Scenario:
Fred and Jane are directors of a private company that is used to operate a small business which is experiencing cash flow difficulties. Fred and Jane are struggling to make their repayments as and when they are falling due and some suppliers of products and services to the business are now even requiring cash on delivery. Fred thinks if he can just get one last large supply of product (on credit from the supplier) that he can make enough profit from its sale to get them out of financial strife. Fred and Jane seek the advice of their business lawyer in relation to their current position and their legal duties as directors of the family company.
Guidance:
Fred and Jane, being directors of a company registered in Australia with Australian Securities & Investments Commission (ASIC) under the Commonwealth Legislation Corporations Act 2001 (Cth) (“the Act”), are lawfully bound by both the Act and by common law directors’ duties.
Directors’ duties are designed to ensure the loyalty of directors to their company.
Fred and Jane already know from previous guidance that as directors they must act at all times in the best interests of the company, in good faith at all times and for a proper purpose.
Now specifically Fred and Jane must heed Section 588G of the Corporations Law 2001 (Cth). Fred and Jane must not take on any further debt in the event the company is already (on an objective view) unable to pay its current debts as and when they fall due. To do so is a breach of the Act and may provide creditors of the company with an ability to initiate legal proceedings against the relevant director(s) for damages incurred (monies unrepaid). In other words this is one of the few ways in which the security of the “corporate veil” may be pierced and directors personally exposed to a company’s financial losses. Fraud by a director of course is another such action.
There is a very fine line between business peaks and troughs, trading ebbs and flows and insolvency. The Directors have the sole responsibility to at all times be fully aware of the company’s financial position and therefore in a position to make an educated decision as to insolvency or merely a business cash flow issue.
The Directors must always measure themselves against the benchmark of a prudent director. A prudent director must make themselves aware of the relevant financial information and position of the company so as to make proper decisions concerning the company’s financial well being. The Directors should also consider seeking professional financial advice at such a time if they believe there are questions in relation to insolvency.
A large one-off “last hurrah” type financial gamble that Fred is considering must be seen in an objective light and together the director’s ought to seek proper advice before such a decision is made particularly where doubt already exists.
Additional information: Blackwell Short Lawyers