A Warning to Company Directors: Discharge from Personal Bankruptcy will not Necessarily Absolve Liabilities for Insolvent Trading

By Nicholas Mason, Law Clerk and Alicia Hill, Principal, MST Lawyers

In the recent case of Taylor (liquidator) v Trustee, bankrupt estate of Heading, in the matter of Heading [2020] FCA 1450, the Federal Court considered the circumstances in which leave will be granted for an insolvent trading action against a company director who has previously been released from debts provable in bankruptcy.  

Background

Peter Heading was a declared a bankrupt on 15 April 2015. Stephen Duncan was then appointed Trustee of his estate. By virtue of s 149(1) of the Bankruptcy Act 1966 (Cth), Mr Heading was automatically discharged from bankruptcy at the expiration of a three-year period on 16 April 2018. Once this discharge occurred, the operation of s 153 of the Bankruptcy Act provides that Mr Heading was released from all debts provable in bankruptcy.

The case brought before the Federal Court concerned an application brought by a liquidator, Mr Austin Taylor, for leave to commence a proceeding against Mr Heading and the Trustee in connection with a debt considered provable in bankruptcy. The application related to activities Mr Heading had undertaken in his capacity as director of Heading Contractors Pty Ltd, in a period prior to the company entering voluntary administration in September 2014.

The liquidator’s case was that, in the seven month period preceding the voluntary administration, Mr Heading had contravened s 588G(2) of the Corporations Act 2001 (Cth) by failing to prevent Heading Contractors from incurring debts while insolvent. Section 588M of the Act provides that where a director has been found to have incurred debts while insolvent, a liquidator may recover from the director, as a debt due to the company, an amount equal to the loss or damage incurred from the insolvent trading.

The liquidator sought leave to commence a proceeding naming Mr Heading as a defendant.

The Insurer

The liquidator also submitted a joinder of Mr Heading as a defendant to the proposed proceeding may facilitate a claim by the Trustee against a policy of insurance for indemnity against any proven liabilities. The indemnity that Mr Heading may have been entitled under the Policy would be vested in the Trustee by virtue of s 177 of the Bankruptcy Act. The liquidator considered that that the Insurer also be named as a defendant in the proposed proceeding, in the event it denied liability under the policy to indemnify the Trustee in respect of the claims.

Mr Heading’s Position

Mr Heading opposed his joinder and that of the Trustee to insolvent trading proceedings. He argued such a proceeding was untenable because no action could be brought in respect of a provable debt against a discharged bankrupt. He also argued that the declaration of liability sought by the applicants would not invoke the Insurers obligations on a proper construction of the relevant policy. Accordingly, he asked that the Court should consider the leave application brought by the liquidators as futile.

Mr Heading otherwise argued that the Court’s discretion to commence a proceeding in which he would be joined as a defendant should be refused owing to concerns over his ability to rebuild his life following discharge from bankruptcy.

Consideration by the Court

Justice Charlesworth proceeded to offer an analysis of s 58(3) of the Bankruptcy Act. The section relevantly provides:

(3) Except as provided by this Act, after a debtor has become bankrupt, it is not competent for a creditor:

  1. a) to enforce any remedy against the person or property of the bankrupt in respect of a provable debt; or
  2. b) Except with the leave of the Court and on such terms as the Court thinks fit, to commence any legal proceeding in respect of a provable debt or take any fresh step in such a proceeding.

The Outcome

His Honour considered that while Mr Heading’s discharge from bankruptcy had operated to release him from personal liability for debts, it did not operate to absolve him from other consequences that may follow from his status as an officer of the Company.

His Honour also considered the Mr Heading remained obliged to give assistance to the Trustee in presenting a claim against the policy to the Insurer. This formed part of Mr Heading’s obligation in section 152 of the Bankruptcy Act to give assistance as the Trustee reasonably requires in the realisation and distribution of property.

Justice Charlesworth also considered that in the exercise of discretion, it would have caused substantial inconvenience to Mr Heading as a non-party, including as an essential witness, if he were not joined as a defendant. While recognising the joinder did expose Mr Heading to a risk of adverse costs orders and obligations as a party in the dispute, they were outweighed by the interests of the company and its creditors in having its interests heard against the Trustee (as well as the Insurer as against the Trustee).

His Honour finally considered that any undue negative impacts upon Mr Heading may be avoided or ameliorated by fashioning procedures that adequately protect his interests, including as to costs. Accordingly, his Honour determined leave should be granted to bring the proceeding with both Mr Heading and the Trustee as joined as defendants.

Take-aways

This case serves as an important reminder to company directors that a bankruptcy declaration will not always absolve liability under the insolvent trading provisions of the Corporations Act. In the exercise of the Court’s discretion under s 58(3) of the Bankruptcy Act as to whether an action for a provable debt can be brought against a bankrupt, prior obligations as a company director can trump the inconvenience such a proceeding against the individual.

If you have any queries about your obligations as a company director or insolvency matters more generally, please contact Alicia Hill on (03) 8540 0292 or alicia.hill@mst.com.au