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Michael Murray’s on-going commentary on issues in corporate and personal insolvency law and related policy and law reform, in Australia and internationally. Given the scope of insolvency, this extends to business, consumer and professional conduct, and ethics, governance and regulation, criminal, tax, environmental and administrative law, and the courts and government.

 

INSOL’s Directors in the Twilght Zone – Australia’s “medium risk” for its directors

INSOL International has released the 5th edition of its excellent review of the international laws regulating director conduct in the ‘twilight zone’ of a company’s financial distress approaching or already in insolvency. Australia features well in the report, with interesting views on its assessment of directors having only a “medium risk” of liability compared to its comparable international neighbours.    

The report covers the laws of 30 countries from Argentina to Vietnam and is available as an ebook.

No justice can be done to it in this brief review but its overview by Professor Philip R Wood offers a useful coverage of all the countries listed, including what he acknowledges is a tentative and impressionistic ranking of those countries in terms of the risk, to directors, of personal liability for their conduct in the twilight zone.  

Australia is listed among the “medium risk” countries, along with England, Ireland, New Zealand, Singapore and Hungary.

That may surprise some in Australia who often refer to the comparative “severity” of our insolvent trading laws.  Australia, and those countries, are said to “adopt the principle of knowingly negligent liability for causing the insolvency”.  Reference is made to the test under Britain’s Insolvency Act 1986 of a director who “knew, or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation”. It is said that the “provisions in Australia and Ireland are to a very similar effect”. Again, that may not be accepted by some in Australia who would have preferred the English test instead of the current safe harbour test proposed by the government, dependent as it remains on determining insolvency. 

The United States is understandably assessed as low risk, the overview referring to the old concept of directors’ liability for “deepening the insolvency” as being “very rare” in the US.  Nevertheless, class actions against directors for causing loss to shareholders and creditors under plaintiff-oriented litigation rules are quite common such that the liability of US directors is said to be not greatly different from elsewhere. On the whole though the US is said to be protective of directors with a “very tolerant business judgment rule”.  Canada is similarly of low risk.

The overview by Professor Wood says that it is a near universal rule that the failure of directors to account for taxes, for example deductions from employee wages, attracts personal liability, the moral being, as he says, “directors should not borrow from the Revenue”.  That is a continuing feature of Australia’s laws, so much so perhaps as to water down any protection that might otherwise be available. 

A problem Australia shares with its international colleagues is the need for detailed statistics “in order to ensure that impressions are corrected by the realities”. Australia’s record on gathering and report on corporate insolvency statistics is not good, despite continual calls for improvement over the years. Our law reform is conducted in twilight or later, such that insolvent trading reform was deferred over the years because “evidence” to substantiate its need was not available.  Even now, much of our reform relies on anecdotal and impressionistic views. 

As to comparative international statistics, Professor Wood acknowledges that they are not easy to compile and compare because of the “number of variables which are involved and also the differing levels of practical enforcement of the black letter rules”.

The overview concludes by noting that over recent years, there has been a “marked toughening” of the laws regulating directors, greater risks and an “insistence on a more exacting attention to duties and responsibilities”, Australia being no exception.

At the micro level the overview refers to the

“enormous differences in the approach between jurisdictions and fundamental disagreements on the policies. The result is that when one gets to the all-important level of detail, there appears to be much fragmentation, fissuring and splintering of legal systems”.

Despite those concluding comments, INSOL’s report has continued to well serve international law reform and exchange of views both on the black letter and how it is applied in practice.  

Australia

Australia has an excellent chapter in the report, the law taken to 1 March 2017, written by Jeffrey Siddle, Kara Thornton, Isabel Coulton and Macpherson Kelley. Through no fault of the authors, it reports on law that has now changed or is about to, under the Insolvency Law Reform Act 2016.  The safe harbour reforms are foreshadowed in the chapter, but not the details since released by the government, and which even now are yet to be settled.

The summary of commercial issues in Australia is very useful and worth setting out in full.  Some may agree or disagree but the conclusions are well stated and in my view can be substantiated.

  • 2.1 Directors of companies in liquidation can be exposed to personal liability.
  • 2.2 Relatively few actions are taken against directors for insolvent trading.
  • 2.3 One reason why such actions are not commonplace is that they are expensive to run and can become complex, for example, in that insolvency of the company at various times needs to be proved by expert evidence. Another reason is that actions for insolvent trading are available only where a company is in liquidation. One major purpose of the voluntary administration procedure is to avoid liquidation.
  • 2.4 On the other hand, litigation funding is available to insolvency practitioners who have minimal or no funds in the administration. This can increase the threat to directors. The Commissioner of Taxation is increasingly more ready to pursue his own remedies against directors of failed companies.
  • 2.5 There are recent examples of the Australian Securities and Investments Commission (ASIC – the corporate watchdog) itself pursuing high profile directors where companies have failed.
  • 2.6 ASIC is also active in taking steps to disqualify directors, although this action usually takes place well after the winding up has concluded.
  • 2.7 The Courts have generally been realistic in the retrospective review of the conduct of directors. They understand that business involves risk and they are reluctant to stifle entrepreneurship on the part of directors.
  • 2.8 At the same time, the Courts have shown no tolerance for passive directors who leave the hard work to others and claim that they did not know what was happening.
  • 2.9 Liquidators have demonstrated an aggressive attitude to litigation, in particular with litigation funding available. Preference actions are commonplace (in Australia there is no requirement to prove an intention to prefer a creditor). These do not, however, universally result in a net return to creditors.
  • 2.10 After the liquidator’s remuneration, secured creditors and priority creditors (for example employees) are paid, returns to unsecured creditors are minimal or (if the company’s assets have been completely depleted) non-existent.
  • Thus unsecured creditors are generally supportive of the voluntary administration procedure, which is intended to keep the business trading. The return from such a procedure is often better than that which would be achieved in a winding up.

Comment

Without having read the INSOL report in detail, but being familiar with it over the years, my only comment is that a country’s twilight zone laws have to be assessed in the broader context of business regulation and corporate transparency generally.  Australia suffers from a lack of transparency, comparatively with England for example, through creditors having no free access to corporate records of their customers or service providers, and where those corporate records do not disclose true or beneficial ownership of a company, and where even the identity of directors is uncertain and their prior conduct hard to trace.  Phoenix misconduct in Australia is consequently a problem, implemented by directors.  Other director misconduct is overlooked.

Protection of directors has to be balanced against the harm suffered by creditors, and the need to maintain good standards of business integrity. Director groups have hardly been at the forefront of promoting corporate transparency. Laws ameliorating the risks of directors would be better accepted if the conduct of directors were more readily lit up before and during the twilight zone.    

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