Vol 7 (2010) - Issue 6

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Biting the Hand that Feeds You

Like their counterparts everywhere, Australian company directors are subject to a number of duties and responsibilities.
According to an Australian Government survey in 2008, the duties which cause them least concern are the duty of care and the duty of good faith. However, 67% of them have a medium-to-high concern about their personal liability for 'insolvent trading'.
'Insolvent trading' is the Australian version of fraudulent trading – with a sting. Directors are personally liable for debts that their company incurs while insolvent, unless they can prove that they had reasonable grounds to expect that the company was solvent. Action can be taken against directors by liquidators, creditors and the Australian Securities and Investments Commission. There is no requirement to prove that the directors had any intention to defraud creditors.
Insolvent trading has been credited with producing significant improvements in standards of corporate governance in Australia. This is because Courts have held that, in order to establish that they had reasonable grounds to expect that their company was solvent, directors must demonstrate that they had an understanding of the company's financial position (or had systems in place to ensure that they had the information necessary to have that understanding). In other words, directors cannot escape liability by claiming ignorance of the company's finances.
On the other side of the coin, company directors have repeatedly argued that the insolvent trading regime is too strict. They claim that it forces directors to appoint a liquidator or other external administrator (and thus avoid potential insolvent trading liability) rather than to attempt to put a rescue plan in place for the company.
No matter which side one takes in the debate, it is clear that the threat of insolvent trading liability is a major concern for company directors. It is also a particular source of concern for company creditors.

Shadow directors
It may seem counter-intuitive that creditors should be worried about a statutory provision that makes directors liable for company debts. However, there is one group of creditors which potentially straddles the line between directors and creditors: shadow directors.
The concept of 'shadow director' in well-known in corporate law systems based on the English model. In Australia, it finds statutory expression in the definition of 'director' in the Corporations Act:
'director' of a company or other body means:
(a) a person who:
(i) is appointed to the position of a director; or
(ii) is appointed to the position of an alternate director and is acting in that capacity;
regardless of the name that is given to their position; and
(b) unless the contrary intention appears, a person who is not validly appointed as a director if:
(i) they act in the position of a director; or
(ii) the directors of the company or body are accustomed to act in accordance with the person's instructions or wishes.
Subparagraph (b)(ii) does not apply merely because the directors act on advice given by the person in the proper performance of functions attaching to the person's professional capacity, or the person's business relationship with the directors or the company or body.' (emphasis added)