Recent calls for reform of Australia’s insolvent trading laws have garnered judicial support, with Justice Robson of the Victorian Supreme Court strongly criticising the tough burden which is imposed upon company directors. The judicial remarks arose during the case of Locktronic Systems (in liq) v Commissioner of Taxation & Ors, which involved a claim by the Commissioner against the directors of Locktronic under section 588FGA of the Corporations Act 2001 (the Act), to indemnify the Commissioner in respect of payments found to be voidable transactions pursuant to sections 588FE and 588FF of the Act, in this case, insolvent transactions.
Under the Act, a transaction will be an insolvent transaction (and therefore a voidable transaction) if:
- the person was a director of the company at the time the debt was incurred; and
- the company is either insolvent at the time the debt is incurred, or becomes insolvent as a result of incurring the debt, or by incurring a number of debts at the time including the debt in question; and
- at the time, there were reasonable grounds for the director to suspect that the company was insolvent, or would become insolvent by incurring that debt.
There is a contravention of the Act if:
- the director failed to prevent the incurring of the debt; and
- at the time the debt was incurred, the director had reasonable grounds to suspect the company was insolvent; or
- a reasonable person in a position similar to the director would be so aware.
Justice Robson expressly sought to use the Locktronic case as an example of “the difficulties in the present law”, noting that he had found the directors to be “honest men who were seeking to save the company they’d worked so hard to make a success of.” His Honour stated that the present law imposes “a very hard test indeed”, and went on to say:
“The law is not that the directors have a reasonable expectation that the debts would be paid in full, but that the company was solvent and would remain solvent, even if the payment was made, and that is a very difficult burden to satisfy when you’ve got what is expected to be temporary illiquidity, and the consequences appear to me to be not in the interests of creditors.”
Bodies such as the IPA and Insolvency Reconstruction Committee of the Law Council of Australia have previously made submissions to the government urging reform in this area, because the current law is too strict on directors and the practical effect is a significant obstacle to any successful restructuring of a financially distressed company. While the test for insolvency under the Act is deceptively simple, it cannot always be applied in a formulaic fashion to what can often be complex corporate circumstances. In circumstances where directors face severe penalties for trading a company whilst technically “insolvent” under the Act, a formal insolvency arrangement may be prematurely entered by directors as a precaution, and sometimes in circumstances where it may not be in the best interests of the company, its shareholders or creditors. Conversely, directors who continue to trade a company in the midst of a temporary lack of liquidity, on the assumption that the situation is indeed temporary and with the best interests of the company and its stakeholders in mind, may be punished for doing so.
His Honour went on to implore of counsel appearing in the Locktronic case that his remarks be made known to the legislature, suggesting that this case is “a classic case which demonstrates that the flaw needs to be adjusted.”
