Director's duties and solvency issues for SME’s

David Brett

As a director of a company, whether you have actual knowledge of the company’s solvency or not, you may be deemed to have knowledge.

What follows is a summary of the statutory basis of some your responsibilities as a director, a discussion of some of the steps companies can put in place to deal with internal management issues, and who or where to turn if the management of the company is dysfunctional and or you suspect there may be solvency issues.

Directors Duties

As a company director, the Corporations Act 2001 (the “Act”) sets out four basic duties of a company director. You are required to:

(a.)    Act with care and diligence i.e. that a reasonable person might be expected to show in the role (s 180);

(b.)    Act in good faith in the best interests of the company and for a proper purpose (s 181);

(c.)    Not improperly use your position (s 182); and

(d.)    Not to improperly use information (s 183).

In addition to the four basic duties, another significant duty is to ensure that a company does not trade whilst insolvent or where the director suspects it might be insolvent (s 588G). There can be severe consequences i.e. criminal sanctions, for failure to comply with directors duties under the Act or other laws governing a company’s activities.

Internal management of company

Section 141 of the Act sets out 39 provisions of what is known as the replaceable rules (for proprietary companies), which serve as a basic guide for managing a company. A useful summary of the replaceable rules can be found on the ASIC website.

The replaceable rules will apply to your company unless the company’s internal management is governed by a constitution (which can displace the replaceable rules or work in concert with them). However you should note that section 135 of the Act provides that the replaceable rules are not applicable to proprietary companies with the same person acting as both the sole director and sole shareholder.

Company constitution

Section 136 of the Act sets out how a company’s shareholders can adopt or modify a constitution. It is a public document which is accessible by its shareholders and may be available to other parties. The advantage of having a constitution is that it gives shareholders flexibility and more certainty than would otherwise be the case if the company relied on just the replaceable rules.

For example, a constitution may provide for several classes of shares with different voting rights (s 610), shares that have different dividend rights (s 254W) or rights to capital upon winding up i.e. preference shares.

If your company has more than one shareholder, regardless of whether the shareholders are made up of friends or family, you may want the additional security of having a shareholders agreement.

Shareholders Agreement

In addition to the replaceable rules or a constitution, some company’s have a shareholders agreement because from time to time internal conflicts can arise between shareholders, or friends and family who are shareholders and the company constitution may not anticipate how every contingency is to be dealt with.

A shareholders agreement is in effect a “contract” between the shareholders that inter alia governs their business arrangements such as how shares are to be valued in a limited market, and spells out in more detail than the replaceable rules what their rights, responsibilities, obligations and liabilities may be.

Typically a Shareholders Agreement will deal with company funding, the entrance or exit of shareholders on the register, the appointment of directors as well as the management and direction of the business and how disputes ought to be resolved without necessarily having to resort to litigation.

Its purpose is to anticipate some of the issues that may arise during the life of a business, and determine in advance, how such issues should be dealt with. The additional security provided by a shareholder agreement is just one way of making a share investment in a SME more attractive to prospective investors.

Solvency and or shareholder oppression

'Solvency' is defined in s 95A (1) of the Act as the ability to pay all debts as and when they become due and payable. A person or organisation who is not solvent is 'insolvent' (s 95A(2)). For proprietary companies with a sole director it should not be too difficult to establish whether the company is solvent or not; however, when there are two or more directors, solvency issues can lead to a decision making crisis.

As a director or minority shareholder you may find yourself in a situation whereby information has been withheld or a majority shareholder has taken or proposes to take action that unfairly prejudices you and or other minority shareholders.

In such cases Section 232 of the Act allows a court to grant relief to a shareholder if the court is of the opinion that the conduct of a company’s affairs; is either contrary to the interests of the shareholders as a whole; or oppressive i.e. unfair to a shareholder or shareholders.

Section 233 of the Act provides that the court can make any order that it considers appropriate in relation to the company, including for example an order that the company be wound up; or limiting your personal liability if possible (i.e. s 588G considerations).

What do you do if the company is in financial difficulty?

If you suspect your company is in financial difficulty, get proper accounting and legal advice as early as possible, in order to:

(a.)    discharge your duties as a director;

(b.)    limit your personal liability if possible (i.e. s 588G considerations); and

(c.)    because early intervention increases the likelihood of the company surviving.

An insolvency accountant can conduct a solvency review of your company and outline available options which may include refinancing, restructuring the company, changing its business activities, or appointing an external administrator. An insolvency lawyer can advise you in relation to your legal options if other directors resist implementing the decisions required to prevent any insolvent trading.

Of course, in some instances the company’s financial circumstances are so bad that a creditor of the company may force your hand and seek to have a receiver appointed to take control of some or all of the company’s assets.

Absent a creditor or court appointed receiver, unless it is possible to restructure, refinance or obtain equity funding to recapitalise the company, your insolvency accountant may advise you to consider voluntary administration (which may lead to a deed of a company arrangement (DOCA)) or liquidation.

For a preliminary discussion in relation to your duties as a director, shareholder agreements, shareholder oppression or solvency concerns, please contact David Brett at DTCH Lawyers.

Email: dbrett@dtch.com.au

Web: www.davidbrettlaw.com

Telephone: (03) 8611 9840

Mobile: 0416 034 466