Insolvent Trading

Insolvent Trading

Introduction

An increasing problem facing many Australian companies in today’s modern society is insolvent trading.  It is therefore essential for all directors of companies to be aware of the law associated with insolvent trading.

As a preliminary, insolvent trading occurs when a company incurs debts when it is insolvent.   For what seems like such a simple statement, the law behind it is quite complex.

The Law

Insolvency and the Corporations Act

Section 95A of the Corporations Act 2001 (Cth) (“Corporations Act”) provides that a company is insolvent if it is not solvent.  A company can only be classed as solvent if it has the ability to pay its debts as and when they become due and payable.

Pursuant to section 588G of the Corporations Act, a director has a duty to prevent insolvent trading by his or her company.  That is, the director must ensure that a company does not incur debts if he/she is aware or has a reasonable belief that their company is insolvent at the time of incurring a debt, or alternatively, that the company will become insolvent as a consequence of incurring the debt.   If a director breaches this duty they are taken to have committed an offence under Section 588G(3) of the Corporations Act.

Directors and the Corporations Act

It must be noted at this juncture that the Corporations Act has a broad definition for a director being:

  1. “A person who:
  2. Is appointed to the position of director; or
  3. Is appointed to the position of an alternate director and is acting in that capacity, regardless of the name of their position.”

It is therefore possible for an individual who is not appointed as a director of a company to be held liable for insolvent trading, for example a shadow director that has control of the company.

Consequences

There are three key consequences a director may face if it is found to be insolvently trading, being civil penalties, compensation proceedings and criminal charges.

Civil penalties

If a director is found to have be committed an offence in breach of section 588G(3) of the Corporations Act , civil penalties can arise against the directors of that company.  This can include monetary penalties of up to $200,000.00.

Compensation proceedings

In situations where a company enters liquidation and there are still debts remaining owing, compensation proceedings can be commenced against the director.  These compensation claims can be made by wholly or partly unsecured creditors, The Australian Securities and Investment Commission (ASIC) and liquidators.

There are a number of factors that must be proven and section 588M of the Corporations Act sets out a time limit of six (6) years from the beginning of the winding up for such action to be taken.

Criminal Charges

Insolvent trading is a criminal offence, and if found guilty, directors may encounter a fine of up to $220,000.00 or imprisonment for up to five (5) years.

In addition to possible criminal charges, directors who are found guilty may also face disqualification.

Defences

There are a number of defences available to directors who are facing liability for breaching Section 588G of the Corporations Act.

Under Section 588H:

“It is a defence if it is proved that, at the time when the debt was incurred, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.

Without limiting the generality of subsection (2), it is a defence if it is proved that, at the time when the debt was incurred, the person:

had reasonable grounds to believe, and did believe:

(i) that a competent and reliable person (the other person) was responsible for providing to the first-mentioned person adequate information about whether the company was solvent; and

(ii) that the other person was fulfilling that responsibility; and

expected, on the basis of information provided to the first-mentioned person by the other person, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.

If the person was a director of the company at the time when the debt was incurred, it is a defence if it is proved that, because of illness or for some other good reason, he or she did not take part at that time in the management of the company.

It is a defence if it is proved that the person took all reasonable steps to prevent the company from incurring the debt.”

When relying on a defence, the onus is always on the director.  If a director is able to adduce evidence to support that he or she had reasons to believe that the company was solvent, it will assist their defence greatly.  Such evidence can include documentation supplied to the director by accountants and/or company advisers.

What should Directors do?

It is crucial for directors to remain informed about the day to day running of the company.  To do this, directors need to ensure that the company keeps updated financial records.  In this way, they will be able to monitor the company’s financial position in terms of income, assets and liabilities and avoid adverse situations developing later on.

If a director finds themselves in a position where the company is suffering financially and is unsure if they have traded insolvency, the first step they must take is to seek professional help and guidance.  JHK Legal are ready, willing and able to assist directors with the directors’ legal needs.

Author: Belinda Emanuel, Lawyer

Published: January 2015

Binding Financial Agreements and Bankruptcy

Introduction

Part VIIA of the Family Law Act 1975 (Cth) (“FLA”) is an extremely important portion of legislation which has had wide reaching impact on Australian families. In particular it provides for four (4) types of financial agreements between married couples:

  1. Before marriage (s 90B of the FLA);
  2. During marriage but before separation (s 90C of the FLA);
  3. During marriage but after separation (s 90C of the FLA); and
  4. After divorce (s 90D of the FLA).

Part VIIIAB of the FLA is equally as important as it provides for three (3) types of financial agreements between de facto couples:

  1. Before a de facto relationship commences (s 90UB of the FLA);
  2. During a de facto relationship (s 90UC of the FLA); and
  3. After a de facto relationship ends (s 90UD of the FLA).

Any agreement entered into before marriage must be made in anticipation of marriage otherwise the agreement has no effect. Further, any agreement entered into whilst in a de facto relationship automatically terminates upon marriage.

Binding Financial Agreements

A binding financial agreement (“BFA”) usually includes the following:

  1. How property and financial resources are dealt with;
  2. Maintenance;
  3. Matters “incidental or ancillary to” the above matters; and
  4. Other matters.

The parties do not require consent or approval from the Court to prepare a BFA. In fact, BFA’s are prepared in order to avoid the Court’s interference into the mutual agreements made between the parties.

However, in order for a BFA to be enforceable, the following requirements must be met (pursuant to s 90G (married couples) of the FLA and section 90UJ (de facto couples) of the FLA):

  1. The agreement must be in writing and signed by both parties;
  2. The parties have signed a statement specifying that they have received independent legal advice from a lawyer in regards to specific matters;
  3. Certification from the lawyers which is attached to the agreement;
  4. The agreement is not to be terminated or set aside; and
  5. A signed copy is given to each of the parties to the agreement.

Provided all the steps are taken above, the Court should not scrutinise the BFA to ensure that it is just and equitable. The Court would only tend to set aside a BFA if there were fundamental flaws with the BFA.

The drafting of BFA’s is now one of the main avenues for claims against lawyers for professional negligence.

Binding Financial Agreements and the Bankruptcy Act 1966 (Cth)

Although BFA’s are binding and exclude the jurisdiction of the Family Court, the transfer of property that takes place under the BFA may be challenged under the provisions of the Bankruptcy Act 1966 (Cth) (“BA”).

Trustees are able to set aside BFA’s entered into under the provisions of the FLA, either between a spouse or de facto couple, pursuant to sections 120 or 121 of the BA.

Section 120 or 121 of the BA permit a trustee to void a transfer of property in circumstances where the transfer was for less than market value consideration or no market value consideration or, in the alternative, there was an intention to defeat creditors. Whilst the onus will be on the trustee to have the transfer set aside, the conclusion can be drawn from all the relevant circumstances and on the balance of probabilities.

Section 120 of the BA – Undervalued transactions

Often a Bankrupt might be inclined to transfer assets to a related party for less than market value before bankruptcy to remove them from ownership and ultimately to avoid creditor realisation. In general, if this occurred within five (5) years before the date of bankruptcy, the transaction may be void against the trustee.

The elements of section 120 of the BA are as follows:

  1. That there has been a transfer of property by a person who later becomes bankrupt;
  2. The transfer took place in the period commencing five years before the commencement of the bankruptcy and ending on the date of the bankruptcy;
  3. The transferee gave no consideration for the transfer; or
  4. The transferee gave consideration of less than market value of the property.

An example of this transaction would be where a debtor sells his or her share in the family house to his or her spouse for $1.00 or “natural love and affection”.

Section 120(3) is a defence to an action under section 120(1) of the BA and provides that a transfer is not void if, in the case of a transfer to a related entity of the transferor the transfer took place more than four (4) years before the commencement of the bankruptcy and the transferee proves that, at the time of the transfer, the transferor was solvent.

Pursuant to section 120(3A) of the BA, the trustee can presume that a transferor was insolvent if books were not kept, unless of course the transferor can effectively rebut this.

There is no obligation to prove intent on the part of the transferor or transferee. It is merely necessary to prove that there was no consideration provided for the transfer or the transfer was of less value than the market value f the property at the time of the transfer.

Section 121 of the BA – Transfers to defeat creditors

A transfer of property by a person who later becomes a bankrupt (“transferor) to another person (“transferee”) is void against the trustee in the transferor’s bankruptcy if:

  1. The Property would probably have become part of the transferor’s estate or would probably have been available to creditors if the property had not been transferred:
  2. The Transferor’s “main purpose” in making the transfer was:

1. To prevent the transferred property from becoming divisible among the transferor’s creditors; or

2. To hinder or delay the process of making property available for division among the transferor’s creditors.

The words “main purpose” invokes an intention which may be necessarily inferred. The transferor’s “main purpose” might be a difficult thing for a trustee to prove or disprove.

The trustee may need to consider that the transferor’s “main purpose” may be to make provision for his or her spouse and/or children and also for the purpose of defeating creditors. The bankrupt would be unlikely to admit that the “main purpose” of the transfer was to defeat creditors. Accordingly, the trustee would need to look at the objective evidence of the surrounding circumstances leading up to the transfer, the alleged genuineness of the separation, solvency and any communications between the transferee and transferor and any professional advisors.

The BA protects transfers where the transferee acted in good faith. Pursuant to section 121(4) of the BA, the transferee may defeat an action to void a transfer if the following can be established:

  1. That the consideration given for the transfer was at least as valuable as the market value of the property;
  2. The transferee did not know and could not reasonably have inferred that the transferor’s main purpose was to defeat creditors; and
  3. The transferee could not have reasonably inferred that, at the time of the transfer, the transferor was, or was about to become insolvent.

Case Law

In Sutherland v Byrne – Smith [2011] FMCA 632, a de facto couple executed a financial agreement and then subsequently purchased a property together. After two years of being in a relationship together, the couple separated and sought to rely on the financial agreement to transfer the share from the male partner to the female partner. After a few months, the male partner filed a debtor’s petition.

The Court examined the contributions to the acquisition of the property and found the transfer (in relation to the male partners’ contribution to the property) void against the trustee pursuant to section 120 of the Act.

Conclusion

It is imperative that legal practitioners advise their clients appropriately when entering into BFA’s of the pitfalls which may arise if the transferring spouse or de factor subsequently becomes bankrupt.

The rules relating to clawing back assets of bankruptcy are complex and detailed advice should be sought in relation to specific circumstances and/or intentions.

JHK Legal has previously acted on behalf of married couples, de facto couples and bankrupts in relation to BFA’s and has previously acted on behalf of trustees in relation to section 120 and 121 of the BA transactions.

If you have any specific questions or require any assistance with any bankruptcy matter you may be involved in, please do not hesitate to contact our office.

Author: Karla Attwells

Published: January 2015