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Key Legal Provisions for Creditors

There is always a risk element for lenders, financial institutions and creditors of companies. It is important to have some knowledge of the law relating to insolvency as the failure of a company will result in creditors receiving less than 100 cents in the dollar in the vast majority of cases.

We have mentioned below some of the more important sections of the Corporations Act:

Section 95 (A) (1)- Defines insolvency as the inability to pay debts as and when they fall due.

Section 588G- A director may incur civil and criminal liability for debts incurred during trading when there are reasonable grounds for suspecting that the company is or may become insolvent.

Section 588V- If a subsidiary should incur a debt when there are reasonable grounds for the directors of the holding company to suspect that the company is insolvent, then the holding company may be liable for a compensation claim made by the liquidator of the subsidiary.

Section 60 – An adviser to a company may be defined as a director. Whilst it is the duty of a director to prevent a company from trading whilst insolvent, the definition of director may be extended to advisers. Anyone who instructs or directs the directors on a day-to-day basis may be defined as being actively involved in the direction of the corporation and may incur a personal liability for the company’s debts. This possibly may extend to bankers if they are actively involved in rehabilitating a company. Care should be taken by lenders not to involve themselves in directors decisions.

Duty of care- It is now a generally accepted principle that where a company is insolvent, its directors owe a duty to the company not to prejudice the interests of its creditors in the exercise of their powers. Where a third party takes the benefit of a transaction with the company, knowing that it has been effected by directors of the company in breach of their duty, that benefit may be clawed back. This may well apply to transactions involving banks obtaining security in respect of a past debt or obtaining a guarantee from a technically insolvent company.

Section 588FJ – Floating Charges- This section seeks to prevent companies from creating a floating charge to secure past debt in the dying days of its business. With certain exceptions, including if new funds are advanced to a company, this section provides that a floating charge created in the six months prior to winding up can be made invalid by a liquidator. It is of utmost importance that floating charges are registered in accordance with the Corporations Act.

Section 588E – Inadequate Books and Records- Companies are required to keep accounting records in accordance with section 289 of the Corporations Act. If the company is wound up and it is found that the company didn’t keep proper records, it is then deemed to be insolvent throughout the period it did not keep proper records. It follows that if proper accounting records are not maintained, directors can hardly form a view as to a company’s current or future position, and likely would have no defence to claims that the company traded while insolvent.

Section 222AGA of the Income Tax Assessment Act- This section allows the Commissioner of Taxation to issue notices on directors of the company, whereby they will automatically become personally liable for any unremitted deductions by the company, without any formal court hearing. The serving of such a notice will force the directors of the company to:

* remit those deductions; or
* have the company placed into voluntary administration; or
* have the company placed into liquidation.