Companies, directors and life after deregistration

In our October 2023 article we discussed the significant rise of corporate insolvencies during 2023. A report by the Australian Institute of Company Directors in January 2024 reiterated these alarming statistics and foreshadowed that there was more to come. The Tax Office started 476 wind-up proceedings in the first seven months of 2023, compared with just 14 in the same period the year prior, according to analysis by The Australian Financial Review.

Corporate insolvencies are unlikely to diminish through 2024 with extrinsic pressures continuing to adversely affect small to medium enterprise more significantly.

According to ASICs official statistics, of the reports lodged:

  • 83% had assets of $100,000 or less

  • 82% had fewer than 20 employees

  • 32% had liabilities of less than $250,000

  • 68% had liabilities of less than $1 million

In this group of creditors, 96% received between 0–11 cents in the dollar, reflecting the asset/liability profile of small to medium size corporate insolvencies.

When things do go wrong is it a matter for boards to simply deregister or liquidate companies and move on?

Company directors have duties to the company under the Corporations Act.

One of these duties is to ensure the company does not trade while it is insolvent. These (and other duties) may continue even after a company has been liquidated, deregistered, or has entered into administration. Liabilities that may arise from breaches of those obligations may materialise after a company is de-registered. Companies may be “brought back to life” and directors may be held personally liable for the conduct of the company.

Looking back after deregistration

There are many cases where deregistered companies can be reinstated (or brought back to life) by application to ASIC (or a court). This is more prevalent where there is a prospect of recovery of monies (such as, where assets have been transferred to related entities, or there is insurance available to a plaintiff). There are many examples where plaintiffs have succeeded against those companies.

Directors may be examined by an appointed liquidator post company reinstatement. Reinstatement returns the company to the state and form it was in at the time of deregistration. When considering whether to reinstate a company, courts will consider:

  1. The circumstances in which the company was dissolved and deregistered.

  2. Whether the reinstated company would be put to good use. Austin J's judgment in ACCC v ASIC [(Australian Competition and Consumer Commission v Australian Securities and Investments Commission (2000) 174 ALR 688] puts it as "whether… good use could be made of it".

  3. Whether any prejudice to third parties is likely to result from reinstatement. Austin J phrases it as "whether any person is likely to be prejudiced", including the company itself.

  4. Questions of public interest, for example in considering:

    • Whether there is any public interest reason not to order reinstatement; or

    • By contrast, whether a strong public interest in reinstatement should overcome the potential for prejudice.

Insurance for directors and officers

Directors’ and officers’ liability (D&O) insurance is underwritten on a ‘claims made and notified’ basis. As such, once a company is deregistered, liquidated, or is entered into administration, the policy goes into ‘run-off’ until policy expiry. During run-off, only conduct prior to the “event” falls for cover, and matters, facts or circumstances likely giving rise to a claim must be notified before expiry.

Trending: insolvency exclusions

Presently, and in light of the trend in insolvencies, insurers have been minded to apply more onerous “financial impairment” or “insolvency” exclusions to the D&O sections of those policies. The scope of these exclusions may differ significantly.

Below are two forms of insolvency exclusions:

  1. The insurer will not be liable to make any payment under this policy for that part of any loss arising out of, based upon or attributable to: (a) a company seeking protection under any bankruptcy laws or regulations, or any plan of reorganization or liquidation (voluntary or otherwise), scheme of arrangement (voluntary or otherwise), or form of composition with third party creditors; (b) the financial failure, liquidation, bankruptcy, insolvency, receivership or administration of a company.

  2. The insurer will not be liable to make any payment under this policy for that part of any loss directly or indirectly caused by, arising out of, attributable to or in any way connected with any Insolvency Event. For the purposes of this endorsement, Insolvency Event means with respect to the Company or any Subsidiary: (a) liquidation, bankruptcy, insolvency, receivership, administration (voluntary or otherwise), administrative receivership, winding up of any kind or any other similar proceeding in the relevant jurisdiction; (b) a supervisor or holder of a similar position in insolvency proceedings in any jurisdiction is appointed to manage all or part of the Company or Subsidiary’s assets; (c) entering into a scheme of arrangement with creditors in satisfaction of its debts or any other similar proceeding in the relevant jurisdiction; or (d) the Company or any Subsidiary being insolvent on the basis: i. it is unable to pay its debts and obligations as they become due; and/or ii. the value of its assets is less than its liabilities, taking into account contingent and prospective liabilities; and/or iii. where applicable, any equivalent or similar legal test to i. and ii. for determining insolvency in the jurisdiction in which such Company or Subsidiary is incorporated.

As regards the interpretation of these two insolvency exclusions, the Courts will look to give it commercial purposes and look to the underlying cause of the loss that gives rise to the claim and whether that is excluded.

While exclusion 1 above appears narrower, the practical outcome of exclusion 2 is likely to be similar assuming the underlying cause of the claim is not the insolvency itself.

In AIG Australia Limited v Kaboko Mining Limited [2019] FCAFC 96, (“Kaboko”)  the Court held that the exclusion didn’t apply to the facts because claims against Kaboko’s directors did not originate from any allegation of insolvency. The claims that were advanced in Kaboko could have been advanced irrespective of Kaboko’s insolvency i.e. the directors’ breaches created the circumstances that lead to insolvency.

It follows then that reference to “in any way connected with an Insolvency Event” in Exclusion 2 provides greater concern that the insurer will attempt to rely on more than simply the underlying cause of the claim; it could intend that the Event itself causes the trigger to enliven.

For many operating private companies, insolvency or financial impairment exclusions are now being included in most management liability insurer policy wordings.

Key takeaways

Directors would be remiss to consider that the risk of claims or actions brought against them are extinguished when companies are deregistered or liquidated. Regulatory actions and inquiries by liquidators can be brought against directors for many years (each cause of action having various limitations) after the conduct has occurred.

Directors and officers must be cognisant of the exclusions being applied by insurers and the impact they have on indemnity: remember, D&O insurance always intends to transfer the indemnity offered by the company to its directors and officers for legal costs and liabilities they may incur as a result of their conduct on behalf of the company. If the company becomes impecunious, what purpose does D&O cover to transfer the risk of such indemnity materialising?

There are a number of ways to ensure that insurers remove or do not apply an insolvency exclusion to your policy:

  1. Preparation of current financial statements,

  2. Recently audited financial statements,

  3. Detailed cashflow, forecast and budgeting analyses,

  4. Financial and operational maturity risk assessment - via Bellrock’s expert panel (Gianni & Co)

We would strongly recommend directors and officers to have their D&O policies reviewed to ensure they adequately cater for the risk of insolvency.

For more information on D&O coverage, please contact one of our advisors via the form below.

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