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[O]wing to the ease with which companies can be formed in this country, and owing to the rigidity with which the courts applied the corporate entity concept ever since the calamitous decision in Salomon v Salomon & Co Ltd  AC 22, a single trader or a group of traders are almost tempted by the law to conduct their business in the form of a limited company, even where no particular business risk is involved, and where no outside capital is required. . . This state of affairs would not necessarily call for reform, if it were not for the fact that the courts have failed to give that protection to the business creditors which should be the corollary of the privilege of limited liability« The flexibility of the law governing this topic contrasts completely with the failure of the courts to mitigate, through the mechanism of the law of agency, the rigidities of the µfolklore¶ of corporate entity in favor of the legitimate interests of the company¶s creditors. As it is, the company has often become a means of evading liabilities and of concealing the real interests behind the business. Modern Law Review, April 1944, pp 54-55.
2. In the light of one of the theoretical models of the corporation you have studied in the course: (a) Give a succinct account of the Austr alian law in sections 588V -X of the Corporations Act, including relevant case law through which the sections have been interpreted; (b) Consider how well you think sections 588V -X in action address the criticisms made of limited liability by Kahn -Freund?
The central complaint of Kahn-Freud is that modern corporations law does not give adequate protection to creditors. The protection of shareholders and the folklore of limited liability has been the paramount consideration ± at the expense of the interests of creditors. Section 588V directly attacks limited liability. To use a cliché; 588V-X pierces the corporate veil in favour of the creditor. This essay will first summarise the powers and defences available in 588V-X. 588V-X is part of a relatively recent legislative instrument. In approaching relevant case law, it will be imperative to take a broad approach. This essay will look at case law regarding 588G ± the corresponding section to prevent insolvent trading in non-group companies. This section uses almost identical language to 588V, and has had much more judicial scrutiny than 588V-X. Following an analysis of relevant case law and a summary of powers, this essay will look at justifications for limited liability, focusing on Bainbridge¶s director primacy
Section 588V-X provides an exemption to the general rule of limited liability. 230. Hawkins v Bank of China (1992) 7 ACSR 349. which limit the scope of the action. 356-357.model of a corporation. 5 In addition it must be found that there were reasonable grounds for suspecting insolvency..7 or having regard to the holding company¶s control over the subsidiary it is reasonable to expect that they would be aware. and has armed creditors. 718. 588V only takes effect if the company was insolvent or became insolvent when taking on the debt. 566.8 Reasonable grounds to Hussein v Good (1990) 1 ACSR 710.[something] which is ascertained or can be ascertained.6 and either the company (or directors) was aware of grounds for suspecting insolvency. 588V prevents a holding company from hiding behind limited liability when a subsidiary company incurred a debt at a time when it was insolvent or there were reasonable grounds for suspecting insolvency. Next. liquidators and the courts with an appropriately sized scalpel with which to pierce the corporate veil. 3 Commissioner of State Taxation (WA) v Pollock (1993) 12 ACSR 217.´1 It cannot be an obligation to pay unliquidated damages. 4 Hymix Concrete Pty Ltd v Garrity (1977) 2 ACLR 559.2 Pay-roll tax can be a debt.3 Insolvency must be more than a ³temporary lack of liquidity´ it must be ³an endemic shortage of working capital whereby liquidity can only be restored by successful outcome of business ventures in which the existing working capital has been deployed. A debt must be ³something recoverable by action for debt . The legislature has recognised KahnFreud¶s concerns. 6 Ibid s 588V(1)(c). 5 Corporations Act 2001 (Cth) s 588V(1)(b). this essay will reconcile the justification of 588V-X with the arguments in favour of limited liability.. 7 Ibid s 588V(1)(d)(i) 8 Ibid s 588V(1)(d)(ii) 2 1 .´4 There are of course qualifications.
s 588W(1)(d). Metropolitan Fire Systems Pty Ltd v Miller (1997) 37 ACSR 589. s 588X(4). 76. The directors and holding company will not be liable if they had reasonable grounds to ³expect´. 15 Ibid. but rather the defence was established for large companies where competent accountants advised the board. 14 Section X provides some defences. s 588X(3)(a). but. and did expect. 238.18 There is also a defence for a director who is aware of solvency problems or had reasonable ground for suspecting problems. 18 Manpac Industries Pty Ltd v Cecattini  NSWSC 330 .suspect insolvency is tested on ³objectively reasonable grounds which must be judged by the standard appropriate to a director of ordinary competence. 11 Corporations Act 2001 (Cth) s 588W(1)(a). 19 Ibid.´10 Section 588W prescribes that the liquidators may only recover money in relation to the debt incurred. 12 Ibid. it is a defence if the holding company took all Group Four Industries Pty Ltd v Brosnan (1991) 56 SARS 234. 16 It is also a defence to believe that a competent and reliable person was responsible for providing adequate information regarding the company¶s solvency. ³liability is. s 588W(1)(c). s 588W(1)(b). 10 9 . 14 Ibid.13 and the company must be being wound up.´9 Questions of knowledge are factual. 17 Ibid. 16 Tourprint International Pty Ltd (in liq) v Bott (1999) 32 ACSR 201. 13 Ibid.11 The creditor must have suffered a loss as a result of the company¶s insolvency. s 588X(2).15 The term ³expect´ requires ³a higher degree of certainty more than µmere hope or possibility¶´. because of illness or ³some other good reason´ that director did not take part in the management of the company at the time the debt was incurred.12 the debt must be unsecured. not contingent on elements personal to the respondent. that the company was solvent and would remain solvent despite accepting the debt.17 The court held that directors could not rely on business consultants. 67. therefore.19 Finally.
1% of the time. however was only successful in 10.reasonable steps to prevent the company from incurring the debt. s 588X(5). 21 20 .´26 However. s 46(a)(ii).29 In other words the courts are free to group companies together if it is just to do so. Redmond argues that a wider more fluid standard is used with ³the practical influence´ as the primary concern. 26 Mount Edon Gold Mines (Aust) Ltd v Burmine Ltd (1994) 12 ACSR 727. the University of Melbourne. 29 Redmond. 28 Ian Ramsey.8% of those cases. 23 Corporations Act 2001 (Cth) s 46(a)(i) 24 Ibid. based on ³the capacity to dominate decision making. an empirical study on insolvent trading cases from that a defence like those listed above was argued 63.23 or has half the votes of a general meeting.27 Ramsey notes a new definition has come into vogue. Ian Ramsey and Polat Siva. 34. 168. does not suffice to establish the relationship of holding company and subsidiary. 27 Paul Redmond. Companies and Securities Law: Commentary and Materials (Thomas Reuters. 22 Paul James.24 or has half the share capital of the other entity. Public Exposure Draft and Explanatory Paper (1992) para 1240. Clayton Utz and Centre for Corporate Law and Securities Regulation. Ibid. 2004) 33. µHolding Company Liability for the Debts of an Insolvent Subsidiary: A Law and Economics Perspective¶ (1994) 17(2) University of New South Wales Law Journal 520. above n 10. 748. 20 The Executive of the day suggested that ³a court might require unequivocal action´ if seeking to rely on this type of defence. 2009) 167. The Act only recognises a holding/subsidiary relationship when one entity: controls the composition of the board. 25 Ibid. directly or indirectly. s 46(a)(iii). µInsolvent Trading ± An Empirical Study¶ (Research Report.21 As final note on defences. Corporate Law Reform Bill 1992.´28 Redmond argues a degree of ambiguity ³promotes interpretative freedom to secure policy goals´. This section only applies to legally defined holding companies. 22 This evidence suggests the courts have held defendants to a relatively high standard. 544. in the absence of any such legally enforceable power. 5th ed.25 It has been held that ³de-facto control.
.. Ian and Siva.It is in a practical sense their [the creditors] assets and not the shareholders¶ assets that.34 it is important to analyse why insolvent trading is frowned upon. have a better opportunity to shield from risk.In direct contrast to Kahn-Freud many scholars hail the limited liability regime for its positive effect on investment and its appropriate positioning of the burden of risk ± on creditors.´30 Shareholders. another factor which assists creditors is that shareholders and managers are unlikely to take action that will harm their reputation. above n 22. This reduces a shareholders¶ capacity to limit risk through diversification of stocks.. above n 10. would risk losing their personal assets. While legislative safeguards relating to insolvent trading have existed since the 1970s. and would therefore need to monitor the company¶s actions. 31 Ibid. she argues. incurring a debt while insolvent creates a special set of circumstances. 30 Helen Anderson. Anderson argues. [T]he difficulties for shareholders with unlimited liability regime exceed the difficulties for creditors with a limited liability regime. Ramsey. Ramsey notes two contractual self-protections mechanisms available to creditors. µPiercing the veil on Corporate Groups in Australia: The Case for Reform¶ (2009) 33 Melbourne University Law Review 333. 523. 524. on the other hand. 338. They can either alter the interest rate.32 In addition to these contractual options which creditors may exercise. Street CJ has held: Where a company is insolvent the interests of the creditors intrude.31 Creditors. and/or restrict the company from incurring debts of similar or higher priorities. 34 James. 338 32 Although 588V-X will only assist the unsecured creditor. 33 Ibid. and places upward pressure on the required return.33 However. 4.
and establish why it is important to pierce the corporate veil to hold parent companies liable for insolvent trading. Bainbridge argues that it is 35 36 Kinsela v Rulless Kinsela Pty Ltd (1986) 4 NSWLR 722. We now need to turn to the holding company. As such it is appropriate to pierce the corporate veil when insolvent trading is established.35 What Street CJ is saying is that when a company is insolvent the shareholders¶ assets have already been expunged. . Unlimited liability would make shareholders unwilling to invest and diversify their investments because of the need to monitor the company and fellow investors. but rather they are using the creditors to play for the ³bonanza payoff that will prevent insolvency. 730. generally powerless to engage in the management of the company. 338. The director primacy model of a corporation places decision making authority at the core of the company ± with the board. 37 Anderson. 14.through the medium of the company.37 The notion that shareholders do not monitor companies they invest in and have very remote influence on the board is a notion explored in detail by Stephen Bainbridge and the director primacy model of a corporation. Ibid. As already stated there is a concern that unlimited liability would give rise to the need for shareholders to closely monitor a company¶s actions. making it worse by taking on more unsecured debt. above 17. The shareholder is peripheral. Helen Anderson argues. Taking on a debt in these circumstances means the directors are no longer gambling with the shareholders¶ money.´36 The legislature is trying to stop companies from exacerbating the problem. are under the management of the directors.
109. those with limited decision making power have limited liability. the practicality of consensus decision making is possible. not receive the benefits of limited liability? The answer is because a holding company is not an ordinary shareholder. and an equality of interest is manifested in an equality of decision making power ± consensus decision making works in a partnership. they have an equality of interests. University of California Los Angles. 39 Ibid. As Helen Anderson argues. When a company engages in insolvent trading. Business Associations 1 Supplementary Materials (Vol 1) Session 2. Faculty of Law. And this is fair enough.38 Centralised decision making makes shareholders apathetic and aware that it is ³easier to switch than fight. and the potential for specialisation of labour. 2010. Partners share equally in the gains and losses of the company. The advantages include efficient and cheap decision making. But why should a holding company. there is economic integration between parent and subsidiary. . Stephen Bainbridge µDirector Primacy¶ (Law-Economics Research Paper No 10-06. and shareholder power is reduced. Companies accept that consensus decision making is inefficient. Consensus decision making works in partnerships. The result is that shareholders are at the periphery of the company¶s management structure. NB: Pinpoint references for this source will refer to the page numbers in the University of New South Wales. On the other side of the coin is the director primacy model ± authority based decision making. Parallel to director primacy is limited liability. The shareholders¶ rights to control the company are minimal and usually limited to some sort of mild accountability and electoral measures.too costly and difficult to have consensus decision making by shareholders. 2010). ³the parent company will be involved in important 38 See.´39 Ownership and management are clearly separate. Partnerships are generally small. It is easy to see how limited liability fits into the director primacy framework.
with power comes liability. 42 Ibid. holding companies are influential on the decision making process. As the maxim goes. This sharp analysis backs up the call from Kahn-Freud to protect the creditor not the parent company. unlimited liability would rely on recovery from multiple shareholders where ³the cost of taking action against them may exceed the benefit´. Ibid. is involved in the decision making processes. The holding company. above n 13. The shareholder. However. the parent companies reap the full rewards of the subsidiaries risk taking. . In conclusion. Bainbridge told us that it is inefficient for shareholders to be involved in decision making. Secondly. they are easy to litigate against. it would limit their ability to reduce risk by diversifying their portfolios. and unlikely to be an impecunious defendant. 352. with power comes responsibility or in this case.41 On the other hand a parent company is a single target for the liquidators. one with immense power. Anderson told us that if shareholders had to monitor the management of the company. Firstly. 353. The legislature has long established that directors should not hide behind the veil if found to have taken on debts while insolvent. 588V-X recognises this and imposes liability for insolvent trading. and they are more like directors than shareholders. Helen Anderson lists other differences between shareholders and holding companies. unlike shareholders.decision-making for the subsidiary. 353. and does monitor the management of subsidiaries. on the other hand.42 The justification for 588V-X lies with the analysis of access to effect the decision to trade while insolvent. the 40 41 Anderson. has little or no decision making power with respect to taking on a debt.´40 A holding company is a very influential shareholder.
only punishes only those who had the capacity to effect decisions to take on debts while insolvent. However. It takes on Kahn-Freud¶s criticism of limited liability. . it would arm the courts with too large a scalpel and undermine the core of limited liability. The section appropriately provides defences including when directors or holding companies did all that they could to stop the subsidiary from taking on the debt. 588V-X appropriately. Without these qualifications on the section. The section provides liquidators.section only imposes liability when the power to effect the decision to trade while insolvent existed ± this is a matter of fact. and courts with a handy mechanism to protect unsecured creditors. The holding company must have been aware or it is reasonable to expect that they would have been aware that the subsidiary was insolvent.
5th ed. Helen. Kinsela v Rulless Kinsela Pty Ltd (1986) 4 NSWLR 722. Clayton Utz and Centre for Corporate Law and Securities Regulation. Tourprint International Pty Ltd (in liq) v Bott (1999) 32 ACSR 201. µDirector Primacy¶ (Law-Economics Research Paper No 10-06. Bainbridge. 2004). 2. 2. Companies and Securities Law: Commentary and Materials (Thomas Reuters. The University of Melbourne. Metropolitan Fire Systems Pty Ltd v Miller (1997) 37 ACSR 589. µPiercing the veil on Corporate Groups in Australia: The Case for Reform¶ (2009) 33 Melbourne University Law Review 333. Hawkins v Bank of China (1992) 7 ACSR 349. 2009). Ramsey. C. Redmond. Hussein v Good (1990) 1 ACSR 710. University of California Los Angles. Articles/ Books/ Reports 1. B. 9. 6. Anderson.Bibliography A. Hymix Concrete Pty Ltd v Garrity (1977) 2 ACLR 559. Cases 1. Paul. Paul. Group Four Industries Pty Ltd v Brosnan (1991) 56 SARS 234. 5. 4. 7. Corporations Act 2001 (Cth). James. Mount Edon Gold Mines (Aust) Ltd v Burmine Ltd (1994) 12 ACSR 727. Commissioner of State Taxation (WA) v Pollock (1993) 12 ACSR 217. 8. 5. Ian Ramsey and Polat Siva. µInsolvent Trading ± An Empirical Study¶ (Research Report. Corporate Law Reform Bill 1992. µHolding Company Liability for the Debts of an Insolvent Subsidiary: A Law and Economics Perspective¶ (1994) 17(2) University of New South Wales Law Journal 520. Public Exposure Draft and Explanatory Paper (1992). Legislation 1. 3. Ian. 2010). 4. Other 1. Stephen. D. 3. 10. . Manpac Industries Pty Ltd v Cecattini  NSWSC 330.
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