A decision of the Federal Court late last year saw a director being found to have contravened the Insolvent Trading provisions of the Corporations Act, but being relieved from the liability that attaches to that contravention. The case was The Stake Man Pty Ltd v Carroll  FCA 1415.
In December 2009 the Federal Court found that the director has contravened section 588G of the Act by not preventing the Company from incurring debts whilst insolvent. But that pursuant to section 1317S(2), the director should be excused from the contravention and relieved from any liability to pay the compensation claim.
The defendant sought and obtained relief under section 1317S of the Corporations Act. This section gives the Court the discretion to excuse the liability of a person (in this case the director) from liability under certain circumstances.
The Act states:
(a) eligible proceedings are brought against a person; and
(b) in the proceedings it appears to the court that the person has, or may have, contravened a civil penalty provision but that:
(i) the person has acted honestly; and
(ii) having regard to all the circumstances of the case (including, where applicable, those connected with the person’s appointment as an officer, or employment as an employee, of a corporation or of a Part 5.7 body), the person ought fairly to be excused for the contravention;
the court may relieve the person either wholly or partly from a liability to which the person would otherwise be subject, or that might otherwise be imposed on the person, because of the contravention.
(3) In determining under subsection (2) whether a person ought fairly to be excused for a contravention of section 588G, the matters to which regard is to be had include, but are not limited to:
(a) any action the person took with a view to appointing an administrator of the company or Part 5.7 body; and
(b) when that action was taken; and
(c) the results of that action.
His honor stated in the original decision: “I am satisfied that throughout the whole of the relevant period and, indeed, at all material times prior to 31 December 2005 [the director] acted honestly. The plaintiffs did not submit to the contrary. In reaching this conclusion I have adopted the criteria for determining such honesty set out by Palmer J in Hall v Poolman (supra) at 193-194 in the following terms:
In my view, when considering whether a person has acted honestly for the purposes of a defence under ss 1317S(2)(b)(i) or 1318 of the CA, the court should be concerned only with the question whether the person has acted honestly in the ordinary meaning of that term, that is, whether the person has acted without deceit or conscious impropriety, without intent to gain improper benefit or advantage for himself, herself or for another, and without carelessness or imprudence to such a degree as to demonstrate that no genuine attempt at all has been to carry out the duties and obligations of his or her office imposed by the Corporations Act or the general law. A failure to consider the interests of the company as a whole, or more particularly the interests of creditors, may be of such a high degree as to demonstrate failure to act honestly in this sense. However, if failure to consider the interests of the company as a whole, including the interests of its creditors, does not rise to such a high degree but is the result of error of judgment, no finding of failure to act honestly should be made, but the failure must be taken into account as one of the circumstances of the case to which the court must have regard under ss 1317S(2)(b)(ii) and 1318 of the CA.”
In this case the director had the advice of an ‘expert accountant’ and heeded the advice that was given, and could show that he had taken active steps in attempting to solve the company’s ‘cashflow problems’ and bring the company back onto a sound financial footing. He had also injected capital himself and was actively seeking other investors. Essentially, even though he could not raise the statutory defences against the claim made by the liquidator, he could show that he was not negligent [my words] in his actions as a director. His honor found that the director had “acted honestly” and “having regard to all the circumstances of the case” should be excused from the liability.
In his Judgment, his Honor stated “Section 1317S is not a defence as such to the substantive action. It is a relief from a liability to pay the amount which otherwise might have been ordered by way of damages.”
The question of who should pay the costs was also discussed. The situation varied from the normal course of “the loser paying the winner’s costs” as the liquidator succeeded in his claim that the director was liable under section 588M (to compensate the company for insolvent trading), albeit that the Court was relieved from paying that claim. The December Order stated:
8. The plaintiffs have succeeded in obtaining findings in their favour in respect of all the integers of the claim required to be established for a cause of action under s 588G of the Act, and for the entitlement to recover the amount of loss and damage suffered by the creditors identified in accordance with s 588M of the Act.
9. The defence which has succeeded in enabling the defendant to avoid liability, is not a defence which the liquidator could have accepted himself. It was not for the liquidator to make the judgment as to whether the defendant would obtain an order that he ought fairly to be excused, because that was a matter for the Court. Only the Court can excuse a defendant under s 1317S. The liquidator might believe that the defendant has acted honestly, but it is not a matter for him to decide that the defendant ought fairly to be excused. That is a matter for the Court to exercise its discretion.
10. In substance, the plaintiffs have established their case for liability of the defendant to pay the damages suffered by the creditors, and by raising the matters identified in s 1317S(2) of the Act, the defendant, in effect, seeks an indulgence. The way the defendant puts the case, in substance, is that he says, “I have been found liable to pay these damages, but I have acted honestly and,” – this is cumulative – “I ought to be excused.” That is akin to seeking an indulgence from the Court.
17. The defendant should be ordered to pay the plaintiffs’ costs of and incidental to the proceeding, including any reserved costs, save for the costs reserved in relation to the interlocutory proceeding which was filed on 12 October 2007 seeking freezing orders against the defendant and his wife, Louise Margaret Carroll.
The end result is that directors who actually (and they have to convince the Court) attempt to save the company and not gain – acted honestly – may be able to seek relief from the liability of paying amounts under insolvent trading claims. But that the costs of the action may still have to be borne by the director if the original claim is upheld.