Exam
Sources of Directors' Duties
Directors' obligations in Australia originate from three primary sources:
General Law: This encompasses common law and equitable principles, from which
fiduciary duties have evolved.
Company's Constitution and Replaceable Rules: These internal documents can
define or modify directors' powers and responsibilities.
Corporations Act 2001 (Cth): This is the main piece of legislation regulating
corporate conduct in Australia, including specific statutory duties for directors and
officers.
Key Fact: Section 185 of the Corporations Act explicitly states that general law duties
apply in addition to statutory duties, meaning directors are subject to both sets of
obligations.
Classification and Nature of Fiduciary Duties (General Law)
Fiduciary duties are rooted in equitable principles, emphasising loyalty and honesty,
and are generally owed to the company.
In rare, specific circumstances a fiduciary duty may extend to an individual shareholder,
particularly when one director has a clear information advantage over another.
company sues
The primary fiduciary duties are:
Duty to Act in Good Faith and in the Best Interests of the Company:
Directors must genuinely believe they are acting for and in the company's
interests.
While some cases have viewed this subjectively, courts increasingly incorporate
an objective element, assessing whether "no reasonable director could have
held such a belief".
"Best interests": For solvent companies, this generally equates to the collective
interests of shareholders ("shareholder primacy").
Insolvency: When a company is insolvent or nearing insolvency, its best
interests "may correspond to the interests of its creditors rather than its
shareholders.”
Duty to Act for a Proper Purpose:
Exam Notes 1Directors' powers, such as issuing shares, must be used for the purpose for
which they were conferred.
An improper purpose often involves manipulating control or diluting shareholder
voting power, even if it appears to benefit the company on the surface
The "but for" test is applied when a share issue has a dual purpose; it will be
invalid if it would not have occurred "but for" the improper purpose.
Duty to Avoid a Conflict of Interest + Duty to Retain Discretion:
This duty arises when there is a "substantial possibility of conflict" between a
director's personal interests and those of the company.
Examples include taking corporate opportunities, personally profiting from
company transactions, or misusing company funds.
Disclosure is crucial: Full and frank disclosure to the board (and in some cases
shareholders) can relieve a director of a breach. However, incomplete disclosure
is insufficient.
Duty to Act with Reasonable Care and Diligence:
Today, an objective standard applies, requiring directors to exhibit the "degree
of care and diligence that a reasonable person would exercise if they...occupied
the office held by, and had the same responsibilities within the corporation as,
the director or officer"
a reasonable person test.
Directors are expected to be proactive, keep informed, attend meetings, make
their own inquiries, and participate in decision-making. Directors must be
involved in management, read and understand financial statements, and inquire
into matters that reasonably attract scrutiny, even outside their expertise
Enforcement and Remedies for Fiduciary Duties
Fiduciary duties are enforced by the company itself, or by a liquidator if the
company is in liquidation. ASIC may also bring actions on behalf of the company in
the public interest (ASIC Act s 50).
Remedies include:
Damages/Compensation: For losses suffered by the company.
Account of Profits: For gains made by the breaching director.
Rescission of Contract: If the breach involved a contract.
Injunction: To prevent or require certain actions.
Constructive Trust: To compel the breaching director to hold property or
benefits gained in trust for the company.
Exam Notes 2Ratification of Fiduciary Duties
Shareholders, through a general meeting, can ratify (approve or forgive) a director's
breach of general law (fiduciary) duties.
Limitations on Ratification:
Insolvency: Ratification is not possible if the company is insolvent, as creditors'
interests are paramount.
Fraud on Minority Shareholders: Ratification is ineffective if it constitutes "a
fraud on the remaining (minority) shareholder".
Statutory Duties: Ratification is not available for breaches of statutory duties
under the Corporations Act.
Dishonesty/Fraud: Ratification is "not possible when a director acted
fraudulently or dishonestly"
Statutory Duties under the Corporations Act
These duties apply to directors and other officers (ss 180-184) and in some cases
employees (ss 182-183), defined broadly to include those who manage the corporation
(s 9AD, s 179).
ASIC sues
Section 180: Care and Diligence (Civil Obligation):
Reflects the objective standard of care and diligence.
Directors must be:
Keeping themselves informed about company matters.
Attending meetings regularly.
Making their own independent inquiries rather than simply relying on
information from others.
Actively participating in decision-making processes.
Directors have an objective, non-delegable duty to be able to read and understand
the company's financial statements. A director cannot simply rely on the existence
of internal systems to fulfill this duty.
The Modern Objective Standard
Under both general law and statute, the assessment of a director's care and
diligence is an objective exercise.
The Business Judgment Rule (BJR) - Section 180(2)
Section 180(2) offers a defense for directors who have made a "business judgment,"
defined in s180(3) as any decision to take or not take action regarding the business
Exam Notes 3operations of the company. To successfully rely on the BJR, a director (who bears the
onus of proof) must demonstrate they have met four conditions:
1. Made the judgment in good faith for a proper purpose.
2. Had no material personal interest in the subject matter of the judgment.
3. Informed themselves about the subject matter to the extent they reasonably
believed appropriate.
4. Rationally believed that the judgment was in the best interests of the company.
The BJR is not an absolute shield.
The rule does not protect a director where a breach involves a failure to monitor the
company's affairs.
Section 181: Good Faith (Civil Obligation):
"Mirrors the general law (fiduciary) duty to act in good faith, in the best interests
of the company and for a proper purpose."
Section 182: Use of Position (Civil Obligation):
Prohibits directors, officers, or employees from improperly using their position to
"gain an advantage for themselves or someone else; or cause detriment to the
corporation."
Section 183: Use of Information (Civil Obligation):
Prohibits directors, officers, or employees from improperly using information
obtained through their position to "gain an advantage for themselves or
someone else; or cause detriment to the corporation." This duty continues even
after leaving the company.
Phoenix activity: Directors of insolvent companies transferring assets to new
entities may breach ss 182 and 183. Advisers facilitating such activity can also be
"involved" in contraventions (s 79), leading to disqualification.
Section 184: Good Faith, Use of Position and Use of Information (Criminal
Offences):
This section applies when conduct under ss 181, 182, or 183 is committed with
recklessness or dishonesty.
Dishonesty is defined in s 9 as "dishonest according to the standards of
ordinary people," introducing an objective element.
Breaches carry severe criminal penalties, including up to 15 years imprisonment
and substantial fines (Schedule 3).
Section 588G: Insolvent Trading (Civil and Criminal):
Applies only to directors (including "de facto" and "shadow" directors, s 9AC).
Exam Notes 4Requires directors to ensure the company does not incur debts if there are
"reasonable grounds to suspect that the company is insolvent."
Breach can lead to civil penalties (fines, disqualification, compensation) or
criminal penalties if dishonesty is involved (s 588G(3)).
A director must ensure the company is not insolvent when it incurs a debt, or
they risk personal liability for those debts.
The standard applied is objective: whether a reasonable director in the
circumstances would have suspected insolvency. This duty reinforces the broader
obligation for directors to remain consistently informed about the company's
financial position.
Corporations Act Section 191 - Director's duty to notify other directors of
material personal interest when conflict arises
Enforcement and Penalties for Statutory Duties
Statutory duties are primarily enforced by ASIC, which has powers to investigate
(ASIC Act s 13), commence prosecutions (s 49), and initiate civil proceedings (s 50).
Civil Penalties
s 1317G: Monetary fine (maximum for an individual: greater of 5,000 penalty
units or 3× the benefit gained/detriment avoided). Pecuniary Penalty (Civil)
s 1317E:
If a director breaches certain duties (care, good faith, misuse of
position/info, insolvent trading), the court must declare the contravention.
The declaration is conclusive evidence and must detail who, what, and how.
After this, ASIC can impose fines or disqualify the director.
Compensation Orders (s 1317H): Directors can be ordered to compensate the
company for damages.
Relinquishment Orders (s 1317GAB): To pay the Commonwealth an amount
equal to the benefit derived/detriment avoided. Director must relinquish
personal benefit obtained from breach.
Refund Orders (s 1317GA): For fees received after termination of arrangements.
Disqualification from Managing a Corporation (s 206C): A protective and
punitive measure.
The standard of proof for civil penalties is the "balance of probabilities." Honesty
may be considered in determining relief.
Criminal Penalties (s 184, Schedule 3, s 1311B, 1311C):
Apply when statutory breaches involve recklessness or dishonesty.
Exam Notes 5Include imprisonment (up to 15 years for serious offenses) and fines.
Fines are calculated based on penalty units and the term of imprisonment, with
corporate fines significantly higher than individual fines.
Criminal proceedings can follow civil proceedings for the same conduct
Key Fact: Sections 199A-199C prohibit companies from insuring directors for wilful
misconduct or breaches of ss 182 and 183.
Corporate Governance and Corporate Social Responsibility
Corporate Governance refers to the framework of rules, relationships, systems and
processes within and by which authority is exercised and controlled in corporations.
ASX Corporate Governance Principles and Recommendations:
These are guidelines for listed companies, operating on an "if not, why not?"
basis (ASX Listing Rule 4.10). Companies must either comply or explain non-
compliance. They cover eight principles, including:
1. Lay solid foundations for management and oversight.
2. Structure the board to be effective and add value (e.g., independent directors,
diversity).
3. Instil a culture of acting lawfully, ethically, and responsibly (e.g., code of
conduct, whistleblower policy).
4. Safeguard the integrity of corporate reports (e.g., audit committee, CEO/CFO
declarations).
5. Make timely and balanced disclosure.
6. Respect the rights of security holders.
7. Recognize and manage risk.
8. Remunerate fairly and responsibly.
These principles are "hybrid laws" – not statutory but persuasive, reflecting
contemporary governance standards and adapting to issues like board diversity.
Financial Reporting and Disclosure Framework
The financial reporting and disclosure obligations aim to ensure transparency and
provide stakeholders, particularly investors, with access to critical information. The
complexity of these obligations varies based on the company's size and type, with listed
entities facing the most stringent requirements.
Core Obligations
Exam Notes 6The fundamental reporting obligations are mandated by the Corporations Act:
Obligation Section Applicable To
Keep financial records s286 All companies
Prepare annual financial & directors'
reports
s292 Large proprietary & public companies
Obtain an audited financial report s301 Large proprietary & public companies
Prepare half-yearly audited financial
reports
s302 Disclosing entities (e.g., listed
companies)
Small proprietary companies are generally exempt from preparing annual reports unless
directed to do so by members holding at least 5% of voting shares (s293) or by ASIC
(s294).
Content and Standards
The substance of financial reporting is governed by strict standards to ensure accuracy
and fairness:
Compliance s296 Financial reports must comply with Australian
Accounting Standards
True & Fair View s297
Reports must present a "true and fair view" of
the company’s financial performance and
position
Directors’ Declaration s295(4)
Directors must formally declare that the
financial statements comply with accounting
standards and provide a true and fair view.
Record Keeping s286(2)
s288
Financial records must be retained for seven
years (s286(2)).
Electronic records must be convertible into
hard copy (s288).
Record Keeping outside
Australia
s289 If records are kept outside Australia, ASIC
must be notified of their location.
Continuous Disclosure for Disclosing Entities
The continuous disclosure regime is a critical mechanism for market integrity, designed
to ensure that all investors have equal and timely access to price-sensitive information.
Its primary purpose is to prevent an "uneven playing field" rather than to achieve perfect
or absolute disclosure.
Legislative and Regulatory Framework
The obligation is enforced through the Corporations Act and the ASX Listing Rules for
listed entities.
Corporations Act (ss 674–675A): A disclosing entity must immediately disclose
information that is not generally available if a reasonable person would expect it to
Exam Notes 7have a material effect on the price or value of its securities.
Section 677 defines "material effect" as information likely to influence persons
who commonly invest in deciding whether to acquire or dispose of securities.
ASX Listing Rules (Rule 3.1): This rule requires listed entities to disclose market-
sensitive information "immediately," a term interpreted to mean "prompt and
vigorous, without any delay." ASX Guidance Note 8 provides detailed explanations
and practical examples to help companies comply.
Exceptions (Listing Rule 3.1A): Disclosure is not required for certain information,
such as incomplete negotiations or trade secrets, provided the information remains
confidential and a reasonable person would not expect it to be disclosed.
Enforcement
Enforcement of continuous disclosure rules is managed by both ASX and ASIC.
ASX Inquiries: The ASX monitors trading activity and can issue a "Price and Volume
Query" or "Aware Query" to a company to seek an explanation for unusual share
price movements, effectively policing compliance with Listing Rule 3.1.
ASIC Infringement Notices: ASIC can issue infringement notices for alleged
contraventions of s674(2) or s675(2). This provides a swift enforcement mechanism.
The Role and Duties of Auditors
Auditors serve as an essential external check, examining company accounts to expose
irregularities and provide assurance to shareholders and other stakeholders. Their
liability can arise in contract, tort, and under the Corporations Act.
Auditor Independence
Independence is fundamental to the auditor's role. The CLERP (Audit Reform and
Corporate Disclosure) Act 2004 introduced significant reforms to foster this principle.
General Requirement (s324CA): Auditors must remain independent of the audited
body, which involves avoiding conflicts of interest. Section 324CH lists
circumstances that may create a conflict, such as being an officer of or having an
investment in the client company.
Mandatory Rotation (s324DA): Individuals playing a significant role in the audit of a
listed company must be rotated after a maximum of five successive years (with a
possible two-year extension).
Waiting Period (s324CI): A two-year "cooling-off" period is required before a
member of an audit team can become a director or take a senior management
position in the client company.
Oversight: ASIC plays a key role in monitoring audit quality and can refer matters to
the Companies Auditors Disciplinary Board (CADB), which has the power to cancel
or suspend an auditor's registration.
Exam Notes 8Statutory Duties
Auditors have specific duties under the Corporations Act (ss 307–313):
Form an Opinion s269
An auditor's principal duty is to
form an opinion on whether the
company's financial report
complies with accounting
standards.
Form an Opinion s297
An auditor's principal duty is to
form an opinion on whether the
company's financial report
provides a "true and fair view".
Report to ASIC s311
Auditors must notify ASIC if
they have reasonable grounds
to suspect a significant
contravention of
the Corporations Act.
Comply with Standards s307A
Audits must be conducted in
accordance with Auditing
Standards.
Right of Access s310
Auditors have a right of access
to the company's books and
can require information from
company officers.
General Law Duties and Liability
Liability to the Company: Auditors owe a duty to the company to exercise
reasonable care and skill.
Liability to Outsiders: An auditor's liability to third parties (e.g., investors who rely
on an audit) is limited.
Foreseeability of third-party reliance is insufficient to establish a duty of care. A
plaintiff must prove the auditor knew or should have known the information
would be communicated to them for a purpose that would be very likely to lead
them to enter into a specific transaction and risk economic loss.
Audit Committees
For larger listed entities, audit committees are a key governance structure.
ASX Listing Rule 12.7: Companies in the S&P All Ordinaries Index must have an audit
committee (largest 500 companies in the Australian equities market)
ASX Recommendations: For companies in the S&P/ASX 300 Index, it is
recommended that the committee have at least three members, all non-executive
directors, with a majority being independent. The chair of the audit committee
should not also be the chair of the board.
Exam Notes 9Role: The committee's role includes making recommendations to the board on the
engagement of auditors and overseeing the internal audit function.
Members Rights & Company Meetings
“Leave to appeal” = permission to appeal a court decision.
“Leave to bring proceedings” = permission to start a case.
Leave means permission from courts
The Foundation of Members' Rights
Members are shareholders except in companies limited by guarantee (and some
pre-1998 unlimited companies). Companies limited by guarantee do not have a share
capital.
Limited by guarantee: Public only and members guarantee a certain amount upon
winding up.
Unlimited companies: Members have unlimited liability.
Members, typically shareholders in companies limited by shares, are the owners of a
company. Their rights derive from both general law and the Corporations Act 2001 (Cth).
These rights are broadly categorised into two main types: personal and derivative.
Personal Rights
Personal rights belong to and are enforceable by the individual shareholder. They
protect the member's individual interests in the company. These rights can be:
Contractual: Such as the right to enforce the company's internal rules under s140 of
the Corporations Act.
Procedural: Including the right to receive proper notice of meetings, to vote, to
inspect company books (s247A), and to correct the member register (s175).
Substantive: Key statutory protections fall under this category, most notably the
right to seek a remedy for oppressive conduct under s232.
Personal rights — belong to the member themselves. The member sues in their own
name because they were directly affected (e.g. denied a vote, dividend, or fair
treatment).
Derivative Rights
The cause of action belongs to the company itself, not the shareholder. When a
shareholder brings a derivative action, they are acquiring the company's right to sue and
are bringing proceedings on behalf of the company. This typically occurs when the
Exam Notes 10company has suffered a wrong but those in control (i.e., the directors) refuse to take
legal action.
Derivative rights — belong to the company, but a member can sue on behalf of the
company when the company has been wronged (e.g. a director breached their duty).
The harm is to the company, not the individual.
The Statutory Derivative Action (s236 & s237)
The right to bring a derivative action at general law is now explicitly abolished by
s236(3) of the Corporations Act.
The sole mechanism for a member to sue on behalf of the company is now the statutory
derivative action provided in Part 2F.1A of the Corporations Act.
Section 236 allows a member, former member, officer, or former officer to bring or
intervene in proceedings on behalf of a company, provided they are granted leave by
the court under s237. Any such proceedings must be brought in the company's name.
Section 237 establishes a mandatory, five-part test that an applicant must satisfy for the
court to grant leave. The court must grant the application if it is satisfied of all the
following criteria:
Section Criterion for Granting Leave Judicial Interpretation & Key Cases
s 237(2)(a)
It is probable that the company
will not bring the proceedings
itself.
Can be inferred from circumstances, such
as deadlock between directors or where the
action is against the major shareholder.
s 237(2)(b) The applicant is acting in good
faith.
A personal interest does not necessarily
indicate a lack of good faith but prior
inaction and benefiting from the conduct
complained of can.
s 237(2)(c)
It is in the best interests of the
company that leave be granted.
The court considers factors like the
prospects of success and the financial
burden on the company.
s 237(2)(d)
There is a serious question to be
tried.
This is a low threshold, similar to that for an
interlocutory injunction. It requires an
infringement of a legal or equitable right.
s 237(2)(e)
The applicant has given 14 days'
written notice to the company, or
it is appropriate to grant leave
anyway.
This requirement can be waived by the
court where the company is already on
notice of the applicant's intentions.
Rebuttable Presumption (s237(3)): A presumption arises that granting leave is not in
the company's best interests if the proceedings involve a third party, and the company's
directors decided not to pursue the action while acting in accordance with the business
judgment rule (i.e., in good faith, for a proper purpose, and with a rational belief that
Exam Notes 11their decision was in the company's best interests). The applicant member then has the
onus to rebut this presumption.
3. Personal Rights and the Oppression Remedy
Members possess a range of personal rights that can be enforced directly, with the
statutory oppression remedy being the most powerful tool for minority shareholders.
3.1 Overview of Personal Rights
Shareholders' personal rights include:
Category Examples Section Reference (if
applicable)
Contractual Rights Right to enforce the company's internal rules. s140
Protection of rights attached to a specific
class of shares.
-
Procedural Rights Right to inspect company books. s247A
Right to correct the member register. s175
Right to challenge a variation of class rights. s246D
Right to receive due notice of meetings, ask
questions, and vote.
-
Substantive
Protections
Applying for an injunction to stop a
contravention of the Act.
s1324
Applying to correct a procedural irregularity. s1322
Applying to wind the company up. s461
Applying for a remedy for oppressive
conduct.
s232
The Oppression Remedy (s232)
Section 232 is a cornerstone of minority shareholder protection. A member can apply
for a court order if the company's affairs are being conducted, or a resolution is
proposed, in a manner that is:
Contrary to the interests of the members as a whole; or
Oppressive to, unfairly prejudicial to, or unfairly discriminatory against a member or
members.
The test for oppression is commercial unfairness, assessed objectively. As established
in Wayde v NSW Rugby League Ltd, the court considers whether the directors' decision
is one that no board of directors acting reasonably would have made.
Examples of oppressive conduct from case law include:
Diversion of Business Opportunity: Transferring a business opportunity from the
company to another entity controlled by the majority shareholders (Scottish Co-
Exam Notes 12operative Wholesale Soc Ltd v Meyer; Vadori v AAV Plumbing).
Unfair Course of Conduct: A combination of actions, such as diverting business,
paying high directors' salaries, and paying no dividends, which collectively oppress
a minority shareholder (Sanford v Sanford Courier Service).
Thwarting Legitimate Expectations: Altering the company's constitution to
extinguish a member's established right to receive a dividend (Sumiseki Materials v
Wambo Coal).
Exclusion from Management: Preventing a director/shareholder from participating
in management when there was a legitimate expectation of doing so (Campbell v
Backoffice Investments).
Conduct that is merely unpopular or disagreeable to the minority is not necessarily
oppressive. For example, restricted dividend payments were not found to be oppressive
in Morgan v 45 Flers Avenue Pty Ltd.
Remedies for Oppression (s233)
If oppression is established under s232, the court has broad powers under s233 to
make any order it considers appropriate. These orders include:
Winding up the company.
Modifying the company's constitution.
Regulating the future conduct of the company's affairs.
Authorizing a member to institute proceedings on behalf of the company.
Ordering the purchase of a member's shares by other members or the company
itself. This is a common and effective remedy, as seen in Vadori v AAV Plumbing,
where the court ordered the purchase of the oppressed member's shares at a price
that accounted for the business opportunities diverted from the company.
Shareholder Class Actions
A class action is a legal proceeding where a group of people with similar claims
collectively sue another party. In a company context, shareholder class actions typically
target a company's failure to provide proper public disclosure, leading to an inflated
share price. Shareholders may claim they suffered a loss because they either would not
have bought the shares or would have sold them earlier had they been given accurate
information.
Key aspects of shareholder class actions include:
Legal Basis: Often founded on breaches of continuous disclosure rules (ss 674A,
675A) or provisions against misleading or deceptive conduct (s1041H). For listed
entities, a fault element (knowledge, recklessness, or negligence) must now be
proven for such breaches.
Exam Notes 13Scale and Cost: These actions are incredibly costly and complex.
Litigation Funding: The growth of litigation funding, where a third party finances the
legal action in return for a percentage of the settlement, has been crucial to the
viability of many class actions. Recent legal and regulatory changes have confirmed
that these funding schemes are exempt from managed investment scheme
regulations.
Purpose: Proponents argue class actions serve a valuable function by promoting
market integrity, deterring corporate misconduct, and enabling investors to recover
losses. Critics question their cost-effectiveness and point to the significant portion
of any recovery that goes to lawyers and litigation funders.
Company Meetings
Company meetings are the primary mechanism for members to participate in corporate
governance and exercise their voting rights.
Types of Meetings
There are three main types of members' meetings:
1. Annual General Meeting (AGM): Compulsory for public companies, which must hold
their first within 18 months of registration and annually thereafter within 5 months of
their financial year-end (s250N).
2. Extraordinary General Meeting (EGM): Can be called at any time to deal with urgent
or specific matters that cannot wait for the next AGM.
3. Class Meeting: A meeting of members holding a particular class of shares, typically
to vote on a variation of their specific rights (s246B).
Meetings may be held at a physical venue, using a hybrid of physical and virtual
technology, or entirely virtually if permitted by the company's constitution (s249R).
Calling and Conducting a Meeting
Procedure Details and Key Sections
Calling an EGM
An EGM can be called by a director (s249C), the court (s249G), or
members. Members with at least 5% of votes can call a meeting at their own
expense (s249F) or request the directors to call one (s249D). If directors fail
to act on a s249D request within 21 days, the members can call the meeting
themselves, with the company bearing the reasonable costs (s249E).
Notice
Members must receive at least 21 days' notice (28 days for listed public
companies). The notice must specify the time, place, and general nature of
business, and include information about proxy votes (s249J, s249L).
Quorum The minimum number of members required to be present for business to be
validly transacted. The replaceable rule (s249T) sets the quorum at two
Exam Notes 14members, who must be present (physically or electronically) throughout the
meeting.
Resolutions
Business is transacted by passing resolutions: • Ordinary
Resolution: Requires a majority of more than 50% of votes cast. Used for
matters like electing or removing directors. • Special Resolution: Requires a
majority of at least 75% of votes cast. Used for more significant matters like
changing the company's constitution or name.
Voting Procedures
Voting can occur by:• Show of Hands: Each member has one
vote. • Poll: Each member has one vote for each share they hold (s250E). A
poll can be demanded by the chair, at least 5 members, or members with at
least 5% of the votes (s250L).
Proxies
A member can appoint a proxy to attend and vote on their behalf. Proxies
can be "directed" (instructed how to vote) or "undirected" (voting is at the
proxy's discretion). The chair of a meeting must vote directed proxies on a
poll as instructed (s250BB), but other proxy holders are not under the same
obligation.
Irregularities
A procedural irregularity (e.g., deficient notice) will not invalidate a
proceeding unless a court finds it has caused or may cause substantial
injustice (s1322).
Takeovers + Financial services and markets
Chapter 6 of the Corporations Act establishes the legal architecture for the acquisition
of control over companies, designed to protect the interests of target shareholders and
the integrity of the market.
Defining Control and the Purpose of Regulation
A takeover occurs when a bidder company seeks to gain control over a target company
by acquiring its shares. The level of control achieved is directly proportional to the
percentage of shares acquired:
Board Control (>50%): Sufficient voting power to pass an ordinary resolution, such
as electing directors.
Constitutional Control (75%): Sufficient voting power to pass a special resolution,
enabling changes to the company's constitution.
Total Control (100%): The target becomes a wholly-owned subsidiary, providing
administrative and tax consolidation benefits.
Purpose of Chapter 6 in s602 is to ensure that the acquisition of control in a listed
company, or an unlisted company with more than 50 members, takes place in
an efficient, competitive, and informed market.
Aims to balance the potential benefits of takeovers against their downsides.
The 20% Threshold and 'Relevant Interest'
Exam Notes 15A person cannot acquire more than 20% of a company’s voting shares unless they do it
through an approved method (like a formal takeover bid) under section 606.
Specifically:
You can’t go from 20% or below → above 20%, or
From 20%–90% → any higher percentage (unless an exemption applies).
Critically, this prohibition is not based on simple ownership but on the broader concept
of a "relevant interest" as defined in section 608. A person has a relevant interest in
securities if they:
Hold the securities;
Have the power to exercise, or control the exercise of, a right to vote attached to the
securities; or
Have the power to dispose of, or control the disposal of, the securities.
This definition is expanded by the concept of "associates" (s12), meaning if you act
together with someone else (like a partner company, family, or business ally) to control a
company, their shares count towards your total too.
That’s how ASIC prevents people from bypassing the 20% rule by splitting shares
between friends or entities.
Permitted and Exempt Acquisitions
Section 611 provides several exemptions and pathways for acquisitions beyond the 20%
threshold.
Exempt Acquisitions Include:
Acquisitions under a will or by operation of law (like a divorce settlement).
Acquisitions resulting from an Initial Public Offering (IPO) which is when the
business firsts lists on the ASX.
Creeping Takeovers: A bidder is allowed to acquire up to 3% every 6 months if they
hold 19% of the company’s shares for a continuous period of 6 months or more.
Permitted Means of Acquisition: These are formal takeover bids that comply with the
procedures outlined in the Corporations Act.
Feature Market Bid (ss634, 635) Off-Market Bid (ss632, 633)
Target Type Listed securities only Listed and unlisted securities
Bid Scope
Must be a full bid for all securities in
the class Can be a full or partial bid
Consideration Cash only Cash, securities, or a combination
Conditions Cannot be conditional Some conditions are permitted
Exam Notes 16Commonality Less common Most popular and common due to
flexibility
The Takeover Procedure and Disclosure Obligations
Bidder’s Statement (s636): This document must be lodged with ASIC and provided
to the target. It must detail:
bidder's identity,
terms of the bid
bidder's intentions regarding:
continuation of the target's business
any major changes
future employment of staff
Target’s Statement (s638): The target company's board must prepare this
statement for its shareholders. It must include:
directors' recommendation on whether to accept the offer or;
provide clear reasons if not and;
all information that shareholders and their advisers would reasonably require to
make an informed assessment of the bid
Expert’s Report (s640): An expert's report on whether the offer is "fair and
reasonable" must accompany the target's statement if the bidder is connected with
the target (e.g., has common directors) or already holds 30% or more of the target's
shares.
Section 670A specifically prohibits misleading or deceptive statements in takeover
documentation, imposing both civil and criminal liability on directors and experts for
false material or significant omissions.
Compulsory Acquisitions and Minority Shareholder Rights
The Corporations Act includes mechanisms to resolve the position of minority
shareholders following a successful takeover.
Compulsory Acquisition by Bidder (s661A): If a bidder and its associates acquire a
relevant interest in at least 90% of the bid class shares, and have acquired at least
75% of the shares offered under the bid, they may compulsorily acquire the
remaining shares on the same terms.
Right of Minority to be Bought Out (s662A): To prevent minority shareholders from
being "locked in" an illiquid investment, where a bidder reaches a 90% relevant
interest, they must offer to buy out the remaining shareholders.
Exam Notes 17General Compulsory Acquisition (ss664A, 664AA): A person who obtains a full
beneficial interest in at least 90% of a company's shares can compulsorily acquire
the remainder within six months of reaching that threshold, even if not part of a
formal takeover bid.
The Role of the Takeovers Panel
The Takeovers Panel, established under the ASIC Act, is the primary forum for resolving
takeover disputes during the bid period.
Function: It provides a mechanism for rapid and efficient resolution of disputes, with
applications able to be made by the bidder, target, ASIC, or any other affected party.
Powers: The Panel can make a declaration of unacceptable circumstances (s657A)
if conduct is deemed to undermine the principles of an efficient, competitive, and
informed market. Following such a declaration, it can make a wide range of orders
(s657D) to protect the rights of interested parties or remedy the situation.
Constitutional Standing: The High Court, in Attorney-General v Alinta Ltd (2008),
confirmed the Panel's constitutional validity, holding that it does not exercise judicial
power and functions as an administrative body.
Regulation of Financial Services and Market Conduct
(Chapter 7)
Chapter 7 of the Corporations Act provides a comprehensive framework for regulating
financial products, financial services, and market operations to ensure market integrity
and consumer protection.
2.1 Overview of Chapter 7 and Licensing
Chapter 7 applies to a broad range of financial products, including securities,
derivatives, and managed investment schemes. Any person carrying on a financial
services business must:
Hold an Australian Financial Services Licence (AFSL) (s911A).
Comply with the general obligations set out in s912A, which include
acting efficiently, honestly, and fairly; maintaining competence; managing conflicts
of interest; and implementing adequate risk management systems.
The Act also mandates specific disclosure documents, such as a Financial Services
Guide (FSG) and a Statement of Advice (SoA), particularly for retail clients, to ensure
they receive clear and adequate information.
Prohibited Market Conduct
To maintain a fair and equitable market, Chapter 7 prohibits several forms of
misconduct.
Exam Notes 18Short Selling (s1020B): Prohibits selling financial products that the seller does not
own, unless they have a "presently exercisable and unconditional right to vest" them
in the buyer.
Market Manipulation (s1041A): Prohibits transactions that have, or are likely to have,
the effect of creating an artificial price for a financial product.
False Trading and Market Rigging (s1041B): Prohibits creating a false or misleading
appearance of active trading, such as through fictitious transactions that involve no
change in beneficial ownership.
Misleading or Deceptive Conduct (s1041H): A general prohibition against engaging
in conduct in relation to a financial product or service that is misleading or
deceptive, or likely to mislead or deceive. This has been used by ASIC to prosecute
"greenwashing"—making false or misleading claims about the ethical or
environmental qualities of financial products.
The Law of Insider Trading
Insider trading is a primary focus of market conduct regulation due to its potential to
severely undermine investor confidence.
The Three Core Offences (s1043A)
Section 1043A prohibits a person (the "insider") who possesses "inside information" and
knows (or ought reasonably to know) that it is inside information from:
1. Trading Offence: Applying for, acquiring, or disposing of relevant financial products.
2. Procuring Offence: Procuring another person to trade in those products.
3. Tipping Offence: Communicating the information to another person if they know (or
ought to know) that the other person is likely to trade or procure someone else to
trade.
Key Legal Concepts
Inside Information (s1042A): Defined as information that is:
a. not generally available and
b. if it were generally available, a reasonable person would expect it to have a
material effect on the price or value of the financial products.
Generally Available (s1042C): Information is considered generally available if it
consists of "readily observable matter" or has been made known in a way likely to
reach common investors, with a reasonable time for dissemination.
Material Effect (s1042D): Information is deemed to have a material effect if it
"would, or would be likely to, influence persons who commonly acquire" those
financial products in deciding whether to buy or sell. The High Court in Mansfield v
Exam Notes 19R (2012) confirmed that information does not need to be accurate or true to be
considered "information" for the purpose of these provisions.
Penalties, Defences, and Compensation
Insider trading is subject to both severe criminal penalties (including up to 15 years
imprisonment) and civil penalties. A key defence for large corporations is the "Chinese
wall" (s1043F), where effective arrangements are in place to ensure that information
possessed by one part of the organization is not communicated to the individuals
making trading decisions in another part. Section 1043L allows parties who suffer loss
from a contravention (such as the counterparty to a trade or the issuing company) to
seek compensation.
Insolvency, Restructuring, Voluntary Administration,
Receivership
Under the Corporations Act 2001 (Cth), the definitions of solvency and insolvency are
fundamentally linked to a company's ability to meet its financial obligations.
Section 95A(1): A person (including a company) is solvent if, and only if, they are
able to pay all their debts as and when they become due and payable.
Section 95A(2): A person who is not solvent is insolvent. A company is also
automatically taken to be insolvent if it proposes a restructuring plan to creditors.
the action or activity of buying and selling goods and services = trading
A temporary lack of liquidity does not necessarily signify insolvency. This perspective
allows for the consideration of available resources such as unsecured borrowings or
extended credit arrangements (Lewis v Doran), and the fact that creditors may not
always demand strict adherence to payment terms (Southern Cross Interiors Pty Ltd v
Deputy Commissioner of Taxation).
In assessing insolvency, courts focus on present or contingent liquidated debts rather
than uncertain future liabilities. As established in Box Valley Pty Ltd v Kidd, potential
liabilities arising from a future default on a contract where no liquidated debt has yet
arisen are not typically included in the solvency assessment.
Warning Signs and Consequences
ASIC has identified numerous common warning signs of impending insolvency that
directors must monitor. Any delay in seeking professional advice can exacerbate
financial problems for the company and expose directors to personal liability.
Common Warning Signs of Insolvency:
Exam Notes 20Financial Indicators Operational Indicators
Low operating profits or poor cash flow Absence of a business plan or budgets
Inability to meet loan repayments on time Incomplete or disorganised financial records
Overdue taxes and superannuation liabilities Suppliers placing the company on cash-on-
delivery
Liquidity ratios below 1:1 Solicitors’ letters, demands, or judgments
Increasing debt (liabilities greater than assets) Board disputes and loss of key management
personnel
Inability to raise funds from shareholders Problems selling stock or collecting debts
Overdraft limit reached or defaults on loan
payments
Increased level of supplier or customer
complaints
Trading while insolvent is a serious breach that can result in civil penalty orders and, in
some cases, criminal charges. Directors may face prosecution, heavy fines, and
recovery actions from a liquidator or ASIC.
Courts look at balance sheet test and cash flow test (better than balance sheet test) to
establish insolvency.
ASIC v Plymen
The Regulatory Framework for Financial Distress
The Corporations Act provides a structured framework for managing corporate
insolvency, offering mechanisms that range from restructuring and rehabilitation to the
final winding up of the company.
Mechanism Part of
Corporations Act
Primary Purpose Key Feature
Scheme of
Arrangement
Part 5.1
Restructure or reorganise the
company (either members'
rights or creditors' debts).
Requires significant
court involvement for
approval.
Receivership Part 5.2
Allow a secured creditor to
recover its debt by taking
control of secured assets.
Primarily serves the
appointing creditor, not
all creditors.
Voluntary
Administration Part 5.3A
Quickly assess a company's
viability and allow creditors to
decide its future.
A fast, flexible process
initiated without court
approval.
Restructuring Part 5.3B
A streamlined process for
small, insolvent businesses to
develop a repayment plan.
Directors retain control
of the company during
the process.
Exam Notes 21Liquidation Part 5.4B
Wind up the company, sell its
assets, and distribute
proceeds to creditors.
The terminal stage; the
company ceases to exist.
The choice of mechanism depends on factors such as whether a creditor has security,
the amount of debt, and the potential for the company to continue trading. For ordinary
unsecured creditors, who rank last in a liquidation, restructuring options like voluntary
administration often provide a greater opportunity to recoup outstanding amounts.
Restructuring Mechanisms
Schemes of Arrangement (Part 5. 1)
A scheme of arrangement is a court-supervised process for reorganising a company's
relationship with its members or creditors.
Types of Schemes:
Creditors' Scheme: Used to rescue a company in financial difficulty through a
compromise (accepting part of a debt) or a moratorium (delaying payment).
Members' Scheme: Used by solvent companies for reorganizations, such as in
"friendly" takeovers. A notable example was the acquisition of Coles Group Ltd
by Wesfarmers Ltd in 2007.
Process:
1. An application is made to the court for an order to hold a meeting of creditors or
members (s 411(1)).
2. If approved, an explanatory statement is prepared for attendees.
3. The scheme must be approved by the requisite majority at the meeting (for
creditors, a majority holding at least 75% of the debt).
4. The court must grant final approval for the scheme to become binding (s 411(4)
(b)).
Drawbacks: For insolvency situations, creditors' schemes are less common than
voluntary administration because they are slow, complex, expensive, and the court
involvement creates uncertainty.
Advantages: They can be effective for complex insolvencies, particularly where
third-party releases are involved, potentially offering a wider application in
reorganizing insolvent companies (Fowler v Lindholm).
Small Business Restructuring (Part 5.3B)
Introduced by the 2020 insolvency reforms, this process is designed for eligible small
businesses to restructure their debts while directors retain control.
Exam Notes 22Eligibility: The company's total liabilities must not exceed $1 million. A director is
prohibited from using this process if they have been a director of another company
that has undergone restructuring or a simplified liquidation within the previous seven
years.
Process Overview:
1. Restructuring Phase: Directors resolve that the company is insolvent (or likely to
become so) and appoint a restructuring practitioner (who must be a registered
liquidator). A moratorium is placed on claims against the company.
2. Director Control: Directors retain control of the business but must obtain the
practitioner's consent for transactions outside the ordinary course of business (s
453L).
3. Restructuring Plan Phase: A restructuring plan must be proposed to creditors
within 20 business days. The company is deemed insolvent once the plan is
proposed (s 455A).
4. Approval: The plan is accepted if a majority of creditors (by value) agree. It then
binds the company, its officers, members, and all creditors.
Director Benefits: Directors are afforded "safe harbour" protection from insolvent
trading liability for debts incurred in the ordinary course of business during this
period (s 588GAAB).
3.3 Voluntary Administration (Part 5.3A)
Voluntary administration (VA) is the most utilized restructuring mechanism, providing a
rapid and flexible framework to resolve a company's solvency issues without initial court
intervention. Its objective is to maximize the chances of the company continuing in
existence or, if that is not possible, to provide a better return for creditors than an
immediate winding up (s 435A).
Commencement and Effect
Appointment of Administrator: An administrator can be appointed by:
The company's board of directors, if they believe the company is or is likely to
become insolvent (s 436A).
A liquidator or provisional liquidator (s 436B).
A secured party with a security interest over substantially all of the company's
property (s 436C).
Effect of Administration: A moratorium (or "stay") is immediately imposed, freezing
most creditor claims, legal proceedings, and winding-up actions against the
company. This provides the administrator with breathing space to assess the
company.
Exam Notes 23Exceptions to the Moratorium: A secured creditor with security over the whole (or
substantially the whole) of the company’s property is not bound by the stay if they
enforce their security within a 13-business-day "decision period" (s 441A).
Exceptions also exist for security enforced prior to administration (s 441B) and
security over perishable property (s 441C).
The Administrator's Role
Qualifications: The administrator must be a registered liquidator and independent of
the company (s 448B).
Control and Powers: The administrator takes full control of the company's business,
property, and affairs (s 437A). They have extensive powers to carry on the business,
investigate its financial position (s 438A), and dispose of property.
Director's Role: During administration, directors' powers are suspended. They may
only perform functions with the administrator's written consent (s 198G). Any
unauthorized transaction is void (s 437D).
Liability: The administrator is an "officer" of the company and owes fiduciary duties.
They are personally liable for debts incurred for services, goods, or hired property
during the administration (s 443A) but have a right of indemnity from company
assets (s 443D).
The Administration Process
The VA process follows a strict, condensed timeline:
1. First Creditors' Meeting (s 436E): Held within 8 business days of the
administrator's appointment. Creditors may decide whether to form a committee of
inspection to assist and monitor the administrator.
2. Administrator's Investigation and Report: The administrator investigates the
company's affairs and forms an opinion on the best path forward for creditors.
3. Meeting to Decide Company's Future (s 439A): This crucial meeting is held
approximately one month (a 20-business-day "convening period") after the
administration begins.
4. Creditors' Choices (s 439C): Based on the administrator's report, creditors vote to
resolve one of three outcomes:
Execute a Deed of Company Arrangement (DOCA): A binding agreement between
the company and its creditors to settle debts, often over time, allowing the business
to continue. This is the primary restructuring outcome of VA.
End the Administration: The company is returned to the control of its directors.
Wind up the Company: The company is placed into liquidation, and the
administrator typically becomes the liquidator.
Exam Notes 24A resolution is passed if a majority of creditors in both number and value vote in favour.
Creditor-Driven and Terminal Processes
Receivership (Part 5.2)
Receivership is not considered a formal restructuring process. It is a remedy used by a
secured creditor to enforce their security interest after a company has defaulted.
Appointment: Most receivers are appointed privately by a secured creditor under
the terms of a security agreement. A court can also appoint a receiver, for instance,
in shareholder oppression cases (s 233) or during an ASIC investigation (s 1323).
Receiver's Role: The receiver must be a registered liquidator (s 418). Their primary
duty is to the appointing creditor. They take control of the specific assets covered by
the security to sell them and repay the secured debt.
Powers and Duties: The receiver has broad powers under the Corporations Act (s
420) to manage and sell the company's property. They are also an "officer" of the
company and have a statutory duty to take all reasonable care to sell property for
not less than market value, or otherwise for the best price reasonably obtainable (s
420A), as explored in Florgale Uniforms Pty Ltd v Orders.
Liquidation (Part 5.4B)
Liquidation is the final form of external administration, resulting in the company being
wound up, ceasing to trade, and eventually being deregistered. This path is often
chosen when restructuring is not viable. The liquidator's role is to collect and sell the
company's assets and distribute the proceeds to creditors according to a statutory order
of priority. For ordinary unsecured creditors, the chance of any substantial return from a
liquidation is often minimal.
The Role of ASIC: ASIC plays a vital role in the insolvency landscape by:
Regulating and disciplining registered liquidators.
Providing information and guidance to directors, creditors, and employees.
Compiling insolvency statistics, which show that common causes of corporate
failure include poor strategic management, inadequate cash flow, and trading
losses.
Prosecuting misconduct, as demonstrated by media releases concerning the
reprimand and sentencing of practitioners for inadequate performance and
misappropriation of funds.
The Liquidation Process
Exam Notes 25Liquidation, or "winding up," is the final legal mechanism to address a company's
financial failure. A liquidator is appointed to take control of the company, ceasing the
powers of its directors. The liquidator's core functions are to finalize outstanding
matters, identify and convert all company assets into cash, and distribute the resulting
funds to creditors in proportion to the amounts they are owed.
Pathways to Liquidation
A company can be wound up either voluntarily by its members or creditors, or
compulsorily by a court order.
Voluntary Winding Up
This process is initiated by the company without court intervention.
Members' Voluntary Winding Up: This is available for solvent companies. It
requires the members to pass a special resolution (75% majority) under s 491 and
the directors to make a written declaration of solvency (s 494), affirming the
company can pay its debts in full within 12 months.
Creditors' Voluntary Winding Up: This occurs when the company is insolvent. It
can be initiated by the company in a general meeting (s 499) or, commonly, by a
vote of creditors at the final meeting of a voluntary administration to wind the
company up (s 439C). This pathway includes the simplified liquidation process.
Compulsory Winding Up
This is a court-ordered process that can be initiated on several grounds.
Winding Up for Insolvency (s 459A): This is the most common form of compulsory
winding up.
Definition of Insolvency: A company is insolvent if it cannot pay all its debts as and
when they become due and payable (s 95A). Courts assess this based on the
company's entire financial position and commercial reality, not just a temporary lack
of liquidity. Indicators include a history of dishonoured cheques, unpaid taxes, legal
proceedings for debts, and failure to prepare financial accounts.
The Statutory Demand: The most common method for a creditor to establish
insolvency is by serving a statutory demand on the company under s 459E. If the
company fails to pay the debt (which must be at least the statutory minimum of
$4,000) within 21 days, the court must presume the company is insolvent (s 459C(2)
(a)). This presumption is a powerful tool for creditors.
Setting Aside a Demand: A company can apply to the court to have a statutory
demand set aside within a strict 21-day period (s 459G). The primary grounds are
that there is a genuine dispute about the debt (s 459H) or a major defect in the
demand (s 459J). Courts require precise compliance with this process, as described
Exam Notes 26by Spigelman CJ, who called it "a carefully formulated series of interlocked steps
which have substantial consequences."
Winding Up on Other Grounds (s 461): A court may also order a winding up for
reasons other than insolvency, including:
Directors have acted in their own interests or in a manner that is unfair or unjust
to members.
The company's affairs are being conducted in an oppressive manner.
ASIC reports that it is in the public interest for the company to be wound up.
The court is of the opinion that it is "just and equitable" that the company be
wound up.
The Simplified Liquidation Process
Introduced by the Corporations Amendment (Corporate Insolvency Reforms) Act 2020
(Cth), this process provides a simpler, less complex, and more cost-effective liquidation
for eligible small companies.
Eligibility Criteria (s 500A): Key requirements include:
The company's liabilities are less than $1 million.
The directors declare the company cannot pay its debts in full within 12 months.
The company and its directors have not undergone restructuring or a simplified
liquidation within the last seven years.
Adoption: The liquidator must adopt the process within 20 business days of the
winding up resolution and provide 10 business days' notice to creditors. The process
cannot be adopted if creditors representing at least 25% of the debt value object (s
500AB).
Benefits: The process reduces costs by eliminating certain requirements, such as
the liquidator's detailed report on contraventions (s 533), certain creditors'
meetings, and committees of inspection. It also streamlines investigations by
reducing the "relation-back" period for unfair preferences from six to three months
and making them non-voidable if the value is no more than $30,000 (and the
creditor is not a related party).
The Liquidator: Role, Powers, and Regulation
Upon appointment, the liquidator assumes full control of the company, and the powers
of the directors cease (s 198G). As an "officer" of the company and an agent, the
liquidator owes fiduciary and statutory duties, including the duty not to improperly use
their position to gain an advantage (s 182).
Distribution of Assets
Exam Notes 27After collecting and realizing the company's assets, the liquidator distributes the funds
according to a strict statutory hierarchy:
1. Secured Creditors: These creditors are generally entitled to enforce their security
over specific assets first. An important exception exists under s 561, where a
creditor with a circulating security interest may lose priority to employees if funds
are insufficient to cover their entitlements.
2. Priority Creditors (s 556): These are certain unsecured creditors who are paid next.
The order of priority includes:
Costs of preserving and realizing company property.
Costs of the winding up itself (including legal and liquidator fees).
Employee entitlements, including wages, superannuation, leave pay, and
retrenchment payments.
3. Unsecured Creditors (s 555): Any remaining funds are distributed to all other
unsecured creditors. They share proportionately under the pari passuprinciple,
which mandates equal treatment. It is common for these creditors to receive only a
fraction of their owed amount.
4. Members (Shareholders): They receive a distribution only in the rare event of a
surplus after all creditors have been paid in full.
Regulation of Liquidators
Liquidators must be registered with ASIC, which assesses their qualifications,
experience, and fitness to perform their duties. They are subject to strict regulation and
can be disciplined for misconduct. Serious breaches can lead to disqualification,
compensation orders, and even criminal charges and imprisonment.
Liquidator's Powers to Recoup Funds
Because companies entering liquidation often have few remaining assets,
the Corporations Act provides liquidators with powerful tools to "claw back" funds and
property that were transferred away from the company prior to its collapse.
Voidable Transactions (Part 5.7B)
A liquidator can apply to a court to have certain pre-liquidation transactions declared
void. This allows the liquidator to recover money or property for the benefit of all
creditors. To be voidable, a transaction must typically have occurred during a specific
"relation-back period" and while the company was insolvent. The "relation-back day"
(the start date for this period) is generally the date the application to wind up was filed
(for compulsory liquidation) or the administration commenced.
The key types of voidable transactions are summarized below:
Exam Notes 28Type of Transaction Insolvency
Required?
Relation-Back Period (s 588FE)
Unfair Preference (s 588FA) Yes
6 months (or 3 months in a simplified
liquidation)
Creditor Defeating Disposition Yes 12 months
Uncommercial Transaction(s
588FB) Yes 2 years
Insolvent Transaction with Related
Entity
Yes 4 years
Transaction to Defeat Creditors Yes 10 years
Unreasonable Director-Related
Transaction
No 4 years
Unfair Loan No Unlimited (any time before winding up
began)
Unfair Preferences and the "Running Account"
An unfair preference (s 588FA) occurs when a creditor receives more for an unsecured
debt than they would in a liquidation. For ongoing business relationships (e.g., a
"running account"), all transactions within the period are treated as a single transaction
(s 588FA(3)). Following the High Court's decision in Bryant v Badenoch [2023] HCA 2,
which affirmed the "doctrine of ultimate effect," a preference only exists if the net effect
of the single transaction was to reduce the company's overall indebtedness to that
creditor. The "peak indebtedness rule," which allowed liquidators to pick the highest
point of debt as the starting point, has been rejected.
Defences for Third Parties
A transaction is not voidable against a person who received a benefit if they can prove
they acted in good faith and had no reasonable grounds for suspecting the company's
insolvency (s 588FG).
Insolvent Trading (s 588G)
This is a powerful provision that holds directors personally liable for company debts,
effectively lifting the corporate veil.
The Breach: A director contravenes s 588G if they fail to prevent the company from
incurring a debt at a time when there are reasonable grounds for suspecting the
company is insolvent or would become insolvent by incurring that debt. The test is
objective: what would a reasonable person in a like position be aware of?
Consequences:
Civil Liability: A liquidator can sue the director to recover the amount of the debt
for the company (s 588M). ASIC can also seek civil penalties, including
Exam Notes 29pecuniary orders and disqualification from managing corporations (s 206C).
In ASIC v Plymin [2003] VSC 123, director John Elliott was fined, disqualified,
and ordered to pay compensation for ignoring a "liquidity crisis."
Criminal Liability: If a director's failure to prevent the debt was dishonest, they
commit a criminal offence (s 588G(3)), punishable by imprisonment and/or
significant fines. The prosecution of the former Kleenmaid directors serves as a
stark example, resulting in lengthy prison sentences for fraud and criminal
insolvent trading.
Defences and Safe Harbour for Directors
While the insolvent trading laws are strict, the Corporations Act provides defences and
protections for directors.
Statutory Defences (s 588H)
A director has a defence against an insolvent trading claim if they can prove:
1. Reasonable Expectation of Solvency (s 588H(2)): The director had reasonable
grounds to expect, and did expect, that the company was and would remain solvent.
This requires more than "mere hope or possibility.
"
2. Reliance on a Competent Person (s 588H(3)): The director reasonably relied on
information from a competent and reliable person responsible for providing advice
on the company's solvency.
3. Absence from Management (s 588H(4)): The director did not take part in
management at the time due to illness or "other good reason." Courts have
interpreted this defence narrowly, holding that a "sleeping director" who completely
abdicates their responsibilities cannot rely on this defence (Deputy Commissioner of
Taxation v Clark [2003] NSWCA 91).
4. Reasonable Steps to Prevent Debt (s 588H(5)): The director took all reasonable
steps to prevent the company from incurring the debt. Taking action to appoint an
administrator is considered a relevant factor (s 588H(6)).
Safe Harbour Provisions (s 588GA)
This protection was introduced to encourage directors to attempt a legitimate
turnaround rather than prematurely placing a company into administration for fear of
personal liability.
The Protection: A director is protected from insolvent trading liability for debts
incurred in connection with developing and taking a course of action that is
"reasonably likely to lead to a better outcome for the company" than the immediate
appointment of an administrator or liquidator.
Exam Notes 30Key Factors: To access the safe harbour, directors should be properly informed,
keep proper records, prevent misconduct, and, critically, obtain advice from an
"appropriately qualified entity" (e.g., an accountant, lawyer, or insolvency
practitioner).
Related Protections: Further protections exist for directors when a company is
formally undertaking a Part 5.3B restructure (ss 588GAAB and 588GAAC).
Conclusion of the Corporate Lifecycle
Pooling and Deregistration
Pooling (s 571): To streamline the liquidation of complex corporate groups, a
liquidator can apply for a pooling order. This treats all companies in the group as
jointly and severally liable for each other's debts, allowing creditors of one company
to access the assets of others in the group.
Deregistration (s 601AC): Once the winding up is complete, the company is
deregistered by ASIC and ceases to legally exist. Any remaining property vests with
ASIC.
If the company is insolvent either voluntary administration, receivership, P5.3B or
Liquidation happens.
One of more persons are appointed to deal with it.
directors: one main question is “did they breach the duty to prevent insolvent
trading?”
this is dealt with ASIC
chapter 2d
ASIC v Plymin
The case ASIC v Plymin refers to the decision ASIC v Plymin (2003) 46 ACSR 126; VSC
123. This case concerned proceedings brought by the Australian Securities and
Investments Commission (ASIC) against directors for insolvent trading under section
588G of the Corporations Act 2001 (Cth).
Exam Notes 31Key details regarding the decision and the subsequent affirmation include:
Context and Findings:
Companies Involved: The facts concerned two companies, Water Wheel Holdings
Ltd and Water Wheels Mills Pty Ltd, which their directors placed into voluntary
administration.
Legal Action: ASIC initiated proceedings under s 588G against three directors,
including Mr Elliott, who was a non-executive director.
Insolvent Trading Breach: The Court found that Mr Elliott had breached the
insolvent trading provisions.
Reasoning: Elliott had substantial business experience, but the Court considered
that he failed to obtain the relevant financial information from management and, in
fact, ignored the company’s liquidity crisis.
Affirmation of Principles: The decision was substantially affirmed by the Victorian
Supreme Court of Appeal in Elliott v ASIC (2004) 48 ACSR 621. The Court of Appeal
noted that in proving a breach of s 588G(2), ASIC was not required to establish that
the director (Elliott) had a duty to take any specific step that would have prevented
the company from incurring the debt. Rather, failing to prevent the company from
incurring a debt is deemed a failure by that director to take all reasonable steps
within his power to prevent the debt.
Consequences: As a result of the finding that he breached the insolvent trading
provisions, Mr Elliott was fined, ordered to pay compensation to the companies, and
disqualified from managing a corporation.
Rejection of Defence (s 588H):
The court in ASIC v Plymin rejected a defence put forth by Mr Elliott based on s
588H(2), which protects a director if they had reasonable grounds to expect, and did
expect, that the company was solvent and would remain solvent.
The defence failed because Elliott had neglected his duty, having failed to obtain
essential matters from those managing the company, such as regular profit and loss
and cash-flow statements and a list of amounts owed to creditors.
Directors cannot rely on "complete ignorance or a neglect of duty" or hide behind
ignorance of the company's affairs that is of their own making or contributed to by their
failure to make necessary inquiries. The requirement for the defence in s 588H(2) is
an actual expectation of solvency and reasonable grounds for that expectation, which is
a higher degree of certainty than "mere hope or possibility" or "suspecting". The case is
also relevant when considering the defence of reliance on a competent and reliable
person under s 588H(3).