On 19 January 2010 the Federal Government announced its Corporate Insolvency Law Reform package. The Reform package is intended to deal with two very topical issues in Australia’s corporate environment, the previous High Court’s decision in the case of Sons of Gwalia, and insolvent trading.

As readers would be aware from previous Newsletter Articles, the decision in Sons of Gwalia opened up a potential can of worms in corporate Australia for shareholders to make claims against, and become creditors of, companies in which they had invested. The decision dealt with the question of whether a shareholder could make a claim for breach of continuous disclosure laws or misleading and deceptive conduct and thereby rank equally with other unsecured creditors in the winding up of the company.

In short the Court held that a shareholder’s claim in such circumstances was not a claim made in their capacity as shareholder, and therefore in a winding up of the company the member could prove alongside other creditors for any valid claim.

The amendments to the Corporations Act announced in the Reform package do not seek to eliminate the rights of shareholders in such circumstances, but rather to provide for such claims (if successful) to rank below that of normal unsecured creditors. Therefore in a winding up such a ‘creditor’ could only expect a distribution from the liquidator in circumstances where other normal unsecured creditors have received 100 cents in the dollar. It does mean however that they would be entitled to a dividend on their claim before any return of capital to shareholders of the company.

The second significant element of the Reform package deals with insolvent trading. Again the topic of insolvent trading has been dealt with on many occasions in our Newsletters, and Fact Sheets are also available on the topic from our web site. In summary however, the basic premise of the current insolvent trading laws in Australia is that if a director finds that the corporate entity he is associated with is insolvent then he is to cease the trading of that company.

There has been much discussion in recent years that the current insolvent trading provisions may act as a deterrent to directors in situations where a company may become technically insolvent but where the director feels (based on what may be valid grounds and business experience) that they are able to re-structure to improve the company’s financial position, return the company to solvency, and continue successfully as a member of the corporate community.

The Reforms seeks to address this issue by including the concept of the business judgment rule to the defences available to a director for insolvent trading. The business judgment rule is currently contained in Section 180 of the Corporations Act.

CORPORATIONS ACT 2001 – SECT 180
Care and diligence–civil obligation only

Care and diligence–directors and other officers
(1) A director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they:
(a) were a director or officer of a corporation in the corporation’s circumstances; and
(b) occupied the office held by, and had the same responsibilities within the corporation as, the director or officer.
Note: This subsection is a civil penalty provision (see section 1317E).

Business judgment rule
(2) A director or other officer of a corporation who makes a business judgment is taken to meet the requirements of subsection (1), and their equivalent duties at common law and in equity, in respect of the judgment if they:
(a) make the judgment in good faith for a proper purpose; and
(b) do not have a material personal interest in the subject matter of the judgment; and
(c) inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and
(d) rationally believe that the judgment is in the best interests of the corporation.

The director’s or officer’s belief that the judgment is in the best interests of the corporation is a rational one unless the belief is one that no reasonable person in their position would hold.

In addition to the inclusion of Section 180 to the defences available to a director for insolvent trading, the Reform also proposes that a director would also need to demonstrate that the following requirements have also been met in order to avoid a successful claim for insolvent trading:-

• The books and records of the company present a true and fair position of the company’s financial affairs;
• The director had sought advice from an appropriately qualified professional with access to the books and records of the company, and that the advice included the feasibility of the company returning to solvency within a reasonable period of time.
• That it was the ‘director’s business judgment’ that the interests of the company’s creditors and members were best served by pursuing any restructuring; and
• That any restricting was acted upon by the director.

Submissions to the reforms close 2 March 2010.