Most readers of this e-Update will be familiar with the concept of directors of a company being potentially liable for debts incurred when the company was insolvent where the debt remains unpaid and the company goes into liquidation. Insolvent trading has been a part of the Corporations Act well before it was called the Corporations Act.
But many readers will not be aware that a holding company can be just as liable for insolvent trading claims by liquidators. There is a five part test to determine whether a company (defined as a holding company for these purposes) is liable for the debts of its subsidiary. All five parts must apply for the liability to occur.
Section 588V of the Corporations Act creates this liability when:
1. the company was a holding company of the subsidiary at the time the debts were incurred by the subsidiary; and
2. the subsidiary was insolvent when it incurred the debts; and
3. at the time there were reasonable grounds for suspecting insolvency; and
4. the holding company or at least one of its directors were aware of the grounds for suspecting insolvency, or “having regard to the nature and extent of the corporation’s control over the company’s affairs and to any other relevant circumstances”, it was reasonable to expect the holding company or one of its directors to be aware of the grounds for suspecting insolvency; and
5. that time is at or after the commencement of this Act.
These points follow the same type of tests that apply to determine whether a director is liable for insolvent trading, and most of the examination into the two claims will be common ground. Point 4 above is essentially a reasonable man test, but modified to be whether a reasonable director should have suspected given the circumstances.
But what defines a holding company that may be caught under these provisions? Section 46 of the Corporations Act defines a holding company as one which:
- controls the composition of the subsidiaries board
- has control of more than half of the votes at a general meeting
- is entitled to 50% of the capital on a winding up
Broadly the same defences that are available to directors accused of insolvent trading are available to a holding company.
Solicitors and accountants providing advice to company groups should bear the provisions of section 588V in mind, as in the last twelve months Worrells has seen a number of insolvencies where the holding company has received demands from one of our liquidator partners.