Insolvent Company

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Melbourne Pty Ltd suffered from financial crisis in the mid-2009, while during this time, the board of directors makes a decision for declaring a dividend to members, and, consequently, the company went into bankrupt shortly afterwards the dividend is paid. The legal issue that needs to be identified is whether the directors of the company have breached the relevant law in relation insolvent trading. Afterwards, it is significant to ascertain whether there are any defences which are available to them, because all of the four directors in this case may be have some relevant evidences to prove their innocence under the Corporations Act 2001. Lastly, it also necessary to outline the possible penalties imposed on them if they are found to have contravened the relevant law in relation to company’s insolvency. Appling relevant law to this particular case study, s 588G states the duty to prevent insolvent trading for a director when the relevant debt is incurred. Section 588H offer defences to directors if they have relevant evidence required in this section. Section 588J, 588K and 588M show the consequence of a contravention of s 588H. It is cannot deny that all the directors have breached s 588G, but each of them can apply certain defences if they provided the relevant proof noted in s 588H. as for the penalties, compensation in ss 588J, 588K and 588M is unavoidable because of breaching s 588G, but some of the director can relieve their duties through applying s 588H.

Question 1
Advise whether there have been any breaches of the directors’ duties in relation to insolvent trading.

In this case, the first issue that needs to be ascertained is, whether the directors contravene the relevant law in relation to insolvent trading. To solve this issue, it is helpful to thoroughly analyses section 588G.

Section 588G states that a director has a duty to prevent a debt from being incurred when the company is insolvent or suspected that it is insolvent under reasonable grounds. To demonstrate whether a director has contravened s 588G, four points are offered here under s588G. Initially, incurring a debt is an essential element as a condition of breaching s 588G. Then s 588G (1) (b) needs evidence that the company was insolvent when there was a debt incurred or became insolvent because of this debt, thus, it is absolutely necessary to ascertain when a debt is incurred. In addition, it also needs to prove that whether a company was insolvent or becoming insolvent. Again, a proof needs to be provided that a director cannot prevent the corporation from incurring a debt under s 588G (2).

In this case study, the financial situation of Melbourne Pty Ltd deteriorated in 2009. Chesterman J stated in Williams v Scholz [2007] QSC 266 that ‘there were reasonable grounds for suspecting that the company was insolvent during the relevant period because the company traded unprofitably and accumulated losses continuously’. Likewise, the company’s financial situations can be suspected as insolvency. Also, the liquidator found that the company financial record was not kept properly. Similarly, in Kenna & Brown Pty v Kenna [1991] NSWSC 533, due to the company’s financial records was falsified which contravened the predecessor of s 289, the company was assumed as insolvency under s 588E (4). Those two points noted above have proved that as a matter of fact the company is insolvent or suspected insolvent under reasonable grounds.

At this time of insolvency, however, the board of directors made a decision that they would declare a dividend to each member. Section 588G (1A) indicates that there are seven actions can be regarded as incurring a debt when the company is insolvent. In particular, paying a dividend is deemed that the company incurred a debt under s 588G (1A).

Furthermore, s 588G (1) (b) states that ‘the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time...
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