Sections of the Corporations Act You May Have Missed #001

Any prudent director of a company would be well aware of their potential liability for insolvent trading under section 588G of the Corporations Act 2001 (Cth). Company officers in corporate groups, however, often overlook a provision which is just as important, if not more so: section 588V. In our first edition of Sections of the Corporations Act You May Have Missed, we explore how a holding company may be found liable for the insolvent trading of its subsidiary. Parent companies, ignore at your peril.

Section 588V, together with the recovery provisions in section 588W, operates to impose liability upon a holding company where:

1. the subsidiary is insolvent at the time it incurs a debt, or becomes insolvent b incurring that debt;
2. there are reasonable grounds at the time for suspecting the subsidiary is insolvent, or would so become insolvent; and
3. either or both of the following apply:
   1. the holding company, or one or more of its directors, is aware that there are such grounds to suspect insolvency; or
   2. a holding company in the same circumstances, or one or more of the holding company’s directors, would be so aware, having regard to the nature and extent of the holding company’s control over the subsidiary’s affairs.

Parent companies found to have contravened section 588V may find themselves at the mercy of the subsidiary’s liquidator, who, under section 588W, has a right to recover from the holding company any amounts equal to the loss or damage suffered in relation to the relevant debt incurred by the insolvent subsidiary.

A company is a holding company and therefore subject to section 588V if it controls the composition of another company’s (the subsidiary’s) board; is in a position to cast, or control the casting of, more than one half of the maximum number of votes at a general meeting of another company; or holds more than one half of the issued share capital of another company. In a contemporary corporate environment often favouring complex corporate structures, there are many parents; and, if section 588V has anything to say about it, there are many bad parents.

Unlike cases of bad parenting, however, holding companies have several defences available to them. These are set out in section 588X of the Act, and operate to deny a liquidator any recovery under section 588W. In short, a parent company can avoid liability if:

1. at the time the debt was incurred, the parent company and any relevant directors had reasonable grounds to suspect, and did suspect, that the company was in fact solvent;
2. the holding company took all reasonable steps to prevent its subsidiary from incurring the debt;
3. the relevant holding company director(s) did not take part in the management of the holding company at the time of the debt due to illness or some other good reason; or
4. at the time the debt was incurred, the holding company and each relevant director had grounds to believe, and did believe, that a competent and reliable person was responsible for providing adequate information about the solvency of the subsidiary, and was fulfilling that responsibility.

Should a parent company satisfy any of the above, only then may it be absolved of liability for the bad behaviour of its children.