act gives a director a defence for insolvent trading if:
He believed on reasonable grounds that a competent and reliable person (including a professional advisor) was responsible for, and was in fact, monitoring the company's solvency position.
Based on the information provided by the adviser, the director expected that the company was solvent at the time of and immediately after the relevant debt was incurred.
Exercise of reasonable judgement
The "business judgement rule" defence is built on reasonable judgements of directors/officers, but applies only to a breach of their duty to exercise care and diligence.
Intent to preserve "ongoing value" of enterprise
Section 588H of the Corporations Act provides for the following four defences against insolvent trading:
Reasonable grounds to expect solvency.
Reasonable reliance on information provided by others with respect to the company's solvency.
Absence from management because of illness or for some other good reason.
Taking reasonable steps to prevent the incurrence of debt.
None of the defences exonerates a director from civil liability on the basis of his intent and motivation for allowing the company to incur a debt. However, a director's intent to preserve the going concern value of the enterprise or to otherwise protect the interests of creditors and his exercise of reasonable judgement are factors that the court may consider when deciding whether to relieve the director from liability under section 1317S(2) of the Corporations Act. The court can relieve a director from civil liability if the director has acted honestly, and having regard to all the circumstances of the case, he should fairly be excused for the contravention.
Intent on the part of an officer or a director to protect the going concern value of the company for the benefit of creditors can assist him in establishing the good faith element in the defences described in Question 30. However, good faith and the good intentions of a director to protect the interests of creditors are not in themselves defences against civil liability for insolvent trading.
Such intentions, combined with the fact that creditors actually benefited from the director's decision to continue operations, are factors that the court can take into account when deciding whether to relieve the director of liability under section 1317S(2) of the Corporations Act.
In circumstances where it appears that the going concern values of a company will result in a higher return to creditors than a liquidation of its assets, one option open to the directors is to place the company into administration and allow the administrator (if he sees fit) to continue to run the company's business and sell it on a going-concern basis.
An officer/director of a company is not automatically disqualified from acting as an officer/director of another company simply because the first company became insolvent or was placed into external administration. However, if he has been an officer/director of two or more companies that have failed within a period of seven years, under section 206D(1) of the Corporations Act and on application by Australian Securities and Investments Commission, the court can disqualify him from managing a company for up to 20 years. This is only if the court is satisfied that both:
The way the companies were managed was wholly or partly responsible for the companies failing.
The disqualification is justified.
A person is automatically disqualified from managing a company if he either:
Becomes an undischarged bankrupt; or
Has executed a personal insolvency agreement (the terms of which have not been fully satisfied).
Once disqualified, a person ceases to be a director, alternate director or a secretary of his current company.
In addition, the director is prohibited from managing any company while he remains an undischarged bankrupt or while full compliance with the personal insolvency agreement remains outstanding.
Australasian Legal Information Institute (AustLII)
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Karen O'Flynn, National Practice Group Leader, Restructuring & Insolvency
Professional qualifications. New South Wales, Australia, 1984; High Court of Australia, 1984; Victoria, Australia, 1986; England and Wales, 1991
Areas of practice. Restructuring & insolvency; commercial litigation.
Non-professional qualifications. Bachelor of Arts, University of Sydney, 1981; Bachelor of Laws (Hons), University of Sydney, 1983
- Advising the liquidators of the Australian Lehman Brothers companies which, prior to their collapse, formed part of the fourth largest financial institution in the world.
- Advising the foreign representatives of an insolvent European bank on their successful application for recognition under the Cross Border Insolvency Act.
- Advising the acting trustee of five superannuation funds, with A$300 million under management, appointed by the Australian Prudential Regulation Authority.
- Over a period of seven years, advised the liquidators of the HIH Insurance Group (HIH) in complex and high-profile recovery actions against auditors, actuaries, directors and others. HIH collapsed with a deficiency estimated between A$5 to A$7 billion.
- Advising the Securities Exchanges Guarantee Corporation in relation to the liquidation of BBY Limited (one of the largest stock broking firms in Australian, prior to its collapse) and claims made by clients of BBY Limited against the National Guarantee Fund.
- Acted for the administrators of Pumpkin Patch Originals Limited (a New Zealand company) in relation to a successful application for UNCITRAL Model Insolvency Law recognition in Australia.
Professional associations/memberships. Australian Restructuring Insolvency and Turnaround Association; International Insolvency Institute; International Bar Association (Insolvency Section); INSOL International.
Publications. Co-editor of Oxford University Press, "Financing Company Group Restructurings".
Flora Innes, Senior Associate, Restructuring & Insolvency
Professional qualifications. New South Wales, Australia, 2011; High Court of Australia, 2011
Areas of practice. Restructuring & insolvency; commercial litigation.
Non-professional qualifications. Bachelor of International Studies, University of Sydney, 2008; Bachelor of Laws (Hons), University of Sydney, 2010
- Advising the liquidators of the Australian Lehman Brothers companies.
- Advising the Securities Exchanges Guarantee Corporation in relation to the liquidation of BBY Limited and claims against the National Guarantee Fund.
- Advising the administrators of Pumpkin Patch Originals Limited.
- Advising the administrators of Hughes Drilling Limited and its subsidiaries.
Languages. English, Chinese (Mandarin and Cantonese)
Professional associations/memberships. Australian Restructuring Insolvency and Turnaround Association.