ASIC is becoming more serious and more active and will take action against directors if there is su cient reason to, so insolvency practitioners should consider all possible actions/recoveries fully in any report to ASIC.
A company's financial distress presents a challenge for its directors and officers of large and complex financial services companies and can raise a range of difficult issues, including potential liability for insolvent trading, which potentially exposes directors both to civil and criminal consequences under the Corporations Act 2001(Cth).
There have been a number of recent criminal prosecutions recently brought by the Australian Securities & Investments Commission (ASIC) against directors for breach of directors' statutory obligations under the Act upon referral by liquidators, who have themselves scrutinised the history of the company and the actions taken by the directors when dealing with the company's financial distress.
However, there hasn't been any cases where a shadow director has been found guilty of dishonest and fraudulent intent until the recent sentencing of the founder and former director of the Kleenmaid group of companies, Andrew Eric Young, who after eight years of prosecution and 11 years after the collapse of the business, was finally sentenced to nine years' imprisonment after being found guilty by a District Court jury of 19 offences.
ASIC is also prosecuting another shadow director for criminal insolvent trading which is currently before the courts.
A shadow director's duty to prevent insolvent trading
In some cases where there is an actual suspicions of insolvency and the failure to prevent the incurring of debts is dishonest, in addition to any compensation proceedings that might be initiated by a liquidator or creditor, criminal liability may apply with a fine of up to $200,000 or imprisonment for up to five years or both under section 588G(3) of the Act. There have been cases where a court has imposed a custodial sentence for insolvent trading with dishonest or fraudulent intent (for example, R v Timothy Rhys Hawker Williams [Supreme Court of Tasmania, 2004, unreported], which led to a 15 month term).
Even if a director is not formally appointed as a director, he or she may still be subject to the same duties and liabilities as a director. For example, if that person acts as a director or gives instructions to the appointed directors on how they should act, then that person may be considered a shadow director.
Shadow directors can still be liable for breaches of the laws relating to directors’ duties, even though they were never formally appointed as a director of the company, if they act as a director or give instructions to the appointed directors on how they should act, and can then be prosecuted by ASIC for criminally insolvent trading.
The Kleenmaid directors' prosecution
Kleenmaid, a white goods importer and retailer which operated a chain of company and franchised stores across Australia, was founded in about 1980 by Mr Young. Based on Queensland’s Sunshine Coast, the Kleenmaid group of companies employed about 200 staff Australia-wide and had 22 stores across Australia. On 9 April 2009, Deloitte was appointed to act as its voluntary administrators.
With no deed of company arrangement proposed to creditors, the creditors resolved in May 2009 to place the company into liquidation with consolidated debts of over $100 million, which included $27 million in customer deposits that had been paid for kitchen appliances yet to be delivered and debts to major creditors (primarily Westpac) of $29 million. Employees were out of pocket approximately $3 million.
In February 2012, after an ASIC investigation and the commencement of legal process, the three former directors of the Kleenmaid group – Mr Young, Bradley Wendell Young and Gary Collyer Armstrong – appeared in court for the first time on criminal charges.
After the hearing from September 2019 to January 2020 (an extraordinary 59 days) Mr Young was found guilty of defrauding Westpac in 2007 in relation to a $13 million loan facility. In addition to the criminal convictions for fraud, he was also convicted of 17 counts of criminal insolvent trading charges that related to him being a shadow director of a corporate entity, for which he received a sentence of three years' imprisonment to be served concurrently with the nine year sentence for fraud.
At the time the criminal insolvent trading offences were committed, Mr Young was found to be acting as a “shadow director” of a related corporate entity, EDIS.
According to news reports, Mr Young, (who was self-represented) argued that he was not a director of the company after a restructure in 2007 and therefore, did not have the same level of culpability as the other directors, and that rehabilitation for his offences would not happen in prison. The prosecution's view was that he had displayed "egregious and flagrant dishonesty," while a director before the company's fall in 2009.
Judge Brian Devereaux said the evidence showed he was still in control of the company's accounts. "It was inescapable the jury found that you were a director," he said during sentencing, he said, adding that "people in the community must be put on notice that dishonesty will bring with it commensurate punishment".
It was a long process from the collapse in 2009 and through the court but eventually ASIC prevailed, sending a clear message that where directors fail in their duty to prevent a company from incurring debts while it is insolvent, ASIC will investigate and take action especially where such conduct has been evidenced to be dishonest.
And another to keep an eye on: the Marcel Plastering prosecution
Marcel Plastering Group Pty Ltd (in liquidation) operated a plastering business which was placed in liquidation on 22 February 2017.
ASIC has recently conducted an investigation into former director Oussama Taleb's conduct following receipt of a report lodged by the liquidator. At the time of the liquidation, Marcel Plastering owed creditors approximately $628,501.
ASIC has subsequently formed the view that Mr Taleb, in his capacity as shadow director, engaged in conduct that resulted in the redirection of company funds both to his then partner’s personal account and a related company, Marcel Group Pty Ltd (deregistered), for the sum of $43,000.
In August 2019, Mr Taleb pleaded guilty to fraudulently removing and redirecting assets belonging to Marcel Plastering. He has appeared in Court on 19 August 2019 and entered a guilty plea. The matter was adjourned for sentencing on 12 December 2019 and has been further adjourned for mention to 11 March 2020.
Lessons for shadow directors and insolvency practitioners
For directors, and those tempted to act like one, the introduction of the safe harbour laws might have seemed to take the edge off insolvent trading laws. While safe harbour certainly gives some breathing room to a company in distress, directors or shadow directors can (subject to the safe harbour protection and already existing defences) still be personally liable for debts incurred by a company while it is insolvent, and risk criminal prosecution if they dishonestly allow such debts to be incurred. And these cases sent a clear signal that ASIC is scrutinising insolvent trading and that the courts are willing to impose a custodial sentence where there is evidence of insolvent trading with dishonest or fraudulent intent.
For insolvency practitioners, the position is as we noted in the last From Red to Black, ASIC is stepping up its enforcement activities not just of insolvent trading but also of breach of directors' duties more generally – and those duties are being reconsidered by society and regulators in the recent wave of corporate social responsibility post the Financial Services Royal Commission. Insolvency practitioners should consider early the merits of convening public examinations to investigate any potential shadow director activities in addition to the directors which may enhance the prospects of any recovery for creditors of the company particularly where professional indemnity insurance might be held.