The importance of directors informing themselves as to their companys financial position

12 February 2010

The case of Cooper v Commissioner of Taxation [2009] NSWSC 880, is a useful illustration of the importance of directors ensuring that their company maintains proper financial records and that they inform themselves as to their company’s financial position.

The liquidator of Butler Blackberry Pty Ltd (the Company) sought orders that amounts paid by the Company to the Commissioner of Taxation (the Commissioner) amounted to an unfair preference and were therefore voidable transactions under section 588FE of the Corporations Act 2001 (Cth).

Commissioner of Taxation’s statutory indemnity from directors

The Commissioner did not dispute that if the Company was insolvent, the payments made to it amounted to an unfair preference. However, the Commissioner sought a statutory indemnity from the director of the Company under section 588FGA as the amounts paid had been applied to the Company’s tax obligations. There are certain defences available to directors found in section 588FGB. They are similar to the insolvent trading defences found in section 588H.

The Company’s director attempted to rely on the statutory defences that:

  • he had reasonable grounds to expect and did expect that the Company was solvent and would remain solvent even if it made the payment; and/or
  • he had reasonable grounds to believe and did believe that competent and reliable persons, in the form of two internal employees responsible for keeping the finances of the Company and also an external accountant for the Company, were responsible for providing him with adequate financial information about whether the Company was solvent and that those persons were fulfilling that responsibility.

Financial records

The Company did not produce financial statements for the 2005, 2006 and 2007 years until November 2007.

The Company originally used MYOB/Excel software but due to being unable to generate accurate staffing reports the Company changed to Work Desk. After this change, the director would request reports regarding the profit and loss, superannuation and workers' compensation. However, even with the new software, the Company was still not able to access this information effectively.

The director had been concentrating on existing clients, getting new clients and developing income streams for the Company and he claimed that he thought others were looking after the financial side of things.

Director unable to establish defence

The Commissioner succeeded in recovering over $70,000 from the director.

The NSW Supreme Court held that the “financial records of the company were in an unacceptable state", and that because of this no reasonable grounds were established on which the director could reasonably expect that the Company was solvent.

As to whether the director had reasonable grounds to rely on information from others the judge said the evidence established that other people were not providing the director with adequate information about whether the Company was solvent because the Company's financial record keeping was not operating, or at least not operating adequately. However, the director’s conduct must be judged not only on what he knew but on what he ought to have known. The director took no steps to inform himself as to the Company’s financial position.

Concluding comment

It is important that:

  • good financial records be maintained so that a company and its directors are able to monitor the company’s solvency; and
  • directors take steps to read, understand and inform themselves as to the company’s financial position.

If these standards are not met, company directors will be unable to take advantage of the “safe harbour” defences to the Commissioner’s statutory indemnity in section 588FGB or to a claim of insolvent trading in section 588H.

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