CAPITAL MAINTENANCE RULE NOW REPLACED BY THE SOLVENCY-BASED TEST FOR PAYMENT OF COMPANY DIVIDENDS
On 24 June 2010, the Federal Parliament passed the Corporations Amendment (Corporate Reporting Reform) Bill 2010 (Cth) (“the Bill”) which replaces the capital maintenance rule that a company can only pay dividends out of profits. The amendments will come into effect for reports for the 30 June 2010 Financial Year, subject to Royal Assent being granted.
Currently, section 254T of the Corporations Act 2001 (Cth) (“the Act”) provides that dividends may only be paid out of the profits of a company. The Bill now allows a company to pay a dividend other than out of profits on the condition that certain criteria are met. The Bill:
1.replaces the “profits” test for company dividends with a new solvency-based test;
2.introduces a number of new measures to improve financial reporting; and
3.reduces the regulatory burden of reporting obligations under the Act.
The amendments to section 254T of the Act will prohibit a company paying a dividend unless:
1.its assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend; and
2.if the payment of the dividend is fair and reasonable to the company’s shareholders as a whole; and
3.the payment of the dividend is not materially prejudicial to the company’s ability to pay creditors.
The company’s assets and liabilities will be calculated in accordance with the accounting standards in force at the relevant time the dividend is declared.
Notwithstanding that the Bill has introduced amendments to section 254T of the Act to allow the payment of dividends to shareholders out of share capital, the procedures for other share capital reductions and buy-backs as set out in Part 2J of the Act remain unchanged and the duty of directors to prevent insolvent trading in section 588G will continue to apply.
What this means for You
You will need to:
1.Establish how the Bill will impact the preparation of reports for the 30 June 2010 Financial Year and beyond;
2.Consider how the Bill will apply to any proposed reductions of capital or planned dividend payments; and
3.Review your company and scheme constitutions to ensure compliance with the new laws.
4.Speak to one of our Legal Advisers. We can also put you in touch with a great Accountant.
For more information on the above, please contact our Mr. Bechara Shamieh (Managing Director, Senior Lawyer) or Ms Melissa Hoffmann (Lawyer) on (02) 9283 2566.
Every company director should know that a company’s debt liabilities effectively die with them upon liquidation or entering into administration. Every financial year, thousands of private proprietary companies cease their operations. We like to think that all of these companies that cease to trade or exist do so on terms that settle all accounts with creditors or failing to do so, make an honest attempt at meeting the company’s debts. The sad reality, as has been recognised by the Australian Taxation Office (“ATO”) and the Australian Securities and Investments Commission (“ASIC”) is that this is not always true.
The phenomenon of registering a company with the intention of accruing debts and then “closing the doors”, or in some circumstances, merely closing the doors without the intention to repay any debt, is called a Phoenix. In essence the company is set up solely to incur debts and the directors are protected by the veil of incorporation. Once the debts are incurred and the commercial benefit obtained, the directors leave the company in its ashes. The directors rise like the mythical phoenix from the company ashes form a new company and repeat the process.
Recent Media Attention
Although a “Phoenix operation” is not a new concept in business, new powers being provided to the ATO to counteract such operations have recently attracted media attention (see Marsha Jacobs and Michaela Whitburn, Small-business fears on phoenix laws, The Australian Financial review, 30 June 2010, P3). This media attention is justified. The new laws, operational since 1 July 2010, grant the ATO the ability to levy upon any business (including any small business), a cash deposit requirement to be held as security by the ATO against any possible debts – including tax debts to the ATO.
Common Law Approach
The common law has for several hundred years recognised that a director who sets up a company for the purpose of creating a debt without the intention of re-paying it, or continues recklessly to incur debt will be liable for the damage they cause. Companies which are registered by the director for the above purposes are called ‘shams’. The legal distinction (the corporate veil) between the company as a legal person and the director as a natural person is said to be “lifted” and the director can be made personally liable for the debt to protect creditors against sham company operations.
The changes
The major new powers that will be exerciseable by the ATO are
1.Director’s penalty notices will be issued
2.Director’s penalty notices will be considered served when sent, not when received.
3.Any agreement reached with the ATO to pay by installments will not remove the penalty notice. This will still apply to the director until all unremitted payments are duly and fully paid to the ATO.
4.When a director is served a director’s penalty notice, a Federal or State Supreme Court has no jurisdiction to grant relief or excuse under section 1318 of the Corporations Act 2001 (Cth)
5.The Commissioner for Taxation may require cash security for any business
(a)that they think will only operate for a limited time, and
(b)when the commissioner thinks it is fit to require such security.
Difficulties of the New Laws
At a time when small business is still recovering from the Global Financial Crisis (“GFC”) and company taxation, Business Activity Statements, Goods and Services Tax and Superannuation remittances, are already creating difficulties on businesses, further ATO imposition on business cashflow would be most unwelcome. This is without statutory penalties that may emanate from being charged by the ATO for breaching a director’s duty or failure to duly remit taxation payments to the ATO. In our view, small business in capital and labour intensive industries such as the building industry will be affected adversely by any heavy handed application of the ATO’s new powers.
How to Respond
The best way to ensure that the ATO does not consider your business to be a Phoenix or vehicle designed for tax and creditor evasion is to develop and practice a regime of firstly, strict corporate compliance, and secondly, operational and financial prudence.
Corporate compliance
1.Know your Corporations Act 2001 (Cth) duties and obligations as a company director.
2.Have a business plan that sets out how you will comply with your director’s duties.
3.Know your company structure.
4.Have legitimate purposes for each company you establish.
Operational and Financial Prudence
1.Monitor cashflow.
2.Use an ATO-approved accounting method, such as Accounting Standard 2000 for the building and construction industry.
3.Remit what is due to be remitted on time.
4.Maintain clear records. Time spent record keeping can save time discussing issues with the ATO or wasting your resources answering an ATO audit.
5.Demonstrate continuity of work.
6.Avoid setting up companies which are not necessary.
7.Pay all creditors on time.
8.Declare all income.
9.Declare estimates of income to insurers in full. This demonstrates honesty.
10.Claim all deductions and maintain accurate records.
11.Record all directors’ loans so that any money removed form the business by the director will be correctly accounted for and not appear as tax evasion.
Further assistance
Should you require further assistance with your corporate structure, contracts administration and taxation scheduling, contact Consolidated Lawyers’ Corporate and Commercial Division, Bechara Shamieh (Managing Director, Senior Lawyer), or Graham Fullick (Director, Senior Lawyer) on (02) 9283 2566.
Before we address the theory on the topic, it is important to note that the Law Reform Council (LRC) published a report in 1993 detailing the difficulties with this present area of law.
Existing Australian law about security over personal property and priorities is difficult, complex and cumbersome.
The concept is very important for purchases, lenders and other interested parties,
whilst it varies widely from jurisdiction to jurisdiction and is based on a mixture of common law, State and Territory legislation.
Types of personal property that can be taken as security are any property other than land and buildings. It includes tangibles and intangibles such as insurance policies, patents, trademarks and choses in action.
Section 262 of the Corporations Act2001 (Cth) sets out the charges required to be registered. Among those not required to be registered but which, in ordinary commercial terms would impact on title are the following:
Retention of title Clauses, as in the Romalpa clauses;
Negative pledges;
Conditional Sale Agreement or Reverse Mortgages.
The Corporations Act 2001 (Cth) provides that a failure to lodge both the charge and the instrument is a contravention of the Corporations Act.
The Chattel Securities Act 1987 (Vic) encourages rather than compels registration of Security of Interests by Section 7, which voids an unregistered security interest as against the bona fide purchaser for value without notice. Therefore if you do not register your security interest, you lose your security.
Section 17(3) of the Sales of Goods Act 1923 (NSW) provides that an implied condition on the part of the seller that is in the case of a sale, has a right to sell the goods and in the case of an agreement, that he has right to sell goods at the time when property is to pass and
“…an implied warranty that the goods shall be free from any charge or encumbrance in favour of any third party.”
So you can see the various complex legislative provisions!
What are “Priorities”?
In some situations competing claims (both legal and equitable) will be made over the same piece of property. Priorities are the rules to work out which interest takes precedence over the other interests.
Legal Interest verses Legal Interest
When two or more legal interests in the land conflict the main principle is that a person cannot convey an interest which he or she does not have (“nemo dat quod non habet”). Partial - when A leases to B, A then sells to C, C’s interest is taken subject to the lease. Wholly inconsistent – A sells to B and then sells to C, C receives nothing.
Equitable Interest verses Equitable Interest
The general rule is the early interest has the better claim if everyone has acted in good conscious. It is to be noted that the ‘nemo dat’ equivalent would apply i.e. equity is a court of conscious so there are many exceptions to the general principal and the first in time principal is a last resort.
Who has the best equity, refer to Heid v Reliance Finance Corporation Ltd (1983) 154 CLR 326, which stipulates that the better equity depends on the circumstances and the conduct of the parties.
The earlier equitable interest may be postponed to the later interest where (a) the conduct of the early interest holder has lead to the later interest holder acquiring an interest (b) in the mistaken belief that the prior interest did not exist.
For example, A agrees to sell his land to B. A gives the title deeds to B and signs a receipt for the purchase money even though he has yet to be paid. B proceeds to grant an equitable mortgage over the land to C.
Who has the Better Interest?
a) A has an equitable lien over the property.
b) C has an equitable mortgage.
Both the equities are security interests however, A’s negligent conduct in giving the Title Deeds and signing the Certificate means that it is his fault that C took his interest without notice, hence C’s interest is superior, refer to Rice v Rice (1953) 61 ER 646. The exception to the above is in the case of land being held under a trust. The beneficiaries will not lose their priority because of negligent or fraudulent conduct by the trustee: Shropshire Union Railways & Canal Company v R.
Prior Legal Interest verses Equitable Interest
In cases where there has been no fraud on the part of the legal estate holder, the prior legal estate prevails over the later equitable estate however, the exceptions are where the legal interest holder was a party to the fraud that lead to the equitable interest being created, Northern Counties of England Fire Insurance Company v Whipp (1884) 26 Ch D 482 all where the legal interest holder was grossly negligent in failing to enquire or obtain possession of the title deeds: Walker v Linom [1907] 2 Ch 25.
Tacking
“Tabula in naufragio,” an equitable interest holder purchased for value and without notice is later able to acquire the legal interest and can tack its equity on to the legal interest and jump priority i.e. if A grants a mortgage to B then an equitable mortgage to C and then another equitable mortgage to D then the order of priority will normally be B, C, D. If D can later buy the land off B then D’s equitable interest will be tacked to the legal interest and C will come in last.
Whilst we all agree that certainty as to the existence of a charge or security interest is greatly desired so as to eliminate the confusion of unregistered dealings, we need to await the outcome of the lobbying by the LRC for the betterment of the system and hope that the suggestions of which suggests inter alia a compulsory system of registering all interests, and the elimination of any unregistered dealings, will take effect sooner rather than later.
In the meantime, if you face any questions on the topic, please feel free to contact our specialist lawyers at Consolidated Lawyers. We will endeavour to keep things simpler.
An unsecured creditor of a company often wonders whether it is worth their time, resources and money in making an application to wind up a company on grounds of insolvency, particularly given that a creditor, in most circumstances is unable to ascertain whether the company holds any or sufficient assets to meet the debt at the time the application is filed.
Let’s just say, as a creditor of a company, you decide to take a chance to recover a debt owed to you by the company. You go through the lengthy (and costly) process, only to find out that the company that once held assets now holds nothing to its name. Not only is your debt not satisfied, you are also out of pocket for legal expenses. Is this the end of your recovery process? Definitely not!
Once the company is wound up and a liquidator is appointed, the liquidator, by virtue of the Corporations Act 2001 (Cth) (“the Act”) has the ability to challenge any ‘suspicious’ transactions that dispose of assets during the period leading up to the company being wound up. A liquidator has the power to set aside of vary transactions, by court order under section 588FF of the Act, that have been entered into by insolvent companies that ultimately defeat, delay or defer creditors.
Division 2 of Part 5.7B of the Act sets out a range of ‘voidable’ transactions, for example, uncommercial transactions (section 588FB), insolvent transactions (section 588FC), preferences (section 588FA) and unfair loans to the company (section 588FD).
A voidable transaction can have occurred within 6 months of the date of filing the application to wind up the company, for example, where the transaction has rendered the company insolvent (insolvent transactions) or occurred within 10 years of the date of filing the application to wind up the company, for example, an insolvent transaction where the transaction was entered into for the purpose of defeating, delaying or interfering with the rights of any or all of the creditors on a winding up of the company.
However, the mere existence of a voidable transaction does not vary or set it aside, the liquidator must seek a court order under section 588FF. Once an order is made, the liquidator can recover the proceeds of the transaction for the benefit of the general body of unsecured creditors.
Notwithstanding the above, a company has the benefit of defences under section 588FG, however, only in relation to orders made by the Court under s588FF, such as a transaction entered into in good faith.
So, don’t just presume that because you think a company does not own any assets or you have been informed that the company has dissipated its assets that there’s no point in pursing the company, you may be pleasantly surprised at what may be available for the general body of unsecured creditor.
So contact our experienced Commercial Team today on (02) 9283 2566 to make an appointment to obtain further advice.
In February 2006, the Government initiated a review of the disclosure obligations contained in the Franchising Code of Conduct. The recommendations of the Franchising Code Review Committee and the Government’s initial response has lead to the enactment of the Trade Practices (Industry Codes – Franchising) Amendment Regulations 2007 (No.1) 2007 No. 240 (Cth) (Regulations).
Commencement Date
Regulation to take effect from 1 March 2008.
Purpose of Amendments
The purpose of the amendments are to place the franchisee in a better position through increased disclosure by a franchisor to both existing and prospective franchisees and the quality and timeliness of such disclosure.
Key Changes and Effects of Change
1. (a) Foreign Franchisors
(a)Change:
The Code currently exempts foreign franchisors (franchisors that are resident, domiciled or incorporated outside Australia) that grant only one franchise or master franchise to be operated in Australia. As part of the new regulations, this exemption no longer applies.
(b)Effect:
This change will apply to both new and existing foreign franchisors. For existing foreign franchisors, the franchisor must comply with all relevant provisions of the Code and Regulations including but not limited to providing disclosure, entering into a franchise agreement and so on.
2. (b) Time Period in which a Franchisor must provide Documentation to the Franchisee and such documentation
(a)Change:
A franchisor must provide an existing or prospective franchisee with the following pursuant to Clause 10 of the Code and items 17 and 18 of the Disclosure Document (Annexure 1):
the franchise agreement in the form it is expected to be signed in;
copies of all associated agreements and contracts (e.g. leases, guarantees etc);
also provide the franchisee with a copy of the Code and not merely direct the franchisee to the Office of Small Business website.
These documents must be provided no less than fourteen-(14) days prior to the anticipated date of signing.
(b)Effect:
A franchisee should only enter into a franchise agreement where the 14 day time period applies and all documentation has been provided to it.
3. (c) Prohibition on General Waivers of Representations
(a)Change:
Currently, any oral or written representations made by the franchisor before the franchise agreement was entered into have no effect. However, Clause 16(1)(b) of the Code prohibits the ‘waiver of any verbal or written representation made by the franchisor’. This will apply to existing franchise agreements entered into after 1 October 1998.
(b)Effect:
Any such provision or clauses in existing franchise agreements will no longer be of any effect. This amendment will also apply to the transfer, renewal or extension of any existing agreements after 1 March 2008. Additionally, any representations made by a franchisor to a franchisee whether it be through conversation, email and mail correspondence and so on are carefully drafted.
Franchisors should review their current agreements and documentations and processes to ensure compliance.
4. (d) Disclosure of Materially Relevant Facts
(a)Change:
All materially relevant facts must continuously be disclosed to a franchisee by a franchisor within fourteen-(14) days of it changing or becoming known to the franchisor. This has been reduced from sixty-(60) days as per the current Clause 18 of the Code.
(b)Effect:
Although this provision currently exists, a franchisor now has a greater obligation to disclose materially relevant facts and ensure their processes pick up on changes in a timely manner.
5. (e) Disclosure of Voluntary Undertakings
(a)Change:
Under the Code, franchisors will be required, within fourteen-(14) days of a franchisor giving an undertaking pursuant to section 87B of the Trade Practices Act to disclose all information relevant to the undertaking to the franchisee. Such information also needs to be included in the Disclosure Documents.
(b)Effect:
The amendment provides a greater emphasis on disclosure by the franchisor. Again, the franchisor will need to ensure its procedures will detect when undertakings are provided.
6.New Disclosures
(a) (a) Ex-Franchisee Details
(i)Change:
Currently, a franchisor must disclose names and contact details in the Disclosure Document of past franchisees for the past three-(3) financial years that have transferred or ceased operating as a franchise. The amendment now provides a franchisor must disclose names, locations and last known contact details for franchisees for the past three-(3) financial years only if the franchisee consents in writing pursuant to item 6.6 of Annexure 1 of the Code.
(ii)Effect:
The franchisor will have to amend existing documentation to include all the above information in its Disclosure Document and in addition put in procedures to obtain the franchisees consent or refusal to disclose its details.
(b) (b) Rebates
(j)Change:
Franchisors will be required to disclose the name of businesses providing a rebate or financial assistance pursuant to Item 9.1(j) of the Disclosure Document.
(ii)Effect:
Amendment to franchise documentation by franchisor and greater disclosure by the franchisor to the franchisee.
(c) (c) Disclosure Documents
(i)Changes:
Pursuant to Clause 6(1), a franchisor must now within four-(4) months (currently three months) of the end of each financial year, provide financial reports and updated disclosure document upon request in accordance with the Corporations Act.
To a franchisor whom Disclosure Document applies, that is, Annexure 2, it cannot refuse a request of a franchisee for any additional information not contained in the in the Disclosure Document Annexure 1.
The Corporations Amendments Insolvency Bill will be were introduced to Parliament on 31 May 2007.
Such a reform to insolvency laws has not occurred in 20 years. These are important changes that your business should be aware of.
The amendments to be introduced to parliament today are:
Employees’ superannuation entitlements will be protected when companies collapse.
Liquidators are required to be more upfront about their fees and declare past advisory relationships to overcome creditor concerns about conflicts of interest.
Scrapping redundant meetings
Allowing liquidators to communicate with creditors via email
Streamlining complex administrations of corporate groups by consolidating related companies.
Easier investigation of insolvency practitioners for wrongdoing by corporate regulators.
New statutory process for pooling the external administration of related companies designed to reduce costs by allowing consolidated accounts and meetings.
The understanding of insolvency laws are a very important part of corporate governance structure.
What’s your opinion on the new bill?
For further information on Corporate Law please contact our Sydney Office on
(02) 9283 2566.
Summarised Article “Insolvency Laws Reformed” The Australian Financial Review, Thursday 31 May 2007.
The Directors of Australian subsidiaries, which operate as subsidiaries for global corporations are faced with a challenged to protect their reputation and assets upon the insolvency of the parent company.
Global corporations typically operate in Australia through a wholly owned subsidiary company. The Corporations Act, stipulates either one or two directors must be Australian residents (S201A). Australian subsidiaries are governed and administered by Australian Law, regardless of the fact that they are part of a worldwide corporation.
In the recent past, there have been a number of high profile corporate collapses such as Walter Constructions, Gate Gourmet and Akai. Directors will not be necessarily spared from personal liability in the event of a corporate collapse and should take on board the tough lessons learnt by examining the wreckage of these cases.
Some of the salient points to take on board include:
Directors have a duty to act in the best interest of the Company and its shareholders and to ensure that the company is trading solvently. In the event that the company becomes insolvent, the primary interest is that of any creditors. In the event that a Liquidator is appointed their responsibility will be to investigate whether any of the assets have been transferred overseas. Directors may be held personally liable to secure debts owed to creditors in the event that assets have been transferred overseas.
Letters of comfort be utilised by Directors. A letter of comfort may be used as a defence against its parent company in the event of insolvency. The letter of comfort is a letter issued to a lending institution by a parent company acknowledging the approval of a subsidiary company's attempt for financing. Legal advice should be sought with respect to various aspects of the letter of comfort and should be personally reviewed to ensure that potential elements are taken into consideration.
D&O Policy, the D & O policy, being the insurance policy, may provide some relief to the directors of the Australian subsidiaries. A Director needs to ensure that the policies are current and the policy covers insolvent trading and legal costs in the event that you could be sued by the Liquidator or be subject to ASIC Investigation.
S95A of the Corporations Act sets out the definition of insolvency which can be effectively summarised as “a company is insolvent if it is unable to pay all its debts when they become due and payable. Legal advices should be sought immediately in the event a director believes the company is insolvent or is approaching insolvency. A self bonding may be available when Directors act promptly.
Contact our specialist Commercial Team now on (02) 9283 2566.
