In nearly all liquidations the liquidator will consider whether there is a potential claim against the directors of the company for insolvent trading. Many commercial and practical factors may mean that a claim is not made, but sometimes one is made and it ends up before the courts.
Directors being pursued for insolvent trading will usually attempt to defend the claim relying on one or both of two areas:
- That the company was not insolvent at the time (the claim does not exist); or
- The statutory defenses under section 588H are available to them.
Without the financial records providing any relief against the insolvency of the company, one common argument raised by directors is “we could personally have given the company our own money to pay its debts”. This point was considered again in 2007 in Williams v Scholz & Anor (QSC 266), and was again disregarded as a valid defense to a claim, with the Judge saying: “As a matter of theoretical accountancy this may be right but it is not, in fact, what happened.”
The judgment went on to say: “The principle requires a debtor to be able to pay all its debts as and when they fall due from its cash resources, or by sale or hypothecation of its assets, within a relatively short time. A debtor need not have on hand a sufficient supply of cash to pay all his debts but he must have assets which can be readily converted to cash, by sale or charge, in order to pay his debts.” A potential further loan that was never made is not a defense against the insolvency of a company.
One of the statutory defenses available under section 588H is reliance upon a competent and reliable person who provided the directors with adequate information about the company’s financial position that lead them to expect, on the basis of what he told them, that the company was solvent. This defense was also raised in the same case.
To be able to rely on that defense, the directors have to be able to give evidence of what information was provided by that person, and why that information led them to believe that the company was solvent. The court must determine whether it was reasonable for the directors to rely upon that information to form an opinion that the company was solvent. It is insufficient to say that they got some information without being able to prove what it was or what a reasonable person would interpret that information to mean.
This defense also failed in the Scholz case as the directors did not provide any details of the information given to them. The directors also pleaded that they did not trust that particular person – hardly an endorsement that they considered him a ‘competent and reliable person’.
Some directors use the “I had no involvement in the business due to illness or other good reason” statutory defense. That defense will also require positive proof and valid reasons as to why a director had no involvement in or knowledge of the company’s affairs.
In the Scholz case, one director pleaded that he was too ill to take part in the management of the business, but admitted that he attended the business premises nearly every day but spent most of his time asleep. The judge – rejecting the defense – noted that, if he was so ill to be able to rely on the defense, he would not have been able to attend the premises on a regular basis.
The onus of proving the statutory defenses lies with the person relying on them, and the courts will require evidence.