Restrictions on enforcing guarantees provided by directors of companies in administration

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25 February 2011

The recent Queensland Supreme Court case of Bank of Western Australia Ltd v Clift [2010] QSC 366 indicates that the protection provided by section 440J of the Corporations Act to company directors, their spouses or relatives from claims during a company administration in relation to guarantees, may not be as absolute as previously thought.

Facts

The plaintiff lent money to two companies, TDC Acquisition Pty Ltd (TDC) and Medeco Australia Pty Ltd (Medeco). The defendant was the sole director of TDC and Medeco. The defendant also guaranteed the loans provided by the plaintiff to TDC and Medeco.

Medeco went into administration in February 2010. The plaintiff issued default notices to TDC and Medeco, followed by demands to the defendant under the guarantees.

Medeco went into liquidation in March 2010. In May 2010, the plaintiff commenced a proceeding against the defendant seeking to enforce the guarantees. Subsequently, in August 2010, an administrator was appointed to TDC.

The plaintiff then applied for summary judgment against the defendant in the existing proceeding.

The provisions

Section 440J(1) of the Corporations Act provides that during a company administration, a guarantee of a liability of the company cannot be enforced (except without leave of the Court) against a director, or a spouse, de facto spouse or relative of the director.

The question for determination was whether leave of the court was required in accordance with s 440J(1) of the Corporations Act in order to enforce the defendant’s guarantees, such as seeking summary judgment in an existing proceeding.

Decision

Justice Wilson found in favour of the plaintiff and held that for the purposes of s 440J(1) leave was not required to take a further step in a proceeding already on foot.

Her Honour drew a distinction between s 440J and the preceding sections of the Corporations Act, which provide that a proceeding may not be begun or proceeded with without leave. Wilson J stated that the chronological sequence in which s 440J(1)(a) and s 440J(1)(b) appear indicates that the legislature did not intend the maintenance of a proceeding already on foot to be caught by the prohibition.

Her Honour considered the explanatory memorandum which accompanied the introduction of s 440J(1), stating that "there was concern that directors of insolvent companies would be discouraged from appointing administrators if guarantees became enforceable as soon as administrators were appointed". However, her Honour found that rather than just applying to situations where the appointment of an administrator would actually trigger liability under a guarantee, the true rationale of s 440J is the administrator’s need for the continuing co-operation of the directors in carrying on the business of a company under administration. By maintaining a proceeding already on foot as opposed to the appointment of an administrator triggering a liability under a guarantee, her Honour stated that in the present case, the potential for discouragement of director cooperation appeared to be less.

Relevantly, the guarantor did not appear at the hearing and no contradictory arguments appear to have been put to her Honour. It remains to be seen whether a similar interpretation will be adopted by other Courts.

Comment

The decision reinforces the importance of company directors seeking professional advice at the earliest indicators of a companies’ potential insolvency. It also highlights the potential advantage to creditors of commencing a proceeding to enforce a guarantee prior to a company entering into administration.