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How to avoid disqualification as a director by ASIC

15 February 2016

#Dispute Resolution & Litigation

Paul Venus

Published by Paul Venus

How to avoid disqualification as a director by ASIC

The principle that underpins the concept of a limited liability company is that companies can fail. Entrepreneurialism is encouraged by this principle because it encourages risk taking. Directors can make decisions with the knowledge that, by taking a risk in running a limited liability company, they will be protected from losing their personal assets. Company failure will not result in personal ruin and so you would expect directors to act accordingly[i].

But this limit on liability does not give directors of a limited liability company carte blanche to act irresponsibly in making decisions that affect the company and those it deals with. With the protections of limited liability comes the responsibility to ensure that the company is well managed and that the law is upheld. Directors must take their duties very seriously if they are to enjoy the benefits of being a director.

As a sanction to the director who fails in their duties, the Australian Securities and Investments Commission (ASIC) has the power to disqualify a person from managing a corporation for up to 5 years in certain circumstances[ii]. ASIC’s decision to disqualify a director is open to appeal, in the first instance to the Administrative Appeals Tribunal and then later to the Federal Court of Australia. But obviously it is a much better outcome if the decision of ASIC does not result in a director being disqualified. The following information discusses how best to achieve that result.

Considerations by the Delegate in determining disqualification

ASIC may disqualify a person if, within 7 years before ASIC gives notice to the person to demonstrate why they should not be disqualified:

  1. the person has been an officer of 2 or more corporations; and
  2. while the person was an officer, or within 12 months after they ceased to be an officer, each of the corporations was wound up and a liquidator lodged a report under s533(1) of the Corporations Act about the corporation’s inability to pay its debts,

and ASIC is satisfied, that disqualification is justified under s 206F of the Corporations Act. 

Disqualification orders are designed to protect the public (including consumers, creditors, shareholders and investors that deal with the company) from the present or future harmful use of the corporate structure or use that is contrary to proper commercial standards. The law seeks to safeguard the public interest in the transparency and accountability of companies and in the suitability of directors to hold office. When deciding whether disqualification is appropriate, and if so for how long, there are a number of matters which ASIC, through its delegate who determines whether to disqualify a director, will be required to take into account[iii].

How the director managed the company and ensured that it met its statutory obligations will be an important consideration for the Delegate. The Delegate will want to ensure that the director understands the duties that are required of them by law, that they do their best to comply with those duties and that they do not act in a way that frustrates others who are attempting to administer the company.

A Delegate will consider the nature and seriousness of any breaches by the directors and, in particular, whether there is any fraud, dishonesty or gross incompetence involved[iv]. The chances of a Delegate deciding that a person should be disqualified from being a director will be very high where these circumstances exist and cannot be explained by mitigating factors.

A Delegate will consider whether a director did their best to avoid insolvent trading. It will be important to show that a director took reasonable steps to cause a company to comply with accounting and reporting provisions and to avoid it incurring debts it cannot pay when due[v]. The financial impact of that conduct on other people will be an important consideration and the Delegate will take into account the interests of shareholders, creditors, financiers and employees which have been affected by the collapse of a company.

The director needs to show that they did not have a casual approach to management. They should demonstrate that they understand the relationship between any group entities and each entities’ financial position. They should also be able to demonstrate that they saw management needs as important and appointed appropriate staff such as a Chief Financial Officer.

A director will need to explain to the Delegate why taxes may have been unpaid and that the director has simply not tried to use the corporate veil as a way to avoid tax[vi]. Where there has been a failure to lodge tax returns, the Delegate will be keen to understand whether its circumstances show a disregard of the interests of creditors including the ATO[vii].

Directors also need to appreciate that their responsibilities do not end when an external administrator is appointed to a company. The Delegate will examine whether a director has assisted, or have been willing to assist administrators, liquidators and statutory authorities[viii]. Often the delegate will have a report from a liquidator that sets out any concerns the liquidator had regarding assistance provided by the director. In those circumstances, the director needs to be prepared to explain what they did to assist the liquidator.

A director’s character will be an important consideration. If a director shows signs of contrition or acceptance of responsibility, an understanding of the proper role of a company director and duty of due diligence owed to the company, they will have a better chance of avoiding being disqualified. The Delegate will also consider whether a banning order is necessary to ensure that the concerning conduct does not occur again. If a director seems likely to engage in similar conduct in the future the Delegate can determine that a banning order may be in the best interests of the public.

External factors causing company failure will be an important consideration when determining what level of culpability should be borne by its directors for failure of a company. The Delegate will consider whether the failure of the company can be attributed or partly attributed to causes outside of a director’s conduct or control. Events such as the GFC, a drought, predatory pricing by competitors, or the unexpected withdrawal of finance may be considered[ix]. It is important not to assume that the Delegate will be aware of or understand such events, even if they are notorious. The specific nature of an event and its impact on the corporation in question needs to be detailed to the Delegate.

The Delegate can consider inter-company relationships, even if those companies are not strictly “related” in the sense of s 206F(2)(a) of the Act. This includes if the companies had connections - including cross-provision of financial support, common directors, common staff or advisors, common shareholders, and similar activities - such that the failure of one was inextricably linked to the failure of the others and they can effectively be regarded as a single entity by the Delegate[x]. It is therefore important to explain those relationships to the Delegate and how they have impacted on corporate failure.

Lastly, the Delegate will consider whether disqualification will cause hardship to personal and commercial interests. The director should explain what current business and personal interests they have that could be affected by a disqualification. Directorships in other companies, involvement in charitable organisations, the need to earn income by being a director to meet family needs and whether or not the director would be capable, by virtue of age, training or other circumstances, from gaining meaningful work are all relevant.

How the hearing works in practice

The hearing to consider disqualification is conducted by a delegate of ASIC. The Delegate is an ASIC officer who is different to the ASIC case officer that initially has investigated the conduct of the director. The Delegate may be physically located in a different city to the case officer and the director who has been given the notice. The Delegate will not have been involved in any initial investigations concerning a director.

Prior to the hearing, the Delegate will require the ASIC case officer to provide the Delegate and the director, with all documents that the ASIC case officer considers relevant. The Delegate will restrict their decision making to a consideration of those documents, as well as any other documents provided by the director. Where more than one director of a company receives a Notice, the delegate will ensure that any evidence provided or submissions that are made by one director that may impact on another director, are informed to the other director. The other director will then be given an opportunity to respond to the material from their fellow director.

The Notice that is sent to a director will ask the director if they wish to be afforded the opportunity to make written submissions, provide written evidence and attend a hearing. If the director asks for an opportunity to be heard, the Delegate will advise the director of a hearing date. Typically that date will be within 4 weeks of the date of the Notice. Even in complex matters, the hearing date is likely to be within 6 to 8 weeks of the date of the Notice. The Delegate will not be unreasonable about minor changes to the timing of a hearing but will not entertain lengthy delays without very strong grounds being advanced.

The director is entitled to engage legal counsel to assist them at the hearing. There does not seem to be any limit on the number of lawyers that a director may engage and ask to attend at a hearing.

Where there are more than one director of a company or group of companies that have received a notice, ASIC may permit the directors to attend a joint hearing.

The hearing will usually occur at the offices of ASIC. The hearing before the Delegate will likely be attended by the case officer who referred the matter to the Delegate. The Delegate will use audio equipment to record the hearing and will ask all parties present to clearly identify themselves at the start of the hearing.

The hearing then proceeds informally. This is not an adversarial hearing, the rules of evidence do not apply and there is strictly no burden of proof[xi]. However, any findings of fact must be based on material that is “relevant, credible and probative”. There are no rules of procedure that apply to the hearing. Witnesses may be led, documents do not have to be formally proved and persons present are not under an obligation to answer questions unless they want to do so.

At the end of the hearing, the Delegate will advise the director that they will consider their decision. The Delegate will note that if further information comes to ASIC’s attention, if the Delegate gives a favourable decision to the director, which causes ASIC concerns that the Delegate may ask for a new hearing. The Delegate will also inform the director of their rights of appeal to the Administrative Appeals Tribunal, the ability to seek a stay of the decision and also the time in which a director must take action if they wish to avail themselves of those processes.

If the Delegate decides that the director should be disqualified, they will provide written reasons.

If the Delegate decides that the director should not be disqualified, they will usually just send an email to the director or their lawyer advising of this outcome.


10 Tips to prepare for and participate in the hearing

  1.  The Delegate is not the enemy
    The Delegate should be addressed respectfully and formally. The process that they are undertaking is very serious and should be treated with respect. The people who are delegates of ASIC are highly trained and experienced professionals. They are not capricious and have no personal animosity towards the directors who are subject to a hearing. It would therefore be wise to treat the Delegate with the same respect that you may pay to a judicial officer, even though the nature of the hearing is much more informal than a judicial hearing.
  2. Written submissions
    It is useful to prepare written submissions. They should be prepared with the understanding that they will be used by the Delegate to form an opinion about whether a director should be disqualified. The preparation of clear and concise submissions can assist a Delegate to form a favourable view of a director. However, it is preferable not to read those submissions aloud at the hearing as the Delegate will read them later.
  3. Statements of witnesses
    Whilst the hearing before the Delegate is “informal” and the rules of evidence do not apply, the better the evidence that can be presented to the Delegate the more likely that it will be persuasive. The best evidence that a director can present will be written statements or affidavits that closely follow the rules of evidence. For this reason, care should be taken to prepare evidence and where possible, statements should be made available to the Delegate.
  4. Listening to the Delegate
    Too often people fail to listen to what is being said to them, particularly when they are experiencing a stressful situation. The hearing will be stressful but despite that, it will be important for the director to listen carefully to any question that the Delegate asks. It is likely that the Delegate will be asking the question because the answer will be important in their decision making. Failure to adequately respond to the exact question asked may therefore adversely affect the director’s prospects.
  5. Ensure the Notice and the documents are correct
    Do not assume that all of the information in the Notice is correct or that the documents that are provided with the Notice are complete. Mistakes can happen such as incorrect dates, names and amounts of money being recorded. Cross check all information that is provided against independent searches and materials.
  6. Undertakings
    It is possible to provide undertakings to the Delegate that certain conduct which is of concern to the Delegate will not occur in the future. Directors should be aware that a breach of such an undertaking will be considered to be unlawful and grounds for immediate disqualification. The Full Court of the Federal Court of Australia decided in Dresna v Misu Nominees (2014) ATPR 42-013 at [16] and [29] by majority, that breaches of an undertaking given to the ACCC were illegal on the basis that they were improper. The same reasoning should apply to breaches of an undertaking given to ASIC.
  7. Personal references
    Strictly speaking, it is irrelevant whether someone is willing to give a personal reference about the good character of a director, who is the subject of a hearing to determine whether they should be disqualified as a director. However, these sort of references can be persuasive and should be included.
  8. Personal submissions 
    In all but exceptional circumstances, even when represented by lawyers, the director should take the opportunity to say something at the hearing. A personal expression of contrition, understanding of why events happened and acceptance of responsibility can be powerful in the presentation of a case by the director.
  9. Liquidators can assist
    A director should contact the liquidator of the company that failed and seek their assistance to better explain to the Delegate what happened. The report that a liquidator provides to a company may not fully explain the assistance given by a director to the liquidator, certain events or even all the reasons for corporate failure.
  10. Creditors, Banks and others
    If a person who has been affected by the corporate collapse is prepared to support a director, then that evidence should be advanced at the hearing. It is powerful if, for example, a banker for the failed company is prepared to give an opinion that the director did their best and that events beyond their control led to the failure of the company.

Conclusion

All that a director needs from the hearing process is an email from the Delegate of ASIC that is likely to read as follows:

“Having considered the material before me I have decided that an order should not be made under s206F of the Corporations Act 2001 disqualifying [director’s name] from managing corporations.”

If a director can achieve that outcome they have successfully navigated the path from Notice under s206F to hearing, to favourable outcome.

This article was first published in the February 2016 issue of Governance Directions, the official journal of Governance Institute of Australia.

Disclaimer

The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this publication is accurate at the date it is received or that it will continue to be accurate in the future. We are not responsible for the information of any source to which a link is provided or reference is made and exclude all liability in connection with use of these sources.

Notes:

[i] Quinlivan v Australian Securities and Investments Commission [2010] AATA 113 at [79]

[ii] Corporations Act 2001, s206F

[iii] See Re HIH Insurance Ltd; Australian Securities and Investments Commission v Adler (2002) 42 ACSR 80 at [56]

[iv] See also Kardas v Australian Securities Commission (1998) 29 ACSR 304 at 312

[v] Re Delonga and Australian Securities Commission (1994) 15 ACSR 450 at [29]

[vi] Cullen v Corporate Affairs Commission (NSW) (1988) 14 ACLR 789

[vii] Healey v Australian Securities and Investments Commission [2000] AATA 9

[viii] Rich v Australian Securities and Investments Commission (2004) 220 CLR 129 at [43]

[ix] Cullen v Corporate Affairs Commission (NSW) (1988) 14 ACLR 789; Feher and Australian Securities Commission [1997] AATA 507

[x] Re Kimball Andrews and Australian Securities and Investments Commission [2006] AATA 25; JYWV v Australian Securities and Investments Commission [2010] AATA 936

[xi] ASIC’s practice manual

Paul Venus

Published by Paul Venus

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