Legal Report- Liquidation 1Legal Report – LiquidationIntroduction The essay gives an analysis of the legal issues that are related to corporate situation inthe liquidation of a corporate company. It gives the rules and the procedures that are used inliquidation according to the law and as presented in corporate company Act. The rules areapplied to the corporate legal situation in question.Summary Liquidation as presented in law can be caused by different things and it can becompulsory or voluntary. Voluntary liquidation can originate from the shareholders of thecompany or from the directors of the company. Liquidation can also be compulsory orthrough a court order. A petition can be made by the creditor to liquidate a company and ifthe court is satisfied it issues a winding up order.Application/Analysis The directors of the Best Dressed Home Ltd are significant shareholders of thecompany and so they have a great interest in the company’s affairs. The company had a chiefoperating officer named Mitchell and he provided the directors with profit forecast andmonthly budgets. If the company used less than the agreed amount of expenses, the chiefoperating officer received an annul bonus. The business started to decline due to decrease insales while two directors of the company were away for an extended holiday. The cash flowof the company was affected by an advertising campaign that was ordered by the directorwho was present. The company was late in remitting the taxes that were collected from the customers.The major suppliers were not paid and solicitor’s letters in demand for the debts were sent to
Legal Report- Liquidation 2the company. The suppliers refused to supply services and goods unless the goods were paidfor on delivery. The cheques issued to the suppliers by the chief operating officer weredishonoured by the bank. The directors of the company did not know about the financial difficulties becausethey were supplied with false financial information and they thought that the company wasdoing well. Mitchell was sacked after the directors discovered the true financial situation.There was a large amount that was owed to unsecured creditors and the bank was one ofthem. Dividends to the shareholders were paid by the directors despite the financial positionof the company. The Tasmania part of the business was also sold to David’s family companyand the contract price was the market value of the business and was to be paid in 50 equalannual instalments over 50 years. One of the unsecured creditors of the company obtained acourt order of winding up the company on the grounds of insolvency and a liquidator wasappointed.Legal rules on Liquidation According to Australian Securities & Investments Commission, (2008), corporatecompanies are put into liquidation because of different reasons and in different situations.One of the situations that may lead a company to be liquidated is when the shareholders ofthe company decide to pass a special resolution of winding up. The creditors of the companymay also pass a resolution to wind up a company or to liquidate a corporate company at awatershed meeting which is allowed by the corporate law. As Hudson, (1987, p. 199-213),states, due to an event that may be specified in the constitution, the board of a company maydecide to pass a resolution of liquidation.
Legal Report- Liquidation 3 Before liquidation by the court order takes place, a liquidator is appointed to thecompany with the aim of investigating the financial affairs of the company and establishingwhat caused the failures. The liquidator also has a duty to investigate the offences that arepossible and later identify the assets of the company that are supposed to be sold and theproceeds are used to pay the creditors. The directors of the company are not liable for the debts of the company because thecompany is a separate legal entity and it has its own rights. The director can only be liable ifhe acts outside his authority and when insolvent trading occurs. Insolvent trading is when adebt occurs that the company is unable to pay when the directors should have known that thecompany is insolvent and could not pay the debt. The director may be held liable for theamount of the unpaid debts. As stated in section 588G of the Corporations Act, the directors of a company aresupposed to take an action if the company is not able to pay its debts when they fall due andon time. They can decide to refinance the company or put forward a Company VoluntaryArrangement that will help pay its creditors. If the two options are not available, the directorsof the company are supposed to cease trading to stop incurring further debts. It is theobligation of the directors to make sure that the position of the company does not deterioratefurther and the amount of debt does not increase. The directors have a duty of protecting theinterest of the creditors of the company and not the interest of the shareholders or directors. The directors are also liable for the losses that are incurred by the company in case ofunreasonable director related transactions such as payment of the money that is made by thecompany without direct benefit to the company. For the payment of money to be directorrelated, it involves the directors of the company and the people who are close to them.
Legal Report- Liquidation 4 The secured creditors and the unsecured creditors of the company are affected byliquidation of a corporate company. The unsecured creditors are not allowed to continue withany legal proceedings against the company or any of its property after the company isliquidated without the permission of the official Assignee or the court. They also cannotenforce any rights against the property of the company which is under liquidation. The creditors of the company are supposed to provide the information of the debtsthat are owed by the company before they are paid. Together with the details of the debts, thecreditors are supposed to provide documentation copies that show the existence of the debts.As suggested by Keith and Hudson, (1996, p 298-399), some of the documentation that arerequired include bank statements, court orders, receipts, invoices and any acknowledgementsof debts. As Company Rescue, (2011), puts it, in a compulsory liquidation where the creditorapplies to the court for liquidation, one of the rules that must be applied is that the creditormust have pursued their debts for a significant period. The court accepts the petition toliquidate a company only if the company refuses to pay the creditors after an agreement. Ifthe company demonstrates inability to pay or refuses to communicate with the creditors, thenthe creditor is supposed to use a solicitor or a debt collector. If the solicitor and debtcollectors fail to collect the debt, a statutory demand is issued. The statutory demand lasts for21 days and the company is supposed to pay the debt within 21 days. If the days are over andthe debt is not paid, a winding up petition is issued by the creditor. As MetLife Guarantees, (2011), puts it, in liquidation, the first debts that are paid bythe liquidator are taxes that are owed by the company. The wages of the workers are also paidbefore the other creditors including the secured and unsecured creditors.Relevant to defendant
Legal Report- Liquidation 5 In the case of Best Dressed Homes Ltd, a creditor who is unsecured has managed toobtain a court order for liquidating the corporate company. The court has appointed aliquidator of the company to carry on the liquidation process. The creditors to the companyare not secured. The company owes $10 million to unsecured creditors and they aresupposed to prove that the company owes them. As illustrated by Corporations Act 2001, (Sect 541), the company that is being woundup must show in all its documents which may be negotiable instruments or public documentsthat it is under liquidation. This is a requirement of every company and failure to include thename liquidation in all documents will result to offence of strict liability. The company wassold to David’s family at the market value and the decision was made by the shareholders ofthe company. The company engaged in a director related transaction by paying the dividends to theshareholders despite knowing the financial situation of the company. The payment of thedividends was director related because the directors were also paid the dividend since theywere shareholders of the company. The non-executive director was supposed to protect theinterest of the minority and the shareholders by not allowing the dividends to be paid. The company could not meet its debts when they fell due and the bill was not paid intime. This was enough to declare the company insolvent, but the company incurred additionaldebts despite being insolvent.Advice/ Conclusion Being that the directors of the company are separate from the company, the liquidatoris not supposed to claim money from the directors of Best Dressed Homes Ltd. A company is
Legal Report- Liquidation 6a separate legal entity and it is liable for its own debts. The directors can only be liable if theyhad a wrongful trading when the debts owed by the company increased. The directors are notliable for the debt that was owed by the company before they discovered the true financialstatus of the business. A defence available for the directors is that when they discovered that there was aproblem in the finances of company, they took the relevant action and tried to refinance thecompany by negotiating with the bank to borrow some amounts that could help in refinancingthe company. They also made efforts of having a Company Voluntary Arrangement byselling a Tasmania part of the business to David’s family company. This would generateincome for the company and the income can be used to pay the creditors. The directors andthe shareholder accepted the 50 equal yearly instalments because the Tasmania part of thebusiness was big. The non-executive director can prove that he acted in good faith and wasgenuine for the interest of the company. The three executive directors and one non-executive director of Best Dressed HomesLtd can use the defence in Section 588H of the Corporations Act and establish that they had areasonable ground to expect that the company was solvent because they were in the cause ofnegotiation with the bank when the debt of the company increased. The aim of thenegotiation was to borrow money for the company to service its debts. The bank alsocontributed to the increase of the debt because the directors expected to receive money fromthe bank but the bank failed them after one month of negotiation. Due to the director relatedtransaction which also can be referred to as conflict of interest, the statutory defence that isavailable for the directors is that they paid the dividends in good faith. Concerning the false statement of accounts that were presented to the directors, thedirectors can rely on section 189 of the corporation Act which permits them to rely oninformation presented to them by delegates. One of the delegates could be an employee
Legal Report- Liquidation 7whom the directors believe that he is reliable and competent. In this case, the directors of bestDressed Homes Ltd did not know the true financial status of the company because they reliedon the information they received from Mitchell who was the finance manager. Mitchell isliable for the false financial information that was given. They can also rely on the section by proving that two of the directors were not in themanagement of the company at the time the company became insolvent because they hadgone to a long holiday in overseas and they did not know the true status of the company. The directors can also establish that they took reasonable steps to prevent thecompany from incurring further debts and they even tried to pay some of the debt owed to thebank by using diminishing cash reserves. Best Dressed homes Ltd can prevent the liquidator from claiming funds from them byopposing the winding up application under s 459(3) Corporations Act 2001. This is a strongdefence because it was assumed that the company was insolvent by failing to comply with thestatutory demand and it was presumed to be insolvent. The directors of the Best DressedCompany can prove that the company is solvent and the liquidators will not claim moneyfrom them. Another defence that can be relied on by the company in proving its solvency is byshowing that it has money and it used the diminishing cash reserves to reduce the loan owedto the bank as in the case: Deputy Commissioner of Taxation v De Simone Consulting Pty Ltdwhere the directors of the company produced a suitcase that was full of cash and the windingup application was withdrawn. They can use the cash reserves to pay all the debtors withoutliquidating the company. On the contrary, the directors of the company can decide to wind upthe company voluntarily which could dismiss the creditors winding up. The company can also argue that they have plans on how to pay the creditors withoutwinding up as in the case of Re Presha Engineering (Aust) Pty Ltd, where there was a better
Legal Report- Liquidation 8prospect of payment and the court acknowledged an adjournment. Being that a substantialpart of the business was sold, the directors can rely on that evidence and argue that it wassold to get ways of paying the creditors. ReferencesAustralian Securities & Investments Commission, (2008), Liquidation: a guide for creditors(online) Available from<http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/Liquidation_guide_for_creditors.pdf/$file/Liquidation_guide_for_creditors.pdf> Viewed on 5 may 2011.
Legal Report- Liquidation 9As Company Rescue, (2011), "A creditor is trying to wind up our company! What does that mean?"( online), Available from <http://www.companyrescue.co.uk/company- rescue/options/compulsory-liquidation >Viewed on 5 may 2011.Corporations act 2001 - Sect 541 (online) Available form<http://www.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s541.html> Viewed on 5 May2011.Hudson, J., (1987), The age , regional, and Industrial structure of company liquidation, Vol14, iss 2, pp 199-213Keith, C., and Hudson, J., (1996), The determinants of compulsory liquidations in the U.K.Journal. Vol. 64 Issue 3, p298, 11pMetLife Guarantees, (2011), In a corporate liquidation, why are unpaid taxes and wages paidbefore general creditors but after secured bondholders? (online) Available from<http://www.investopedia.com/ask/answers/09/corporate-liquidation-unpaid-taxes-wages.asp> Viewed on 5 May 2011.CasesIn Deputy Commissioner of Taxation v De Simone Consulting Pty Ltd (2006) 24 ACLC 726Re Presha Engineering (Aust) Pty Ltd (1983) 1 ACLC 675 at 677