In 1971, ss 347C and 374D were introduced into New South Wales companies legislation by the Companies (Amendment) Act 1971. These provisions empowered the courts to give civil remedies to creditors and were followed by similar legislation in other states at later dates. These new amendments made it clear that if a director incurred a debt without reasonable expectation of repayment then he or she would be personally responsible with- out any limitation of liability. However, like its predecessor, personal liability under this provision was dependent on the appropriate authority proceeding against a director and obtaining a conviction. The parliamentary intention and policy for the operation of s 374C and s 374D was to give the law teeth which did not previously exist, in order to deal with persons who carried on the affairs of a company recklessly.14
9. Ibid, 8 April 1964 at 8387 (Hon H J R Clayton). 10. Ibid, 8 April 1964 at 8380 (Hon A D Bridges). 11. Ibid, 9 April 1964 at 8466 (Hon R R Downing). 12. Ibid at 8461 (Hon H D Ahern).
13. The Australian Law Reform Commission, General Insolvency Inquiry, Report No 45, 1988 (Harmer Report), Vol l at 123.
14. Victoria, Parliamentary Debates, Legislative Assembly, 27 September 1966 at 361. The full quotation of the Honourable R J Harmer’s speech on ss 374C and 374D is as follows: “Proposed new sections 374C and 374D
The introduction of these provisions and the issues raised in the parliamentary debates indicates that progressively more was expected of directors. It is interesting that there was no consideration of the court’s approach to the issues of directors’ diligence in relation to insolvent trading. Instead, it was considered that the new laws were “tools” to assist the courts in their public duty. Moreover, the failing of the old s 303(3) was never analysed by parliament and as a result the problems of that section were passed on to its successors. Sections 374C and 374D consequently had little effective operation. The criminal purpose continued to be primary and so the use of the sections was restricted to business decisions of directors affecting creditors that were dishonest, but not those that were reckless or careless errors of judgment.
In 1981 the High Court considered the operation of s 303(3) in Shapowloff v Dunn.15 The section was considered because it had become the subject of a number of appeals in the lower courts since 1975, evidencing the controversial and arguably ineffective opera- tion of the section.16 Shapowloff can be regarded as the first important decision to offer judicial guidance on the operation of the insolvent trading provisions under the uniform legislation, making it worthy of detailed consideration. The case concerned a director who entered into a series of transactions involving the purchase of shares from a stockbroking firm. The share purchases were debited to the company account. The company paid its account from time to time, but in 1971 the company was wound-up leaving its account with the stockbrokers unpaid. Because there was a series of share transactions not paid, the question for consideration was at what point of time did the “debt” arise? Did it arise at the time of each transaction, or at the conclusion of all transactions when the balance was declared or computed? The High Court in considering these questions resolved that the time when the debt was due or each contract was formed, was the time when each liability arose and not when the debt was recorded or computed.
The leading judgment was given by Stephen J who considered that s 303(3) could not be understood by looking at the “ultimate fate of the debt”17 but instead the section looked to the date “when debt was contracted”.18 Accordingly, His Honour concluded that the “debt” was, in the circumstances of the case, contracted by the company on the date when the broker bought the shares, as this was the point of time when the liability arose. The second leading judgment was given by Wilson J who recognised that the meaning of “debt” within s 303 had long been the subject of controversy,19 and considered s 303
re-enact the provisions which make it an offence for an officer knowingly to contract a debt at a time when there is no reasonable prospect of the company being able to pay, and of carrying on business with intent to defraud creditors or otherwise. If a person is convicted of either of those offences, on the application of the appropriate officer or, with the consent of the Attorney-General, any creditor or contributory, the court may make an order against the convicted person to pay to the company the whole or such part as it thinks fit of the amount of the debt incurred in the first case, or the total or such part of the total of the debt incurred by the company as the court thinks fit in the second case.”
15. (1981) 148 CLR 72.
16. Shapowloff v Dunn (1973) 2 NSWLR 468.
17. Shapowloff v Dunn (1981) 148 CLR 72 at 78 (Stephens J). 18. Ibid.
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Insolvent Trading in Australia: The Legal Principles
against the background of bankruptcy legislation. His Honour thought it clear that the pros- ecution must prove beyond reasonable doubt “expectation, reasonably grounded in the whole of the circumstances” of inability to pay the debt.20 This approach involved a blend- ing of subjective and objective considerations. In Wilson J’s opinion the test imported an objective standard, but was to be applied to the facts known to the defendant.21 In finding that a “debt” arose under s 303(3) at the time it was contracted, the High Court took a narrow approach to the interpretation of the section, but this is not surprising given that the section under consideration had a criminal operation.
The courts in Australia had historically recognised that directors and officers of the company were not liable for honest errors of commercial judgment.22 Directors could not be held responsible for the debts of creditors short of dishonesty; a reckless attitude was insufficient to invoke the operation of the provisions. The judiciary showed a reluctance to review business judgments made in good faith,23 perceiving directors not as criminals, but merely people who made mistakes in business. The position can be best summarised in the words of the High Court who commented that “directors in whom are vested the right and duty of deciding where the company’s interests lie and how they are to be saved may be concerned with a wide range of practical considerations, and their judgment, if exercised in good faith and not for irrelevant purposes, is not open to review in the Courts”.24 Con- victions against directors for insolvent trading were difficult to obtain and the procedure was lengthy. In Shapowloff alone, there were no less than five hearings between 1973 and 1981.25 This did not seem to be too unusual. In another case a director was convicted five years after the winding-up of the company for which he was fined $500.26
It cannot be said that the insolvent trading law up to 1981 developed with any form of direction. This lack of direction could be attributed to the fact that unlike England, Aus- tralia had not undertaken any national investigation into insolvent trading but had instead relied on the British law reform experience. The policy considerations as articulated by parliamentarians addressed a perception rather than specific problems within the legisla- tion and failed to separate the civil and criminal consequences of insolvent trading. As a consequence, the insolvent trading legislation in Australia up to 1981 had no effective commercial remedies for creditors.