Insolvent Trading: Lessons From One.Tel Paul J Hayes Barrister-at-Law Owen Dixon Chambers West (Dever’s List) - Melbourne 39 Essex Street Chambers - London Insolvency Practitioners Conference 31 August 2006 PAUL J. HAYES BARRISTER-AT-LAW Insolvent Trading: Lessons From One.Tel A Case Study: The story of One.Tel… • The prospect of an allegation of “insolvent trading” is one which strikes fear into the heart of the most hardened company director, when the director is seeking to manage the affairs of a company in financial difficulty. • In support of this proposition, one need look no further than the reactions of James Packer and Lachlan Murdoch, when One.Tel spectacularly crashed in May 2001, with a deficiency of assets in the vicinity of AUD$240 Million. When it appeared that One.Tel may have been trading while insolvent, each of Packer and Murdoch (both non-executive directors of One.Tel), promptly claimed to have been “profoundly mislead” as to the company’s financial position (ie. solvency) by One.Tel Executive Directors Jodee Rich and Brad Keeling. • Following One.Tel’s demise, ASIC commenced civil proceedings in the New South Wales Supreme Court against Rich, Keeling, Finance Director Mark Silberman and One.Tel Chairman, John Greaves seeking orders that the 4 defendants be jointly and severally liable to pay compensation to the liquidator of the company, in the amount of AUD$92 Million. The AUD$92 Million compensation sought represented the amount ASIC believed One.Tel lost between February 2001 (the date alleged by ASIC to be from when One.Tel continued to trade while insolvent) and May 2001, when One.Tel was placed into liquidation. • The case against Keeling was settled in 2003. He was disqualified from managing a corporation for 10 years and ordered to contribute to the compensation sought by ASIC. (Keeling went bankrupt in 2003). PAUL J. HAYES BARRISTER-AT-LAW Insolvent Trading: Lessons From One.Tel A Case Study: The story of One.Tel continued… • Greaves too settled the case brought against him in 2003 and he was disqualified from managing a corporation for 4 years and ordered to pay AUD$20 Million compensation to the Liquidator of One.Tel. Greaves entered into an arrangement pursuant to Part X of the Bankruptcy Act 1966, with the consent of ASIC. Greaves initially contended that he too was a victim of relying upon financial information provided to him by others, which was limited or inaccurate. ASIC proceeded against Greaves though as it was contended that the case against him was stronger than that against Packer and Murdoch, (and the other non-executive directors), by reason of Greaves’s position as Chairman of the company and an expectation that he ought to have exercised a greater vigilance over the company’s affairs, more so than the other non-executive directors, by reason of his role. • The remainder of the case brought by ASIC against Rich and Silberman has not yet been concluded. It was originally estimated to run for 3 months. It has now been running for 2 years before Justice Austin (NSW Supreme Court) and is currently forecast to run until February 2007. ASIC in addition to seeking compensation will no doubt seek orders that Rich and Silberman be disqualified from managing a corporation for at least 10 years. • Packer and Murdoch as non-executive directors have not been made subject to any claim of insolvent trading (civil or criminal) and in fact gave evidence on behalf of ASIC in the proceedings it is running against Rich and Silberman, who unlike Keeling and Greaves, are contesting the claim brought by ASIC in the NSW Supreme Court against the 4 defendant directors of the former One.Tel. PAUL J. HAYES BARRISTER-AT-LAW Insolvent Trading: Lessons From One.Tel Part 5.7B, Divisions 3 to 5 Corporations Act Overview • Company Directors (executive and non-executive) have a statutory duty to prevent a company from trading while insolvent by reason of s. 588G Corporations Act . • Defences which may be relied upon by a company director in response to proceedings brought against him or her are set out under s. 588H Corporations Act . • Remedies in civil proceedings brought against a company director are prescribed by s.588J of the Corporations Act . • Holding Companies have the same liability for the insolvent trading of a subsidiary, as a company director does in the ordinary course, pursuant to ss.588V-Y of the Corporations Act . • Criminal liability for insolvent trading (fraudulent conduct) is established under ss. 588K Corporations Act . PAUL J. HAYES BARRISTER-AT-LAW Insolvent Trading: Lessons From One.Tel Insolvent Trading Under s.588G – Part 1 Liability under s.588G arises where: • a person is a director of the company, when the company incurs a debt; • the company is insolvent when it incurs the debt, or becomes insolvent because it incurs the debt; • when it incurs the debt there are reasonable grounds for suspecting that the company is insolvent or would become insolvent because it incurs the debt; and • the director is aware at the time the debt is incurred that there are reasonable grounds for suspecting the company is insolvent or where a reasonable person in a similar position in a company in the company’s circumstances would be aware. When is a debt is incurred? • In the case of ‘deemed debts’, the debt table set out under s.588G(1A) applies. Otherwise, the debt must be for a specific amount (ie. capable of calculation), it can be contingent (ie. in the case of a guarantee) and it must be voluntarily incurred by the company. PAUL J. HAYES BARRISTER-AT-LAW Insolvent Trading: Lessons From One.Tel Insolvent Trading Under s.588G – Part 2 Company Insolvent? • A company is insolvent if it is unable to pay its debts, as and when they fall due for payment, (s.95A), although a temporary lack of liquidity will not necessarily mean that a company is insolvent. Ultimately it is a matter of evidence. In some instances a company may be presumed to be insolvent where it has not kept proper records (s.588E(4) and s.286) and for an entire 12 month period, where on a winding up application it has been proved that during the 12 months prior to the date of the application, the company was at one time insolvent (s.588E(3)). In these latter cases, the presumption is one which is rebuttable by the director. (Note too “industry” and “economy” tests for insolvency. See: Manpac Industries Pty Ltd v Ceccattini [2002] NSWSC 330. See also generally: ASIC v Plymin [No.1] (2003) 175 FLR 124). Reasonable Grounds for Suspecting Insolvency? • The test is that of a director of ordinary competence who is capable of understanding the company’s financial status . More than mere speculation is needed – a positive feeling of actual apprehension of insolvency has been judicially suggested. Knowledge of Director? • Actual knowledge or the constructive knowledge of a financially literate reasonable director in comparable circumstances is required. PAUL J. HAYES BARRISTER-AT-LAW Insolvent Trading: Lessons From One.Tel Defences Four Defences are available to a Director under s.588H where there: • are reasonable grounds or good reason to have expected solvency; An expectation requires more than a mere hope or a possibility – a measure of well founded confidence in the company’s solvency would satisfy the test. • has been reasonable reliance on information provided by others; The One.Tel Defence (discussed below). • has been proper absence from management; and Illness or a ‘good reason’ is needed (s.588H(4)). • have been steps taken to prevent the incurring of the debt. Reasonable steps are necessary and include whether a view was taken by the director as to the appointment of an Administrator to the company’s assets and undertaking at the appropriate time. (s.588H(6)). PAUL J. HAYES BARRISTER-AT-LAW Insolvent Trading: Lessons From One.Tel The “One.Tel” Defence Reasonable Reliance on Information Provided by Others (s.588H(3)) • According to Packer and Murdoch, they were “profoundly mislead” by Rich and Silberman as to the state of One.Tel’s financial affairs in the months leading up to its demise in May 2001. • The defence is not available where non-executive directors have been passively acquiescent and have not undertaken their common law and statutory duties to the company by not actively participating in the management of the company and have unreasonably relied upon others to manage the company’s affairs. (See: Metal Manufacturers Ltd v Lewis (1988) 13 NSWLR 315 per Kirby P and ASIC v Plymin [No.1] (2003) 175 FLR 124 (Water Wheel ) per Mandie J). • The director must be able to demonstrate that he or she had reasonable grounds to believe and did so believe, that the person providing information as to the company’s solvency was competent and reliable, (ie. an executive director such as the CEO or CFO), that they adequately and properly discharged their role and that the information as to the company’s solvency was complete and accurate, so as to enable the director to make an informed and considered assessment of the company’s financial position. (See: Manpac Industries Pty Ltd v Ceccattini [2002] NSWSC 330 per Young CJ in Eq. See also: s.189 re director’s duties – reliance on information provided by others). • Fraud or dishonesty on the part of the person providing the information as to the company’s solvency to the director concerned would obviously fall within parameters of this defence. (See also: s.588E(6) which provides that there is no presumption of insolvency under s.286(2), where an officer improperly destroys or manipulates the company’s records without the director’s knowledge).