Consequences of enterprises failing in the financial markets

Those who have been caught up in failed enterprises in the financial markets will no doubt be wanting to draw a line under 2008 and start fresh in 2009. The reality might, however, be very different.

Depending on the nature of the enterprise and its state (from ‘affected’, ‘stressed’, ‘on the way out’ to ‘in liquidation’) the directors and management of financial institutions might be subject to any number of interruptions to starting afresh in 2009 including the following.

If the enterprise is publicly listed and under strain the ASX will be keeping a watch and company officers may be caught up in responding to market supervision enquiries or investigations into suspected breaches of the various ASX Rules or, possibly, disciplinary proceedings.

In all probability, however, the ASX will be the least of the problems.

There is no doubt that regulators generally are increasingly better funded and, consequently, more active.  It has certainly been my experience that there has been an increase in activity. In the last six months or so my firm has acted for clients being required to produce documents or to attend for oral examination by the ACCC, Australian Crime Commission (ACC), ASIC and the Victorian State Revenue Office (SRO).

Many companies that are failing or have failed can expect scrutiny from ASIC. The nature of that scrutiny will depend on the nature of the company and the nature of its business. However, ASIC is regularly exercising its powers under Part 3 of the ASIC Act to require relevant persons to produce documents and/or to attend for oral examination and it might be expected that financial services entities will come in for their fair share of scrutiny. ASIC’s enquiries might range from whether directors met duties under the Corporations Act of honesty and diligence to whether they have traded whilst the company was insolvent, and beyond.

For management that has moved on from the enterprise under scrutiny this can be a time consuming process. The production of documents alone can be a major task depending on the nature of the investigation. For example, in an insider trading investigation the documents required to be produced might extend from purchase orders and contract notes to bank statements and other financial records and on to telephone records (both mobile and land lines) and personal diaries.

There is also cost. In regard to oral examinations, although the role of the lawyer for an examinee is not a large one, it is my experience that it is highly desirable to involve a lawyer to ensure that questions asked are reasonable (for example, that they don’t rest on hypothesis assumed as fact), that legal professional privilege is protected and, although an examinee cannot refuse to answer questions on the ground of self incrimination, that protection is maintained by the assertion of such a claim where appropriate. In addition, a lawyer can usually ask questions at the conclusion of an examination (generally on transcript) to correct any misunderstandings or errors.

ASIC may also ban persons from managing corporations. For example, where a person has been an officer of two or more corporations that are being wound up and the liquidator lodges a report under section 533(1) of the Corporations Act (which includes the fact that the company has been unable to pay creditors more than 50 cents in the dollar) the person may be banned for up to five years.

Of course, the outcome of investigations may be action by ASIC for breaches such as misleading representations in connection with the supply or promotion of financial services.

Another source of activity is the ATO. Again, for an enterprise that is still surviving, any tax irregularities might provoke a notice pursuant to section 264 of the Income Tax Assessment Act (ITAA) to the corporate taxpayer and others, including officers of the company, to produce documents and to attend for oral examination. If the company is failing, the directors might receive a notice from the ATO under section 222AOE of the ITAA requiring payment of the tax arrears. A consequence of a failure within 14 days to comply with such a notice by either paying the arrears or for the company to appoint an administrator or for a liquidator to be appointed is to make the directors personally liable for the tax debts referred to in the notice.

For enterprises that have failed altogether, directors can look forward to close scrutiny from the liquidator.  This can range from requests to produce books and records of the company to attending for oral examination.  These may be a precursor to actions to recover company funds by reason of insolvent trading by the directors.  It is clear that, increasingly, directors are becoming concerned about struggling on, even with the periodic extension of facilities by the company’s bankers.

In addition to all of the above, there is the possibility of third party claims against the management.  These could come from former staff, contractors, customers or shareholders based on, for example, misleading and deceptive conduct. In the Sons of Gwalia1 case the shareholder was successful in a claim against the company for misleading and deceptive conduct by failure to disclose material information in relation to share price and value. Although a claim in that case was not brought against the directors there appears to be no reason why directors could not be sued as accessories.

Finally, there are dealings with professional indemnity insurers. Those lucky enough to be part of a company with professional indemnity insurance and directors and officers’ liability insurance can look forward to negotiations over whether cover will in fact be provided. If it is, there will be the usual demands on time associated with instructing lawyers appointed by the insurer in connection with whatever claims have been made. If cover is denied, not only will the director or former director have to appoint their own legal advisers for such claims, they may well have to embark on separate proceedings against the insurer to compel the provision of indemnity.

All things considered, the tribulations of 2008 might extend well into 2010 and beyond.

1 (2007) 25 ACLC 1


Noel Batrouney

Consultant Noel is a corporate & commercial lawyer who advises on commercial disputes, banking & finance and insolvency.

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