03 December 2009

Director excused from liability for insolvent trading


McLellan, in the matter of The Stake Man Pty Ltd v Carroll
[2009] FCA 1415 concerned liability for insolvent trading under s 588G of the Corporations Act. The case applies established principle in finding a breach of the insolvent trading provisions. Significantly, however, Goldberg J ultimately relieved the director from liability under s 1317S of the Corporations Act.


The liquidator of the The Stake Man Pty Ltd (in liquidation) ("the company") applied for orders against its sole director, Mr Carroll under sections 588G and 588M of the Corporations Act. These sections allow a liquidator to recover money from a director where the director has breached the statutory provisions relating to insolvent trading.

The company had operated successfully and profitably for many years processing and wholesaling raw timber. In 2004 the company purchased a kiln and related equipment to enable it to dry and machine its own timber rather than being limited to selling green timber.

Unfortunately, the kiln and related equipment did not function as expected. By mid-2005, the continuing kiln problems were having an adverse effect on the company's cashflow, as were the significant losses suffered because of timber becoming unsaleable through damage in the kiln.

In March 2005, the company engaged a new accountant, Mr Bright, who had experience in the timber industry. In June 2005, Mr Bright told Mr Carroll that the business was close to insolvency and, as a result, both Mr Carroll and the other shareholder, (the Cameron Family Trust) advanced substantial funds to the company. Mr Carroll also approached the kiln manufacturer, Brunner-Hildebrand, to invest in the company but nothing came of that proposal.

In February 2006, the funds invested by the shareholders in July 2005 had been exhausted, and Mr Bright consulted an insolvency practitioner, Mr Marchesi. Mr Marchesi advised Mr Carroll that if he believed that the business was viable, he should find an investor or further capital. Following this advice, Mr Carroll engaged a consultant to help him find an investor in the Company potentially to provide further capital. During April and into May, Mr Carroll was also seeking further avenues of finance for all the Company's business.

On 3 May 2006, the Australian Taxation Office advised Mr Carroll that the company owed it $110,000 and that Mr Carroll had until 17 May to review how he was going to reduce that debt over the next 18 months. On 4 May, Mr Carroll spoke to Mr Bright about this conversation and said that the company did not have the funds on hand to pay the tax bill. On 5 May, Mr Bright gave Mr Carroll the contact details of a restructuring specialist, Mr McLellan. Mr Carroll met Mr McLellan on 7 May, and on 10 May Mr Carroll appointed Mr McLellan as voluntary administrator of the company. On 6 June the creditors resolved that the company be wound up and Mr McLellan became the liquidator of the company.

This case concerned the solvency of the company between 31 December 2005 and 10 May 2006.

Findings on sections 588G and 588H

The court referred to and applied the authorities on the meaning of insolvency, including: Sandell v Porter
[1966] HCA 28; (1966) 115 CLR 666 at 670-1, ASIC v Plymin
[2003] VSC 123; (2003) 46 ACSR 126, at [370]-[380], Re United Medical Protection Ltd (prov liq appt)
[2003] NSWSC 1031; (2003) 47 ACSR 705 at 718 and Hall v Poolman
[2007] NSWSC 1330; (2007) 65 ACSR 123 at [267]. In particular, the court adopted the broard general guide laid down in the last case that "a director would be justified in 'expecting solvency' if an asset could be realised to pay accrued and future creditors in full within about 90 days."

The court found that the company was insolvent during the relevant period, and that each of the elements of s 588G was satisfied. The court also found that Mr Carroll had not established either of the defences under sections 588H(2) (reasonable grounds to expect solvency) or 588H(3) (expectation of solvency based on reasonable reliance on a competent and reliable person who was responsible for providing him with information).

In relation to the defence under section 588H(2), the court applied the staged inquiry explained by Palmer J in Hall v Poolman at [269]-[275].

In relation to the defence under section 588H(3), Mr Carroll had argued that he relied on the advice of his accountant Mr Bright. The court found that Mr Bright was engaged by the company as its accountant, but that Mr Bright was not "responsible" for providing adequate information to Mr Carroll about whether the company was solvent in the sense that he was specifically given that role or task. This was notwithstanding that Mr Bright did give advice about whether the company was solvent on various occasions.

Whether Mr Carroll should be excused under sections 1317S or 1318.

These sections give the court power to excuse a director from the contravention of section 588M of the Corporations Act, where the director has acted honestly and, having regard to all the circumstances of the case, he ought fairly to be excused.

In finding that Mr Carroll had acted honestly, the court applied the criteria set out by Palmer J in Hall v Poolman at [325] which adopt the ordinary meaning of that term.

The circumstances of the case leading to the finding that Mr Carroll ought fairly to be excused included that:

  • Mr Carroll was taking advice from Mr Bright during the relevant period;
  • Mr Bright told Mr Carroll on several occasions that he did not believe that the company was insolvent
  • It was reasonable for Mr Carroll to rely on Mr Bright because of his qualifications and experience and, in particular, his experience in the timber industry. (This was notwithstanding the finding that Mr Bright was not a person to who was responsible for providing information on solvency under section 588H(3));
  • Mr Carroll was active throughout the period, taking steps to expand sales and trying to get the kilns working properly;
  • Mr Carroll took advice from Mr Marchesi, an insolvency practitioner, who told him that if he believed the company's business was viable it would be necessary to find an investor or further capital, and Mr Carroll attempted to do this; and
  • When finally confronted with the ultimatum from the Australian Taxation Office on 3 May 2006, Mr Carroll did not procrastinate. He spoke to Mr Bright the next day, who put him in contact with Mr McLellan and Mr Carroll met Mc McLellan three days later.


The court accordingly found that Mr Carroll should be excused from his contravention of s 588G(2) and that he should be relieved from a liability to pay the plaintiffs the amount of the loss suffered by creditors of the company throughout the relevant period.


This case is significant as a rare instance where a director has been excused from liability under section 1317S. The key factors in the finding that Mr Carroll should be excused were Mr Carroll's reliance on his accountant, Mr Bright, and the fact that Mr Carroll acted promptly on the expert advice he received.

This corresponds with ASIC's draft guidance to directors earlier this month (09-236AD ASIC releases consultation paper outlining proposed guidance to directors on their duty to prevent insolvent trading), that, in seeking to avoid liability for insolvent trading, a director:

  • must keep him or herself informed about the financial affairs of the company and regularly assess the company's solvency;
  • immediately on identifying concerns about the company's viability, should take positive steps to confirm the company's financial position and realistically assess the options available to deal with the company's financial difficulties;
  • should obtain appropriate advice from a suitably qualified person; and
  • should consider and act appropriately on the advice received in a timely manner.



23 October 2009

Public and private enforcement of disclosure breaches in Australia

In an article published this week in the Journal of Corporate Law Studies, (2009) 9 JCLS 409, I discuss the remedies that are available for continuous disclosure breaches and for false or misleading disclosure. The article examines the enforcement options available to ASIC, ASX, individual litigants and classes. It also looks at the interaction between public and private enforcement. The abstract of the article is as follows:

The law relating to disclosure breaches in Australia has developed incrementally, with the result that there is a range of potentially overlapping remedies, and the Australian Securities and Investments Commission, which is the primary regulator in this context, will often have to bring more than one type of action in order to achieve a desired regulatory outcome. Actions for compensation by investors have received a fillip from reforms to facilitate class actions. However, uncertainty remains as to the extent to which investors are required to establish reliance. Recent growth in enforcement of disclosure breaches has highlighted the need to rationalise the available remedies and, in that process, to consider the desirable balance between compensatory and deterrent remedies, entity and individual liability, and public and private enforcement.

21 October 2009

Diversion of corporate opportunity

Two recent cases on diversion of corporate opportunities highlight:

  • The strictness of the equitable rule; and
  • The importance of the facts in determining whether it has been breached.

The two cases are the decision of the Supreme Court of New South Wales in Manildra Laboratories Ltd v Campbell
[2009] NSWSC 987 and the decision of the English Court of Appeal in O'Donnell v Shanahan
[2009] EWCA Civ 751.

O'Donnell v Shanahan

This case concerned a quasi-partnership company which at the time of these events had three director/shareholders. The key transaction complained of related to the engagement by the company to find a purchaser for a property called Aria House. The initial purchaser pulled out of the transaction at a late stage. In an attempt to salvage the deal, the defendants approached a client of the company, Mr Holleran. He expressed interest in buying a 50% interest in the property, but only on the basis that the defendants would take the other 50% stake. Mr Holleran was also not prepared to pay the £30,000 commission to the company that was part of the original deal.

At first instance, the judge had found that proceeding with this transaction was not a breach of duty by the defendants because there was no suggestion that the company might buy the property and because purchasing property fell outside the scope of the company's business. In reaching this conclusion the judge relied on Aas v Benham [1891] 2 Ch 244. In that case, a partner was free to exploit information he obtained as a partner in the firm where the opportunity did not compete with and was beyond the scope of the business of the partnership.

That decision was reversed on appeal. For Rimer LJ, with whom the other members of the Court of Appeal agreed, the critical fact was that the defendants had obtained the information in the course of acting as directors of the company. The court also distinguished trusts and companies on the one hand from partnerships and held that there was no support for a "scope of business" exception in relation to the application of the "no profit" rule to companies. In the case of a partnership, the extent of a partner's fiduciary duties is determined by the nature of the partnership business. In contrast, the authorities about directors' fiduciary duties "make it clear that any inquiry as to whether the company could, would or might have taken up the opportunity itself is irrelevant; so also, therefore, must be a 'scope of business' inquiry". (para 70).

Manildra Laboratories Ltd v Campbell

This was a case where senior manager who left his employment and established a competing business was found not to have breached his fiduciary duty to his former employer. Mr Campbell was the manager of a flour mill owned by Manildra. He later left that employment, completed the purchase of a flour mill (negotiations for which had commenced while he was an employee of Manildra) and began exporting wheat flour to Indonesia. It was also found that he had approached Manildra's employees to join his new venture while he was still employed by Manildra.

The court formulated Mr Campbell's duties in virtually identical terms to the Court of Appeal in O'Donnell's case. However, it also pointed out the importance of assessing the existence and scope of fiduciary obligations in their context. The court found as follows:

  • It is not necessarily a breach of duty if during the course of employment the defendant prepares to compete with their employer once the employment comes to an end. It will only be a breach if some or all of the steps taken involve a breach of duty, not because, collectively, they can be described as "preparing to compete".
  • Purchasing the flour mill was not a breach of duty because Mr Campbell did not become aware of the possible availability of the mill through any aspect of his duties or responsibilities as an employee of Manildra, and it was not part of his responsibilities to seek out opportunities for Manildra to grow by acquiring competitive businesses.
  • It was not a breach of duty to compete with Manildra in selling flour to Indonesia after his employment ceased. Manildra's capacity to sell flour into that market was limited by its own internal decision to sell the bulk of its flour for ethanol production, and Mr Campbell did not take part in that decision. Mr Campbell had also not diverted or usurped any of Manildra's contracts for the sale of flour in Indonesia. Rather, the court classified Mr Campbell's knowledge of the Indonesian market and potential customers within it as part of his general stock of knowledge or know-how.
  • To the extent that the business plan that Mr Campbell developed embodied knowledge or experience gained by Mr Campbell in the course of his employment, it was not something that was capable of protection in equity. The information, though notionally confidential, fell into the category of information which was capable of being reverse engineered by a person with Mr Campbell's substantial industry experience rather than being a secret formula or process.
  • Although Mr Campbell did approach Manildra's staff while still employed by Manildra, there was no suggestion that Manildra had suffered substantial damage as a result. At most there was an entitlement to some nominal amount of damages for breach of contract.

In light of the court's finding that there was no breach of fiduciary duty and no breach of contract in relation to confidential information, the court also found that there was no contravention of sections 182 or 183 of the Corporations Act.


It is possible for companies to limit their activities by specifying objects in their constitutions. Query whether if a company did this, it would operate in the same way as regards fiduciary duties as the limitation on the scope of the business of the partnership in Aas v Benham.