Insolvency, company directors and their professional advisors

29 August 2013

In this issue

Reviewing dealings of directors at a time when their company is experiencing financial difficulties
External advisors becoming involved in such director dealings
Significance of section 79 Corporations Act 2001 (Cth)

Background

Where a company is insolvent it is not uncommon for directors, concerned about the financial predicament of their company, to begin to exercise their powers in a manner motivated by personal gain, or at least in a manner contrary to the interests of creditors. Such director-initiated dealings will undergo close scrutiny in any subsequent insolvency administration.

A further aspect of such dealings relates to the professional advisor who becomes involved with the directors in their implementation of business decisions.

Becoming involved in the affairs of an insolvent corporate client

When a professional advisor, such as an accountant or solicitor, becomes involved in the affairs of a corporate client experiencing financial difficulties, the professional advisor will need to exercise caution so as to avoid becoming an accessory to the wrongful conduct of directors.

The potential for liability of the external advisor arises from the following:

Often the proposed dealings of directors can only be formulated and implemented with the advice and assistance of professional advisors, such as the company’s external accountant or solicitor
Under the Corporations Act a person providing assistance to directors may be “involved in a contravention” (as defined in section 79, Corporations Act) of certain statutory duties owed by directors (see sections 181 – 183, Corporations Act) and, as a consequence, is also in contravention of those duties

The meaning of "involvement in contraventions" is set out in section 79, Corporations Act in the following terms:

“A person is involved in a contravention if, and only if, the person:

has aided, abetted, counselled or procured the contravention; or
has induced, whether by threats or promises or otherwise, the contravention; or
has been in any way, by act or omission, directly or indirectly, knowingly concerned in, or party to, the contravention; or
has conspired with others to effect the contravention.”

On becoming involved with director dealings the professional advisor will need to ensure that he or she has not aided, abetted, counselled or been knowingly concerned in conduct of directors that may be challenged where the company subsequently proceeds into an insolvency process.

Improper dealings of directors in which external advisors may become involved

Typically, improper dealings of directors with which their accountants or solicitors may become involved, relate to:

transactions that bestow unfair preferences on the directors,
uncommercial dealings between the directors and their company,
the divesting of corporate assets to the directors or nominated third parties,
payments by the company having the effect of discharging a personal liability of a director,
the granting of a security interest by the company to a director,
the writing off of a material asset or liability

The courts have had occasion to review dealings of the above kind in which external advisors have become implicated in breaches of directors’ duties.

For example, in Australian Securities Commission v Spencer¹ an accountant of some 22 years’ experience in practice devised and implemented a scheme whereby a director caused his company to assign property of the company to a third party in order to satisfy a personal debt owed by the director. Within the meaning of section 79, Corporations Act the court found the accountant liable as being involved in the contravention of the director’s duty not to make improper use of position to gain an advantage or to cause detriment to the company.

More recently the NSW Supreme Court had occasion to review the conduct of directors in respect of phoenix activity, together with their legal advisor². In this highly publicised case the court found that eight directors of various unrelated companies had acted in breach of their duties under the Corporations Act in implementing phoenix activity in respect of their insolvent or near insolvent companies.

In each case the transactions were entered into by the director as a result of advice sought from their legal advisor. In each case the transactions had the effect of taking assets out of their companies and out of the reach of creditors.

Concluding comments

We have seen that section 79, Corporations Act is a significant provision ensuring that those who are involved with directors in breach of Corporations Act duties are themselves also in contravention of those duties. Where a company is insolvent, and subsequently proceeds into an external administration under the Corporations Act it may be expected that the appointed insolvency practitioner and ASIC will closely scrutinise the role of the professional advisor when investigating the conduct of directors.

In the event that a professional advisor has contravened the Corporations Act along with the directors, the consequences for the professional advisor may be far reaching, extending to ethical concerns, professional standing, and liability under the Corporations Act, including the possibility of criminal sanction.

1 (1997) 25 ACSR 143, Fed C
2 ASIC v Sommerville & Ors (2009) NSWSC 934