Section 588G of the Corporations Act 2001 (Cth) (the Act) governs the director’s duty to prevent insolvent trading by the company. Although this section expressly applies to directors, does it also apply to officers? Below, we set out who is an officer of a corporation and whether or not this duty applies to them.

Who is an Officer?

Section 9 of the Act defines an officer as follows:

  • A director or secretary of the corporation; or
  • A person who participates or hands down decisions that affect the whole, or a substantial part, of the business of the corporation; or
  • An individual who can significantly affect the corporation’s financial standing.

Officers can, therefore, include senior management, depending on their role in the company.

What Duties Does an Officer Have?

Officers have duties to the company under sections 180-185 of the Act. These duties include acting with care and diligence, acting in good faith, not improperly using their position and not misusing information to gain an advantage for themselves or cause detriment to the company.

Do Officers Have a Duty to Prevent Insolvent Trading?

The duty to prevent insolvent trading applies only to directors of a company and not officers. A director can also include those who are not formally appointed or listed on ASIC records such as individuals who act in the capacity of a director (de facto directors). It also includes those individuals whose instructions or wishes the other directors of the company are accustomed to act (shadow directors).

The duty to prevent insolvent trading will only apply if officers are deemed to be acting as a de facto or shadow director. The reason being is that they have a responsibility to oversee the whole management of the company. For senior managers, contractual and general law duties will determine their liability where the company trades while insolvent.

Who is a Shadow Director?

The law will not deem every person whose advice the board of a company follows to be a shadow director. A person might be acting in their professional capacity or through their business relationship with the company or directors.

A shadow director must exercise their power to control the decisions of the board. Notably, the fact that the person’s advice is disregarded from time to time or that they don’t seek to control every aspect of the company will not prevent a person from being classed as a shadow director.

In determining whether someone is a shadow director, the court will take a substance over form approach, looking at whether a person is performing the functions of a director, or has sufficient influence to control the board or company.

When Will the Court Deem Someone a Shadow Director?

The case of Deputy Commissioner of Taxation v Austin [1998] FCA 1034, outlined the following principles for establishing whether a person is a shadow director (i.e. someone acting in the position of a director):

  • It is not necessary to show that the person has done acts that only a director can lawfully do; and
  • It is a question of degree and requires a consideration of the duties performed by that person in the context of the operations and circumstances of the particular company concerned.

In this case, the “shadow director” had exercised top level management functions in the company over a period. The court established that he was occupying or acting in the position of a director at the relevant times.

Further, the case of Mining NL (No 2) (2012) 200 FCR 296 stated the following summary of principles:

  • A person may be a director even without any purported appointment of that person to the position at any time;
  • The shadow director must have at least contemplated doing the work of a director of the company and others could reasonably see them as doing so;
  • It is possible for the role of a person to evolve into one of a shadow director over time. It is also possible that a person could act as a shadow director for a limited period;
  • Titles such as “consultant” are not decisive as to whether a person is or is not a director. The test looks to the substance of the person’s role.

The court also noted that:

  • A general, unconstrained role that allows the person to actively direct the company’s affairs is more likely to indicate they are a director; and
  • The individual does not need to be in ‘ultimate control’; and
  • The board can still subject them to their direction or control.

This case also highlighted that the law can still deem a person an officer even if a person is not a shadow director.

More recently, the Court considered when the law would regard an employee (and former director) as a shadow director in Featherstone v D J Hambleton as liquidators of Ashala Pty Ltd (in liq) [2015] QCA 043. Here, the Court looked at the written agreement (which stated Featherstone would have no responsibility or powers as a director) and the ASIC records to show the person in question was acting as a director.

The accepted facts included:

  • The employee had an ultimate say over the business’ operations;
  • Decisions in the business required his consent; and
  • He continued running the day-to-day affairs of the business.

When Will an Officer Also be a Shadow Director?

In light of the case law above, an officer will be deemed a shadow director if she or he:

  • Had control and exercised influence over the directors of a company in respect of operations and decisions; or
  • If decisions required their consent.

When Will an Officer be Liable For Not Preventing Insolvent Trading?

If an officer is also a shadow director, they may be personally liable as a director for insolvent trading. A shadow director will breach his or her duty to prevent insolvent trading after satisfying the following elements:

  • The person is a director (or a de facto or shadow director) at a time when the company incurs a debt;
  • At that time, the company is insolvent or becomes insolvent by incurring that debt;
  • A reasonable person could have suspected that the company was insolvent or would become insolvent by taking on that debt; and
  • The director or a reasonable person in a similar position is aware at the time the company incurs the debt that there are reasonable grounds for suspecting the company is or would become insolvent.

What are the Consequences for the Director?

A director may be personally liable if the company became insolvent because of that debt. A company is insolvent when it is unable to pay its debts as and when they become due and payable.

A director could receive a civil penalty order from the court which can:

  • Seek to recover compensation;
  • Disqualify the individual from acting as a director of a company for a certain period; and/or
  • Require them to pay a fine to ASIC (for an amount of up to $200,000).

If the director has knowingly, intentionally or recklessly committed the breach and was to gain an advantage or to deceive or defraud someone, the director could also be guilty of a criminal offence. They could pay a fine of up to $200,000 and/or imprisonment for up to 5 years. A director guilty of a criminal offence is also prohibited from directing any company for five years.

Key Takeaways

An officer of a company will not be liable for insolvent trading unless they are also a shadow director. If you are a senior employee of a company and your role involves managing aspects of the company and making decisions on its behalf, it is possible the law will regard you to be a shadow director. Have any questions about insolvent trading? Unsure whether you might be a shadow director? Get in touch with our commercial lawyers on 1300 544 755.

Bianca Reynolds

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