If you’re not an officially appointed company director, you may be operating as a shadow director or de facto director. You need to be aware of your legal obligations, especially if there’s a question of insolvency or fraud.
On 10 January 2020, Justice Brian Devereaux of the District Court of Queensland sentenced former shadow director of Kleenmaid Andrew Eric Young to nine years’ imprisonment after being found guilty of 19 offences of fraud and insolvent trading.
Background – Kleenmaid shadow director case
Kleenmaid was an Australian-based manufacturer that sold kitchen appliances to electrical retailers. Kleenmaid operated across five states in Australia, with over 20 retail outlets, five of which were owned by Kleenmaid, and the others were franchises. In 2008, Kleenmaid was listed in Business Review Weekly’s Top 500 Australian Companies and sold products to major retailers, including Harvey Norman and Clive Peeters.
On 9 April 2009, Kleenmaid went into voluntary administration with debts of over $100 million. A Report to Creditors was shortly published indicating that Kleenmaid may have been trading while insolvent since 2007.
In 2015, former director of Kleenmaid Gary Collyer Armstrong pleaded guilty and was sentenced to seven years’ imprisonment for fraud and insolvent trading. Shortly after, in 2016, another former director of Kleenmaid was also convicted of fraud and insolvent trading and sentenced to nine years.
What is insolvent trading?
Under Section 95A of the Corporations Act 2001 (Cth) (Act), a company is considered solvent if, and only if, the company can pay all its debts as and when they fall due. The Act goes on to state the obvious: if a company is not solvent, it is insolvent.
The Court applies several principles in determining the solvency of a company, and fundamentally this will be a question of fact to be determined by considering the company’s financial position as a whole.
The primary test applied by the Court to determine solvency is classically described as the ‘cash-flow test’. However, the Court may take the balance sheet position of the company into account. Under the cash-flow test, broadly, if a company cannot liquidate its assets quickly to satisfy its debts, it may be deemed insolvent.
Under Section 588G of the Act, a person who is a director (including shadow and de facto directors) of a company when the company incurs a debt, and that company is insolvent (or becomes insolvent by incurring that debt), and there are reasonable grounds for suspecting that the company is insolvent at that time, then by failing to prevent the company from incurring that debt, the director may be found to have contravened Section 588G(2) of the Act if:
- The person was aware at that time that there were such grounds for suspecting insolvency; or
- A reasonable person in a like position in a company in the company’s circumstances would have been so aware.
Defences available to insolvent trading include:
- Coming within the Act’s safe harbour regime, which includes where – when the person starts to suspect insolvency – the person starts to develop a course of action likely to lead to a better outcome for the company. This is a highly nuanced defence and would need careful consideration
- There were reasonable grounds to expect the company was solvent;
- A competent and reliable person provided information to support the company was solvent;
- Because of illness or for some other good reason, the director did not take part in the management of the company; and
- The director took all reasonable steps to prevent the company from incurring the debt.
What is a shadow director?
In this latest conviction in the Kleenmaid saga, someone who was not validly appointed a director was found criminally liable as a shadow director – he was treated as if he had been appointed a director.
It is not only persons who are formally appointed directors who may fall within the definition of a director. Under Section 9 of the Act, a director includes persons acting in the position of a director or persons on whose instructions or wishes the directors of the company or body are accustomed to act in accordance with, even though they are not formally appointed a director of the company.
In this case, Mr Andrew Eric Young was a shadow director and was giving instructions in relation to the affairs of Kleenmaid. Being deemed a shadow or de facto director carries responsibilities and the risk of personal civil and criminal liability.
Director penalties for insolvent trading
A director (including a shadow or de facto director) found liable for contravening the insolvent trading provisions of the Act may face civil penalties, including a fine of up to $200,000. If dishonesty is a factor in insolvent trading, as was found in this Kleenmaid case, the director may face up to five years’ imprisonment or a fine of up to $220,000 (or both) for each count. There is, of course, also director disqualification to consider.
Directors (including shadow or de facto directors) who suspect the company is insolvent should immediately obtain advice from an accountant, lawyer or insolvency practitioner.
If a company is experiencing financial problems, even borderline, it is important to continually and consistently monitor its finances to ensure it can still pay its debts.
Some signs (which are non-exhaustive) of insolvency include financial loss, a clear inability to pay bills and paying creditors outside the agreed terms. If a company is experiencing these signs, and the directors are worried about its financial stability or suspect insolvency, it is important to get professional advice as soon as possible.
The Kleenmaid case also highlights the need to carefully consider your position if you are exercising influence in a company and may be deemed a shadow or de facto director.
Being deemed a director can give rise to directorial liability despite not being appointed a director. If you are concerned, you should check that your company has directors’ and officers’ insurance that includes, or at the very least does not exclude, coverage for shadow and de facto directors.
For more information about insolvency and shadow directors, contact Trevor Withane: