Managing a company in distress is by no means an easy feat.

Directors are often pulled between acting in the best interests of the company and protecting their own position.

The two scenarios should never cross paths, but they can be managed by separate independent strategies (and by separate advisors).

The Corporations Act imposes a number of duties on company directors to ensure the best interests of the company is upheld at all times. The directors' primary duties are owed to the company, however, at times when a company is experiencing financial distress and potentially facing insolvency, directors must also consider the interests of the company’s creditors.

It is important that directors are aware of their general duties and how these are affected in times of financial distress, as the impact of acting contrary to their fiduciary and statutory duties may result in a risk of personal liability.

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What duties are imposed on company directors?

The primary general duties imposed on company directors under the Corporations Act are:

Section 180 - Care and Diligence

A director is required to exercise their powers and discharge their duties in good faith, in the best interests of the company and for a proper purpose. This duty requires a director to be informed about the company’s financial position, guide the company to ensure transactions entered into by the company are for the benefit of the company and to monitor the management of the company at all times.

Section 181 - Good Faith

A director must not improperly use their position to gain advantage for themselves or someone else, or cause detriment to the company. This includes acting in the best interests of the company so as not to obtain personal advantage or an advantage for a related party/entity at the detriment of the company. A director must ensure that they do not put themselves in a position where they may be in conflict with the company’s best interests.

Section 182 - Use of Position

A director must not improperly use their position to gain advantage for themselves or someone else, or cause detriment to the company.

Section 183 - Use of Information

A director must not improperly use information to gain advantage for themselves or someone else, or cause detriment to the company.

Section 184 - Good Faith, Use of Position and Use of Information (criminal offences)

An offence is committed if a director is reckless, intentionally dishonest and/or fails to exercise their power and discharge their duties in good faith, in the best interests of the company and for a proper purpose.

Section 588G - Directors Duty to Prevent Insolvent Trading

A director is required to prevent the company from incurring a debt (or debts incurring that debt) if the company is already insolvent, or, if by incurring the debt, the company becomes insolvent.

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It is imperative that a director maintains a sound knowledge of the company’s financial circumstances at all times. This will enable a director to make financial decisions that are in the best interests of the company and its creditors and ensure the director is acting with proper care, diligence and in good faith.

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Statutory defences afforded for insolvent trading

The Corporations Act outlines a number of statutory defences available to directors that have failed to prevent a company from trading whilst insolvent. These include:

• Having reasonable grounds to suspect that the company was solvent or would remain solvent once a debt was incurred.
• Relying on a competent and reliable person (i.e. an accountant) to provide information about the company’s solvency.
• Not actively participating in the management of a company due to illness or some other good reason.
• Taking all reasonable steps to prevent the company from incurring a debt.
• Having taken the appropriate steps under the Safe Harbour provisions.

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Consequences of breaching directors' duties

A director that breaches the general duties imposed by the Corporations Act may be personally liable to compensate the company for any loss or damage caused. There are both civil and criminal penalties imposed for breaches of directors’ duties which include pecuniary fines, imprisonment or a prohibition from managing a company. In respect of failing to prevent a company from trading whilst insolvent, a director may become personally liable for debts incurred by the company if:

• They are a director of a company at the time when the company incurs a debt.
• The company is insolvent at that time, or becomes insolvent by incurring that debt, and at that time, there are reasonable grounds for suspecting that the company is insolvent or would become insolvent.

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Actions to take if you suspect financial distress

It is important that directors obtain professional advice immediately if there is a suspicion that a company is suffering financial distress. Early intervention is often critical to ensure a company has any ability of continuing to trade out of a difficult period. In addition, this is the most effective way to undertake a restructure and ensure that the company’s best interests are maintained. Under the Safe Harbour provisions in the Corporations Act (refer to our separate guidance on the Cor Cordis website), directors that take appropriate action in times of financial distress may be afforded protection from being personally pursued for insolvent trading.

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How to protect your own personal position

Directors should seek separate and independent professional advice to understand how to protect their own personal position in times of dealing with a company enduring financial distress. Such advice may include financial and legal advice advice on their statutory duties and how to ensure the company’s best interests are being maintained, and advice in relation to relevant and adequate directors’ insurance.

[1] Corporations Act (2001) – s180 to s184 & s588G

[2] Corporations Act (2001) – s588H

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How can Cor Cordis assist?

If you require further information or would like a confidential discussion, please contact one of our partners at our office near you.