Assignment Topic:

One of the main ways in which the
‘veil of incorporation’ can be lifted is when...

Question

Assignment Topic:

One of the main ways in which the
‘veil of incorporation’ can be lifted is when directors breach their
duties. This essay question is set
around the duty to prevent insolvent trading.
You will need to have read the chapter in your prescribed text that
deals with this duty and have then researched more widely by looking at other
textbooks, the relevant CCH online library, articles from the internet and
journal articles. You must answer both
parts of this topic. Please make sure
you have REFERENCED in the body of your work ACCURATELY,. Remember, referencing shows you have
researched and thought about what material will be relevant to assist you in
answering the questions.

Read the
following scenario and answer BOTH parts (questions) at the end.

OHS Solutions Pty. Ltd. is a company
formed by three friends (Des, Satish and Emma) who bring different skills and
abilities to the business. Emma is an
accounting graduate, Des has expertise in occupational health and safety (OHS)
and Satish has an IT degree. They
decided to start up a business which would provide a portal through which the
public and businesses could access (for free) information on all aspects of
OHS. OHS Solutions would finance its
business, and make profits, by charging businesses to advertise via their
website. 
The directors of OHS Solutions
are: 
Managing Director – Des
Finance Director – Emma (non
executive)
Director – Satish (executive –
employed also to run the technological side of the business)
Director – Ying (non executive) – a
friend of Des’ and director of Support Pty. Ltd. (Support Pty. Ltd. has gone guarantor for a
$50,000 loan from the Business Bank Ltd. to OHS Solutions)

The Shareholders of OHS Solutions
(holding equal amounts of ordinary shares) are Des, Emma, Satish and Support
Pty. Ltd.

As at January 2007 OHS Solutions had
been operating for six months. It had
some initial IT problems which prevented some of the advertisers’ material from
being accessed. In order to try to help
overcome these technical problems Satish engaged Trouble Shooters Pty.
Ltd.

At the February Board meeting, Satish
reported that two businesses who had paid to advertise on the website were
dissatisfied with what was happening and were threatening to sue for breach of
contract. Emma was unable to table any
financial information as the employee who had been doing the accounts had been
sick and when Emma looked at the records she found that they seemed to be in a
bit of a mess. She did find a large
account from Trouble Shooters that was over due. Des reported that he was disturbed by this
news. He had been told by Satish that
the IT problems had been fixed since Trouble Shooters had been engaged, and he
had just signed a $10,000 advertising contract with Promotions Plus Pty. Ltd.
to advertise the website and signed up to go to a trade show to be held in
conjunction with a forthcoming OHS conference.
He said this was needed because a number of high profile advertisers
were threatening to discontinue their association with OHS Solutions unless the
portal became better known.

Ying just listens in disbelief at the
March Board meeting. It seemed to her
that OHS Solutions is being poorly managed and is failing to make the most of a
potentially profitable business opportunity.
This could present an opportunity for Support Pty. Ltd. to make an offer
to buy OHS Solutions at a good price. On
the other hand Support Pty. Ltd. is exposed as a guarantor.

Assume she consults you, an
accountant, for your preliminary view about the predicament of OHS Solutions
and what she should do. Assume also
that the first thing that comes to your mind is whether Ying herself may be
vulnerable as a director of OHS Solutions for failing to prevent OHS Solutions
from trading when it is insolvent.

YOUR TASK
Part A - (approx 800-1,000 words) 10 marks
Write a brief explanation
about why the directors’ duty to prevent insolvent trading exists and the
circumstances and consequences of the ‘veil of incorporation’ being lifted for
insolvent trading. (Do not just repeat
the words of the relevant sections in the Corporations
Act).

And

Part B(approx 1,500-1,700
words) 25 marks
From what you know of OHS Solutions’
predicament, DISCUSS whether any of the directors may be about to breach or
have already breached the duty to prevent insolvent trading. (In order to do this you will need to compare
what is happening in OHS Solutions case with other precedent cases and refer to
the relevant sections in the Corporations
Act.) What will you advise Ying?

(Note:
you do not have full information, so state briefly in the essay what
information you need and make reasonable assumptions that will allow you to
give your advice. ONLY DISCUSS INSOLVENT
TRADING – THAT IS THE QUESTION AND YOU DON’T HAVE ENOUGH WORDS TO GO INTO OTHER
AREAS)

PLEASE NOTE THE FOLLOWING
INSTRUCTIONS:
References must be cited in Harvard
referencing style (eg Smith XXXXXXXXXXThe assignment must include a bibliography
(list of references used in the assignment).
The Internet may be used for authoritative reference material provided
the source, author, date of access, and site address is clearly shown in
footnote format. 
In addition to sources from the
Internet, at least three hard-copy sources must also be used. These can be either books or articles or
both. Materials from any common law
jurisdiction may be used.

David · Accepted Answer

Part A 
Director‟s duty to prevent insolvent trading is a responsibility placed upon the directors of a 
company. This responsibility is placed upon the directors of the company by the various 
provisions of the Corporations Act, 2001. This duty or responsibility exists to make sure that 
the company is not insolvent or is solvent, and is particularly so when a liability or debt is 
acquired by it. This duty is applicable to such a person who, at the time of incurring of a debt 
by a company, is the director of the company. The relevant provisions of this duty are 
contained in Section 588G Corporations Act, 2001. Pursuant to these provisions, this duty is 
applicable to case where the company is insolvent at the time of, or becomes insolvent by 
acquiring that debt or liability, or by acquiring at that stage debt comprising that debt. 
Another element of these provisions is that at that time of adoption of the liability, there were 
rational and sound reasons which suggest that the company is insolvent, or it would become 
insolvent (Bevan,1994). Finally, these provisions also expect that the director needs to be 
mindful that such reasons of suspecting and insolvency exist or a normal person of reasonable 
intelligence in a similar position in the company or in the conditions of the company would 
be so responsive and mindful of the situation.  
From the above discussion concerning the scope of this duty and the relevant provisions of 
Section 588G of the Corporations Act, 2001, it is clear that the purpose for imposing this duty 
upon directors is to confirm that the company which they represent, does not trade while it is 
insolvent. The emphasis is laid upon absolving and restricting the company from trading and 
incurring any further liability or debt, especially in case where it has become insolvent or is 
likely to become insolvent in the future by virtue of such trading activity. The reason for 
encouraging such restriction is to prevent a financial crisis for the company in particular, and 
the economy as a whole. (Ramsay, 2013). These provisions and the resultant directors‟ duty 
to prevent insolvent trading, hold further importance due to the advent of the current global 
financial crisis. The purpose is to stop the companies from trading and acquiring further debts 
while they are insolvent, or would become insolvent, and thus unable to pay the acquired 
debts and liabilities. The ultimate objective is to withhold the companies from going into a 
situation of financial crisis and finally, the economy from going into recession and financial 
crisis.  
It must be noted that a company is a separate legal entity, which is distinct and separate from 
its shareholders, directors, and managers. In the leading case of Salomon v. Salomon & Co. 
Ltd., it was held that S as shareholder had no personal liability to creditors. This refers to the 
„veil of incorporation‟ which cannot be lifted to hold the shareholders responsible for any act 
of the company. The consequences of this „veil of incorporation‟ are that the company has 
limited liability to the extent of the unpaid amount by the shareholders on their share capital. 
Secondly, it enters into contracts in its own name, and in event of any litigation it can sue and 
be sued also in its own name. It can own assets and property in its own name, and irrespective 
of its shareholders, it has perpetual succession. 
However, this „veil of incorporation‟ can be lifted whereby the courts can look through the 
company and make its members or directors personally liable for the debts of the company. 
Under the common law, the corporate veil will be lifted where there are special 
circumstances which indicate that the incorporation of the entity is a mere façade for the 
purpose of concealing the true facts (James Hardy and Co. v. Hall). Under the Corporations 
Act, the veil may be lifted under various circumstances such as-  
 Section 588V relating to liability of a holding company for allowing a subsidiary 
company to trade while it is insolvent. 
 Section 197where the directors are liable for debts acquired by body corporate in its 
capacity as a trustee. 
 Section 588FB relating to Uncommercial transactions where the veil may be lifted for 
the purpose of considering directors and other corporate insiders differently from 
other outsiders such as creditors who have dealings with the company.  
 Section 267 where the company officers who loan funds to the company which is 
secured by a charge over its assets are treated in a manner which is different from the 
secured creditors who are at arms‟ length.

Assignment Topic: One of the main ways in which the ‘veil of incorporation’ can be lifted is when directors breach their duties. This essay question is set around the duty to prevent insolvent...

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