Taking directors to court

By JOHN VAGUE

The role of a liquidator is to realise assets in such a manner that the return to creditors is maximised.

Assets include not only debtors, stock, plant and machinery, but also the right of legal action against various parties. One of those rights of action is the right to issue proceedings against directors for reckless trading.

The Companies Act 1993 states that a director of a company must not cause or allow the business of a company to be carried on in a manner likely to cause substantial risk to creditors. If a director does so then the director may be made personally liable for the debts of the company.

Linked with actions for reckless trading are actions in respect of obligations. In particular, a director of a company must not agree to the company incurring an obligation unless the director believes at that time, on reasonable grounds, that the company will be able to perform the obligation when it is required to do so.

The signs of reckless trading are reasonably obvious. The forensic accountant will find a few of the less obvious signs.

Obvious signs are:

* The serving of statutory demands by creditors.

* Creditors being paid late.

* Letters or meetings requesting indulgence from creditors.

* A decision by the bank to change management of the account to a debt recovery department.

The smaller company has other obvious signs. There will be no directors' minute books and directors' meetings will not have been held. The company will be "flying blind" in that there will be no profit forecast or cashflow projections.

What is perhaps the saddest part is that often the directors will have taken out an additional mortgage on their house and put more good money into a failed company.

However, when discussing reckless trading we usually refer to actions against directors - the net is often cast much wider. Certainly actions in respect of reckless trading often include professional people and managers. Solicitors can also be sued. These people can be regarded as shadow directors.

It is common for a person to claim that they were a director in name only. Justice Wild clarified this when he recently stated in a judgment: "Directorship of any company involves acceptance of all directorial duties imposed by law. There is no halfway house."

Before bringing an action the liquidators must examine several issues:

* The liquidators must select a barrister who has confidence in the proposed case and is competent in this area of the law.

* The liquidators must have the support of creditors. Creditors sometimes would prefer 20c in the $1.00 immediately rather than have the liquidator spend the money on legal fees, accounting fees, and liquidators fees and have recoveries some two or three years later.

* The liquidator must have sufficient money to fund a legal action. Even a comparatively simple action will cost in excess of $50,000.

* Lastly and most importantly, the directors must be people of substance.

There is no benefit in being awarded a substantial sum by the court if the directors are people of straw.

McDonald Vague is from time to time engaged in cases against directors. Before we issue proceedings in respect of reckless trading, we get one of our forensic accountants to examine the shareholders' current account.

Often payment of this account puts the director in a position where he has no more assets and an action for reckless trading would be pointless.

Our most recent success was with mining company DML Resources (In Liquidation). In that case we focused through barrister Kerry Fulton on the entire unpaid trade creditors' debts at the date of liquidation. The case settled out of court just days before the trial and a sum in excess of $6 million was paid into the trust account of the liquidators for the benefit of creditors.

* John L Vague FCA ACIS AFNZIM is a senior partner in insolvency specialist McDonald Vague. John has presented papers on insolvency and is a member of the Joint Insolvency Committee.