The Implications for Directors Falling Foul of their Obligations.
One aspect of a liquidator’s role is to investigate the financial affairs and circumstances of a company and the conduct of the directors in discharging their duties to the company. Once appointed, the liquidator will reach out to the directors and the company’s professional service providers (accountants, auditors, and bookkeepers) to collect the company’s financial records.
Naturally there is an obligation for companies to keep financial records. This is enshrined in section 286(1) of the Corporations Act 2001 (the Act). The obligation requires written financial records to be maintained that correctly record and explain the company’s transactions, financial position and performance, and would enable true and fair financial statements to be prepared and audited. The obligation also extends to transactions undertaken by a company acting as trustee.
When a liquidator reviews the books and records, they assess whether they have been maintained in accordance with section 286(1) of the Act. The definition of financial records is broad, extending to source documents and adjustments made in preparing the financial statements. Source documents include invoices, receipts, working papers, and other documents needed to explain the methods by which the financial statements were prepared.
Directors and advisors should also consider (under Part 2M.2 of the Corporations Act):
- If the financial records are maintained in another language, they must be provided to the liquidator in English within a reasonable time.
- Electronic financial records must be convertible to hard copy and made available to the liquidator within a reasonable time (if requested).
- If the financial records are kept on a computer owned and operated by a third party (for instance the company’s accountant), there remains a responsibility to provide a hard copy to the liquidator.
- The obligation to maintain the records for a seven-year minimum.
It is apparent that the obligation to maintain financial records extends to financial records that enable financial statements to be prepared. In other words, the preparation of financial statements of the company is not always required, but it is paramount that a director ensures the underlying source documents are maintained so financial statements can be prepared.
Now, to return to the liquidator’s investigation into the company’s books and records.
Liquidators investigate the adequacy of the company’s books and records for two main reasons. Firstly, the liquidator must file a report with ASIC that outlines, among other things, whether the director maintained the records in accordance with their obligations. Secondly, if the records are inadequately maintained, the liquidator could have a cause of action against the director to compensate the company.
So, what are the risks for directors?
According to section 286(3) of the Act, failing to maintain the books and records is a strict liability offence and ASIC can take action against a director. Penalties range from a director banning, or a director being fined.
Where a company is presumed insolvent under section 588E(4) of the Act, section 588M of the Act permits the liquidator to recover the debt incurred from the director. A director can also be found in breach of their fiduciary duty to the company and be held liable to compensate the company for amounts that could not be identifiable as payable to the company, if they’ve failed to accurately maintain the records.
Case law suggests the burden is on a liquidator to prove the company’s records have not been maintained appropriately. In the matter of Fisher v Divine Homes Pty Ltd; Allen v Harb  NSWSC 8 the Court found that in order for the presumption of insolvency to be applied, the liquidator must prove either that no document was kept in relation to the relevant period, or that the documents maintained were deficient in their content. Also where certain records did exist, such as invoices, receipts and loan agreements, the presumption was not available unless the liquidator could prove clear deficiencies in the records that were in fact maintained.
The presumption of insolvency has limitations. For instance, if it is proven that the director’s failure to maintain the books and records was only minor or technical, the presumption will not apply. Further, the presumption will not have effect if the contravention of the Act was the result of a person’s actions who was not a company director, who, for example, destroyed the books and records, and the director in question had no involvement in the activity.
So what should be made of all of this?
Directors who fail to retain company books and records for the seven-year minimum statutory period are at risk of having to personally compensate the company. We often see the company’s books and records are neglected while directors focus their efforts on attempting to turn the company’s fortunes around. It could be the case that the director just feels they can’t attend to this responsibility, given the company’s misfortunes they are attending to.
Nonetheless, directors should always be conscious that failing to maintain the books and records potentially extends the company’s misfortune to them personally. In these scenarios, the liquidator can pierce the corporate veil and make the director personally responsible for compensating the company.
For further information, a helpful ASIC guide outlines the basic books and records that might be expected for a company to maintain (to comply with Section 286), click here.
 Lawrence Waterhouse Pty Ltd (In Liq) – Shaw v. Minsden Pty Ltd  NSWSC 964