Most readers would be aware of a director’s duty to prevent the company from trading (incurring debts) whilst insolvent, and the liability that may arise to the company’s liquidator and creditors if they breach that duty. This duty and the right of the liquidator to seek compensation for breaching the duty arise from section 588G of the Corporations Act.
Readers will also be aware that ASIC has the right to pursue directors for civil or criminal liability for insolvent trading in certain circumstances. ASIC’s right also originates from section 588G the Corporations Act.
CORPORATIONS ACT 2001 – SECT 588G
Director’s duty to prevent insolvent trading by company
(3) A person commits an offence if:
(a) a company incurs a debt at a particular time; and
(aa) at that time, a person is a director of the company; and
(b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and
(c) the person suspected at the time when the company incurred the debt that the company was insolvent or would become insolvent as a result of incurring that debt or other debts (as in paragraph (1)(b)); and
(d) the person’s failure to prevent the company incurring the debt was dishonest.
I had occasion to discuss this matter late last year when asked why we (as liquidators) did not take recovery action against directors more often, and why the criminal prosecution of directors was not undertaken more often. The question is worth answering by way of this article.
Only ASIC can commence a criminal prosecution of directors, albeit that these actions usually originate from a report from the liquidator. Liquidator’s rights of action are limited to proceedings to recover money for the company by way of compensation from the director when the 588G duty has been breached. It is aso worth remembering that our law here in Australia is considered to be one of the toughest in the world.
The most common reason that liquidators do not take these actions more regularly is that often the directors have no money or other means to satisfy any claim that may be made against them. It is not unusual for companies to be commenced with very little working capital. This is usually because the director or directors have little money available personally to provide that capital. Whatever capital the company had is lost by the time liquidators are appointed.
It is also not unusual for directors to ‘invest’ everything that they have into the company in the period before the liquidation. It is also not unusual for them to borrow money against every asset they own simply to get a company started or to keep the company alive a little longer when it is bordering on insolvency.
It is also not uncommon for directors to pour whatever they can get, beg or borrow into the financial ‘black hole’ when finances get really bad.
Often by the time that liquidators are appointed there is nothing to recover from directors. They are heading towards bankruptcy themselves. Commercially then it would be irresponsible for liquidators to spend money (assuming they have some available) chasing a recovery action that they know will not lead to any recovery.
Why doesn’t ASIC take civil or criminal actions more often? The only party that can answer that fully is ASIC, but consider the following figures.
Leaving aside the very real fact that sufficient evidence would have to be discovered in order to maintain a criminal claim and in many cases this evidence would not be sufficient for a conviction (given the high standard of proof required in acriminal case), I personally could refer at least 25 directors a year to ASIC for possible prosecution. At least 100 other liquidators in the country could do the same.
2,500 possible claims a year
The cost of ASIC’s time in investigating the claim and preparing the material for the prosecution, the cost of the DPP’s time in running the prosecutions would have to be at least $100,000 each on average (much lower in some cases but probably significant more for complex cases). Remember that, in most cases, these costs will not be recovered.
$250,000,000 in costs
On average it would have to take about 3 years from the start of the investigation to obtaining result in court. Usually more than half of this time would be spent in the investigation stage, before charges were laid and the matter went to court.
7,500 actions running at any one time
The staff at ASIC and the DPP offices would have to be increased just to handle the number of these claims, and the number of court rooms and Judges may have to be increased simply to be able to hear them. This does not include the costs of keeping any person found guilty in prison.
37,500 court days, if each of the 7,500 claims running at any time only used on average 5 days in court (or 12,500 days a year – or 50 courts running a full 50 week year)
Divide these figures in half, and the numbers are still large. Simply the cost of taking actions against every director that may be guilty of insolvent trading is extremely large – and payable by us, the taxpayer.
I doubt that there is any evidence to show that prosecutions on these large scales actually would stop other people from committing the act in any event, especially when most directors do not think that they are doing anything wrong – they are just trying to save their company.
I have no doubt that ASIC would like a larger budget to undertake more prosecutions that it currently can handle, but I think that their approach of taking on the big offenders provides the same deterrent message as taking on thousands of small offenders.