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The Relationship of Corporate Governance to Insolvency

Apart from being at least 18 years of age, there are no statutory, academic, business or required qualifications necessary to be appointed as a director of an Australian company.

The ease with which an appointment can happen belies the raft of duties and obligations a director inherits when they take on an appointment.

Those duties and obligations focus substantially on what is for the benefit of the company and its stakeholders, as opposed to what is for the benefit of the shareholders. When a company is forced to consider restructuring or liquidation, the directors (who are often the shareholders and guarantors of company facilities) are placed in a position of real conflict. They must battle between opposing forces of proper corporate governance and the financial implications for them as shareholders and guarantors.

Directors of companies facing financial distress must pay the highest regard to the proper exercise of their statutory duties. This responsibility can mean making tough decisions that are in the best interest of the company and its creditors, such as ceasing to trade or selling or divesting part or all of the business.

Whilst not repeating the Corporations Act 2001 (“Act”) provisions concerning directors' duties, we set out below a list of what we consider to be the proper standards of corporate governance directors should follow:

• Appreciate the responsibility that limited liability gives. When solvency concerns loom, it’s the suppliers who have real money to lose and their interest must prevail – the shareholder equity has already been lost.
• Apply proper financial diligence to the management of the business. Understand and monitor the cash flow, stock, debtors, creditors and profitability of the business on a weekly basis.
• Engage with key stakeholders – bankers, key suppliers and customers are “partners” in your businesses success and you should work with them in good times and bad.
• Utilise proper risk management processes – risk, not just financial risk, should be evaluated in all business transactions and processes as should appropriate treatment, management and sharing strategies.
• If solvency concerns loom, do not delay taking advice and making appointments if necessary.

In our view, companies whose directors display the highest level of good corporate governance improve their chances of avoiding insolvency and failure. This is because they will be more alert to their company’s impending problems and aware of the proper decisions required to restructure and turn around performance at an early stage.

A word of warning we offer; in the last few months we have seen an instance of a company that passed into liquidation with a recently appointed puppet director in place (a person paid to take over the directorship of a company on the brink of failure).

Further investigation has shown the puppet director was induced into the role by a pre-insolvency advisory firm who had appointed the same person to several other pre-insolvent companies in an effort to divert the focus of the failure away from the real director. The strategy did not work and attempts to avoid the focus of attention for the failure are clearly at conflict with the duties of a director acting conscientiously.

Reminder about Director Personal Liability for Tax

It is often tempting for directors to delay the payment of tax to the Australian Taxation Office (“ATO”) when cash flow becomes tight.

This form of working capital funding comes with a high risk that directors must be conscious of. A director of a company that fails to meet a PAYG withholding or SGC liability by the due date automatically becomes personally liable for a penalty equal to the unpaid amount.

However, this liability, which is in the nature of a penalty, will be remitted if:

• The company pays the outstanding amount; or
• On or before the 21st day after a Director Penalty Notice (“DPN”) is given:
• The company has gone into voluntary administration or liquidation; and
• It had reported its PAYG and SGC liabilities to the ATO within three months of their due dates.

This last point is part of the criteria that is often missed. That is: companies that don’t pay tax on time also fail to advise the ATO of the amount they have not paid.

Therefore, rule number one is to keep the ATO informed of the debt they are owed at all times.

This is especially important since June 2012, where new DPN laws were introduced to apply in circumstances where a company has not lodged its returns on time. Since then, if the debts are unreported the ATO can use a harsh version of the DPN commonly referred to as a “Lockdown DPN”.

The Lockdown DPN informs the director that they are already liable for the amount on the DPN and even a liquidation will not help them to avoid liability.

Therefore, if PAYG and SGC liabilities are not reported within three months of the due date and a Lockdown DPN is issued, the only option available to a director to avoid personal liability is for the company to pay the debt.

With respect to director personal liability for unremitted PAYG and SGC our advice is:

• Pay the PAYG and SGC on time, but if not possible:
• Report unpaid PAYG and SGC to the ATO on time; and
• If a 21 Day DPN is issued, either pay the debt or put the company into voluntary administration or liquidation within this timeframe.

Directors’ Duties: What Spouses Should Know

It is not uncommon for spouses, who are not involved in the operation of their family businesses, to be appointed as a director of the operating company (a silent director).

There can be many good reasons for this, but it is important that the director who is appointed is aware of their duties, rights and obligations.

The Act gives directors particular rights and in return places certain obligations with respect to their companies. Failure to comply may result in the director having to pay compensation to the company.

The most common duty that is cause for concern for a silent director is the duty not to let their company trade whilst insolvent.

The Courts have made it very clear that directors cannot absolve themselves from liability for insolvent trading by asserting they took no part in the company’s affairs.

Once a director realises their company is insolvent, a director acting conscientiously must take steps to ensure the company does not continue to incur debt that is not paid or risk personal liability for that debt.

We have seen instances of spouses caught in the insolvency of businesses after a marriage failure without knowing their duties and rights or how to assess the risk of insolvency.

In these cases, the silent director needs to know they have a general right of access to company documents in order to comply with their duties and this right should be exercised if they feel they cannot fulfil their director duties.

The other key duties that often come into focus when insolvency accountants review the affairs of a failed company are the duties to act in the best interest of the company and to act with due care and diligence. For a silent director we advise that the best way to discharge these duties is to:

• Ask questions and be satisfied with the answers before signing a document as a director; and
• Inform themselves about the performance of the company they are a director of.

These days it is possible to have companies with only one director and it is our advice that spouses who are not involved in the business simply stay out of the boardroom!

Where are Bankruptcies Happening?

The Australian Financial Security Authority (AFSA) has just released its regional personal insolvency statistics for the December 2014 quarter.

The results for the quarter show that the regions with the highest number of people entering into a personal insolvency were:

• Onkaparinga (51 debtors)
• Charles Sturt (40 debtors)
• Salisbury (39 debtors)

Liquidation Success Story

Many readers will be aware of the Charterhill failure that we have been administering.

We are pleased to report that to date 30 investors who lost money in this matter have been compensated for their losses.