Additional Research - If you wish to conduct additional research for your answer, I would suggest the following texts and online resources (in addition to your prescribed text):
- CCH Intelliconnect suite of databases, in particular: "Australian Company Law Commentary Premium"; and "Australian Insolvency Management Practice Commentary". You may also wish to search for relevant cases in the CCH databases. Type 'CCH intelliconnect' when conducting a library catalogue database search.
- Pamela F. Hanrahan, Ian M. Ramsay, Geof Stapledon, Commercial Applications of Company Law (17th edition), CCH Australia Limited, 2016
- Recommended and further readings under the "Readings" tab on L@G.
Facts
You are employed as an accountant for a leading insolvency, restructuring and turnaround firm. You have been asked by the Liquidator to prepare a section 533 report on Phoenix Pty Ltd (In Liquidation) (the Company), which went into liquidation in August 2017. The Liquidator asks that you advise her on the liability of the Company's key management and directors for insolvent trading, pursuant to sections 588G and 588M of the Corporations Act 2001 (Cth) (the Act).
Greg (CEO) and two independent directors (Lisa and Wendy) have been on the board of the Company for many years. The board meets every 6 weeks. Sam (CFO) is not on the board, but has been employed as the CFO since 2015. Sam is CPA qualified and reports weekly to the CEO. In May 2017, Mark (Chief Restructuring Officer or CRO) joined the board on a short-term engagement, to restructure the Company. He is a partner of a rival insolvency firm.
The report as to the Company's affairs, that the CEO provides the Liquidator on appointment, says that the causes for the Company's failure were due to the loss of financial support from their banking syndicate, a lack of management oversight and poor record keeping. Your investigations reveal:
- Sam and his team recorded financial information in MYOB, but only reconciled bank accounts half-yearly (at bank covenant reporting time), allocated inventory purchases directly to the COGS account, and only tested for depreciation of assets yearly.
- The Company was reliant on the banking syndicate to pay its debts, and to reinvest in new assets. Net cash flows from financing activities for FY17 was $1million, yet net cash flows from operating activities was negative ($2million). The Company's banking covenants were: net assets greater than $zero, liquidity ratio greater than 1.5x and net operating cash flows greater than $zero.
- The Company's draft management accounts for December 2016 showed that none of these covenants had been met. Due to the poor record keeping, the Company only reported the covenant breaches 3 months late (in March).
The banking syndicate engaged Mark to perform an investigative accounts report on the Company to determine whether the Company was viable and what the banking syndicate should do. Whilst the report was being prepared, the banking syndicate refused to provide further funding. In early May 2017, Mark reported to the banking syndicate on the basis that the underlying business of the Company could be restructured and recommending that he be appointed as CRO. The banking syndicate agreed to this, but required the consent of the Company's Board. At the May 2017 board meeting, Greg finally informed the board of the funding issues and recommended that Mark be appointed as CRO. The board agreed. Lisa and Wendy claimed that they were unaware of the funding issues until the May 2017 board meeting.
Between December 2016 and May 2017, total liabilities owed to unsecured creditors increased from $1.5million to $4million. Greg took 20 sick leave days during this period for the common cold. Sam's team was inundated with angry creditors, refusing to supply goods until payment in full was received. Employee wages were met, but PAYG tax (totaling $500k) and superannuation ($100k) remained unpaid. The ATO remained in regular contact with Sam, during which time the Company defaulted on 4 repayment arrangements with the ATO.
Between June 2017 and August 2017, total liabilities owed to unsecured creditors increased another $250k. Although the banking syndicate had agreed to Mark's appointment, they still refused to provide further funding, believing that Mark would sell the business of the Company to an interested private equity firm. That deal never came to fruition, leading to your appointment.
Advise the Liquidator on what action (if any) she can take against Greg, Lisa, Wendy, Sam and Mark for breach of the duty to prevent insolvent trading (s 588G of the Act) and the remedy (if applicable).