The recent case of SSET Construction Pty Ltd (in liq), Re; Sims v Khattar (2010) NSWSC 102 has reinforced the duties placed on directors to avoid insolvency. The case also encourages the importance of preserving and updating financial records.
QUICK FACTS:
- SSET’s business was in the building and construction field.
- Three of its directors, also the defendants in this case, represented the company at all relevant times since 1995.
- Several years later, a disagreement arose between SSET and a body corporate over faulty works carried out by the company.
- This clash led the body corporate to issue winding up orders against the company, resulting in a liquidator taking over.
LIQUIDATOR’S RESPONSE:
The liquidator filed proceedings against the defendants claiming firstly that they had breached the insolvent trading provisions under section 588G of the Corporations Act, 2001 (the Act). This breach had further caused them to accrue a huge debt on behalf of the company.
Secondly, under sections 588G and 588 M (2), the liquidator is empowered to recover such debts from defaulting directors, where the company and its creditors suffer a loss. The liquidator needs to show that:
- the directors failed to protect the company from incurring debts when the company was insolvent or became insolvent as a result of the debt; and
- there were reasonable grounds for suspecting that the company was insolvent or would become insolvent; and
- that each director or a reasonable person in the director’s position would have been aware of these grounds.
FINANCIAL RECORDS:
The liquidator further relied on section 588E (4) of the Act. This provision states that a company is required to maintain financial records for a specific period as per section 286 of the Act, failing which, it can be presumed that the company is insolvent for that period.
COURT’S FINDINGS:
It was held by Austin J that SSET had failed to retain adequate financial records, thus breaching section 286 of the Act. This was applicable for all accounting periods till January 2006. The presumption of insolvency arose only from May 2005 as SSET’s solicitor was in possession of the financial records prior to May 2005 and had refused to return them.
The presumption of insolvency did not stop here. The directors were guilty in manipulating cash payments paid out to creditors from August until November 2005.
Relying on section 588E(3), the company was insolvent from August 2005 until the relation-back day – 30 January 2006. The presumptions of insolvency were strong in this case but were eventually outweighed by the liquidator’s proof of the company’s insolvency on 30 June 2005.
His Honor also found that sections 588G and 588M (2) were violated by the defendants. Consequently, the directors were ordered to pay the outstanding debt to the liquidator.
LESSONS TO BE LEARNED:
Directors, like lawyers, trustees and accountants, owe a stringent duty of care and diligence to the company. In theory, this makes one feel honored. In practice, worringly, quite a few directors fall into the trap of dishonoring their duties.
This decision emphasises directors should keep written financial records that correctly record and reflect the company’s transactions and financial and performance. A failure to do so may lead to the presumption of insolvency arising against the company, for the period of time that adequate records were not maintained, as was the case with SSET.
Moreover, in the absence of financial records, directors may not even realize they are trading insolvent. This situation makes a liquidator’s claim against a director easier and a director’s defense, harder.