Advising companies under threat of insolvency

2 September, 2009

A recent decision of the New South Wales Supreme Court in a test case brought by ASIC brings home the difficulties solicitors face when advising directors of small companies nearing insolvency on how to protect the company assets.

Sections 181, 182 and 183 of the Corporations Act 2001 (Cth) (the Act) require directors of corporations to act in good faith, in the best interests of the corporation, for proper purposes and not to act improperly and use their position to gain advantage for themselves or cause detriment to the corporation.

The NSW Supreme Court in ASIC v Somerville & Ors [2009] NSWSC 934 held that a solicitor, Timothy Somerville, was personally liable along with various company directors for breaches by the directors of their duties under sections 181, 182 and 183 of the Act. The solicitor was liable as a person involved in the breaches because he aided, abetted, counselled or procured the contraventions.

The solicitor was found to have advised the directors of various companies in nearly identical terms on how to transfer all the assets of the companies into new entities in exchange for shares which were found to be valueless. Somerville prepared all the necessary documents to carry out the transactions and arranged execution of the documents. The various companies then became shells, holding only the valueless shares and being left with all the original creditors. The Court found that ‘there was no proper basis for the transactions other than to keep the benefit of the assets in another company without the burden of liabilities’.

It was argued that it would be extraordinary if a solicitor just giving advice should be liable under the aiding and abetting provisions of section 79 of the Act. The Court said that this would depend on the circumstances and:

‘If advice is given the result of which brings about an action by directors in breach of the relevant sections of the Act, in
other words, when advice is given by a solicitor to carry out an improper activity and the solicitor does all the work involved in
carrying it out apart from signing documents, it seems to me that there can be no question as to liability.’

Given the current financial climate, practitioners will often be asked by directors to advise companies facing financial difficulties. Practitioners may advise as to the options facing the directors and the companies and as to the obligations and duties of the directors. This would include advising the directors of their potential exposures if they seek to undertake any steps to defeat or defraud creditors. If however the practitioner is then asked to assist the directors with a transaction which may breach the duties of the directors such as the disposal of assets to defeat or defraud creditors, the practitioner may face joint and several liability with the directors for aiding and abetting them in the breach of their duties.