THE PERILS OF E-INSOLVENCY, INSOLVENT TRADING AND ... · startups will continue to collapse as they fail to gain further funding. Business to business on-line exchanges will fade

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THE PERILS OF E-INSOLVENCY,

INSOLVENT TRADING

AND DIRECTORS AND

OFFICERS’ INSURANCE

Helen Horsington

Lawyer

Allens Arthur Robinson

4 July 2001

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The Perils of E-Insolvency, Insolvent Trading and

Directors and Officers’ Insurance

1. Background

In the 1990’s a lot of people spent a lot of time worrying about Y2K. As it has turned out

they were worrying about the wrong kind of computer related collapses. They should have

been concentrating on the imminent collapse of a raft of ecommerce and dot coms: Eisa,

Allmybills, Oven Digital, Liberty One, K Grind, Big Fat Radio, Breathe.com, Infosentials (in

administration), My Price, Planetel and Mainstreet Internet Services are just some of the

companies to go in the Year 2000. The experts predict that that trend will continue in 2001.

According to Brad Howarth (reporting in the Business Review Weekly of 15 December

2000):

“For many of the more ambitious internet startups in the on-line retailing and

information services sector, 2001 will be a battle for survival as they try to make

cash reserves last until they achieve profitability … traditional businesses will

assert their authority on the internet through ecommerce initiatives. Dot com

startups will continue to collapse as they fail to gain further funding. Business to

business on-line exchanges will fade away as issues of funding and corporate

governance cripple them. The on-line advertising industry will face further

consolidation until revenues increase. Broadband will grow in importance, but will

be some way from reaching mass adoption. Mobile ecommerce will struggle

because of low use of handsets and uncertain morals for generating revenue.

Venture capitalists will remain cautious about investing in ecommerce ventures.”

On 16 January 2001 Merrill Lynch predicted that some “dot coms” will run out of cash by

2002.

It seems clear that 2001 will feature a fair share of ecommerce and dot com collapses. For

insolvency practitioners this may mean work, but whether or not most of it is lucrative work

is another question. Clearly there remains a lot of money in ecommerce. Figures from A C

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Nielsen/www.consult predicted that the Australian e-tailing sector would turn over $2.5

billion in 2000 which is close to three times the 1999 figure of $920 million. According to

Goldman Sachs the value of electronic commerce transactions in Australia will reach a

staggering $127 billion by 2005 (reported in Daily Telegraph 4 July 2000 p.46).

The problem for insolvency practitioners and creditors of these companies is that when

they go into voluntary administration or liquidation the practitioner often finds that there are:

• no fixed assets;

• just a relatively insignificant number of items of furniture or computer equipment,

some or all of which may be leased;

• intellectual property assets which may still be works in progress;

• trade marks, names or banners which may have little remaining value following

publicity surrounding the insolvency of the company or may never have been

properly registered.

If there is no or little money in the kitty and few easily realisable assets practitioners and

creditors may seek to look elsewhere in order to recover funds. One source may be claims

against directors for insolvent trading or other breaches of the Corporations Law (the Law).

Like many professionals who may be faced with personal liability in the future many

directors take steps to ensure that they have few if any assets in their own name. So there

may be little benefit to a practitioner or creditors in successfully pursuing a director unless

of course the director is covered by directors’ and officers’ (D&O) insurance giving the

practitioner and creditors access to the funds of an insurance company (and hopefully not

an insolvent one).

This paper considers the general nature of insolvent trading and the liability which may be

imposed on a director if found liable. It contains a brief discussion of the historical

problems facing liquidators who sought to bring proceedings against rogue directors before

considering D&O insurance and exploring the possibilities which this presents to liquidators

in recovering funds for creditors. An analysis of the usefulness of D&O insurance in the

context of insolvent trading is made, before finally considering litigation insurance funding

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as an option for liquidators in financing proceedings against delinquent directors for

insolvent trading.

2. Overview

2.1 What is insolvent trading?

Section 588G of the Law imposes liability on a director of a company who allows the

company to incur a debt at a time when the company is insolvent and at the time that the

debt was incurred there existed reasonable grounds for suspecting that the company was,

or may become as a result of incurring the debt, insolvent. A director will be liable if at the

time the debt was incurred he or she was actually aware of the existence of reasonable

grounds to suspect insolvency or a reasonable person in a similar position within a similar

company would have been aware.

One of the main problems directors face is being able to identify when a company is

insolvent. The somewhat vague definition of insolvency does not assist. Prior to 23 June

1993 no statutory definition of insolvency existed. The Law now contains section 95A

which states that a person (including a company) is insolvent if they are not solvent. They

are only solvent if they are able to pay all their debts as and when they become due and

payable. The emphasis is on the ability to discharge all of one’s debts, rather than merely

particular debts. Insolvency is not usually determined merely by looking at the balance

sheet of a company and determining whether there is a surplus of assets over liabilities.

Rather, the emphasis is on cash-flow. Of course Companies may experience both types of

insolvency simultaneously.

The term ‘debt’ has a wide meaning which often varies according to the context in which it

is used. The courts have stated that the terms ‘debt’ and ‘incurs’ are not terms of precise

definition but are to be applied flexibly in a practical and commonsense manner.

A number of defences are available to directors against whom an insolvent trading action is

brought:

• The director had reasonable grounds to expect that the company was solvent and

would remain solvent even if it incurred the relevant debt. This requires a director

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to prove that he or she had an actual expectation of solvency as well as the

existence of reasonable grounds for that expectation.

• The director relied upon information regarding the solvency of the company which

was provided by another and which led to a belief in the actual solvency of the

company based on that information. This is intended to encourage a system of

proper financial management.

• The director did not participate in the management of the company at the time the

debt was incurred. There must be a connection between the non-participation and

the ‘good reason’.

• The director took reasonable steps to prevent the company incurring the debt, such

as appointing a voluntary administrator to the company.

The court can also excuse the director from liability if they have acted honestly and ought

fairly to be excused.

2.2 What liability is imposed for insolvent trading?

The liability which may be imposed on a director for insolvent trading is wide-ranging and

stringent. The sanctions which can be imposed fall into two categories: civil penalties or

criminal penalties. Where a director allows a company to trade whilst insolvent and this is

done knowingly, intentionally or recklessly and was either dishonest with a view to gaining

an advantage or was intended to deceive or defraud someone then the director is guilty of

a criminal offence. The maximum penalty payable for such criminal offence is a fine of

$200,000 and/or imprisonment for 5 years. A director who is guilty of a criminal offence is

prohibited from managing any company for 5 years.

Civil penalties are similar to criminal penalties but are imposed as a result of criminal intent

and do not include an automatic disqualification from managing companies. A director can

be made to pay a pecuniary penalty, or a fine, to ASIC. This fine can be for an amount of

up to $200,000. A director can also be ordered to pay compensation to the company under

either of two provisions facilitating the ordering of compensation. Under one (ss588J(1))

the compensation payable is equal to the loss and damage suffered by an unsecured

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creditor. Under the other (s1317H) the compensation payable is equal to the ’damage’

suffered by the relevant unsecured creditor or creditors. Presumably these two standards

are the same, or substantially similar. Finally, a director can be prohibited from managing

any company for a specified period if he or she is not a fit and proper person to manage a

company.

As discussed in the Introduction, while the e-tailing industry is likely to enjoy a ‘boomtime’

in the next few years, during the same period many dot com and new economy companies

will collapse as a result of insolvency. However, the tentacles of the insolvent trading

provisions may affect many directors of new economy companies who may not ordinarily

consider their company insolvent. A major difficulty in proving insolvent trading has

traditionally been the problem of proving insolvency on the day that the particular debt was

incurred. Often the financial records of the company are inadequate or they enable proof

of insolvency on dates other than the one required. To remedy this situation the Law now

specifies two rebuttable presumptions of insolvency. The first states that where it is proved

that a company was insolvent at a particular time during the 12 months ending on the

‘relation back day’ (most often the date on which an application to wind up was filed or an

administrator was appointed) it is presumed that the company was insolvent from that time

until the relation back day. Under the second presumption a company will be presumed

insolvent where it is proved that the company failed to keep proper accounting records

which correctly explain and record its transactions and financial position and which enable

true and fair financial statements to be prepared and audited (s588E(4)). These

presumptions can be rebutted.

Recent actions by ASIC suggest that many dot coms and new economy companies are

failing to keep proper accounting records. In January of this year ASIC wrote to 53 new

economy companies asking them to clarify their financial reporting and disclosure. This

action was prompted by an ASIC surveillance of the industry which reviewed cash flow

statements of companies in the high-tech, dot com and other related sectors. Many of

these were start-up companies who had listed on the ASX within the last 3 years. Major

problems were identified in relation to the acquisition of businesses, the reporting and

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valuation of intangible assets, the recognition of revenue and the general accuracy of

reporting statements. The premature recognition of revenue, lack of notes on revenue and

inadequate disclosure were also problems identified by ASIC.

These inadequate accounting records and procedures within the new economy industry

may be suggestive of an endemic problem which may lead to exposure for insolvent

trading for many directors of these companies based on the presumption of insolvency for

inadequate accounting records.

ASIC has foreshadowed enforcement actions where appropriate in these circumstances.

Directors of new economy companies should beware!

Under the auspices of the new ASIC Chairman, Mr David Knott, ASIC has recently taken a

tough stance on insolvent trading. Clearly it is an area of company law which ASIC intends

to crack down on. This could not have been made more abundantly clear than when ASIC

announced in late November last year that it would commence proceedings in the

Supreme Court of Victoria against high profile businessman Mr John Elliott. This action

has been commenced against Mr Elliot as a director of the failed listed company Water

Wheel Holdings and its subsidiary Water Wheel Mills for allegedly allowing them to trade

whilst insolvent. As part of this 'crackdown' ASIC is seeking orders that Mr Elliot and

another director together pay $5 million compensation to unsecured creditors, each pay a

fine of $400,000 ($200,000 for each of two breaches) and an order prohibiting them from

managing companies for a specified period.

With ASIC on the prowl and a number of new economy companies apparently failing to

heed to proper accounting and reporting standards it is important for all directors to be

aware of their possible exposure for insolvent trading.

2.3 Why there have been so few insolvent trading cases to date?

The main power to bring proceedings for insolvent trading lies in the hands of ASIC and the

liquidator. In limited circumstances a creditor can initiate proceedings, but only after either

the liquidator has failed to act within 3 months or if they receive the written consent of the

liquidator.

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However, until recently the insolvent trading provisions have been utilised somewhat

infrequently. Until recently ASIC has instigated a small number of proceedings.

Liquidators have often failed to utilise the provisions because there are often insufficient

funds available within the company to fund and sustain proceedings or to ensure that the

liquidator’s fees and costs are covered by the funds of the company. There are usually a

large number of unsecured creditors to a failed company, each of which is often owed only

a small amount of money. As a result it is often not financially worth it to an unsecured

creditor to bring an action for insolvent trading as the costs of bringing the proceedings are

likely to be more than the money the would receive back if the action was successful.

A number of developments, including litigation funding and an increasingly vigilant

corporate watchdog, have seen a rise in the number of insolvent trading actions brought

against rogue directors in the last few years. It is likely that this trend will continue.

2.4 What is directors’ and officers’ insurance and indemnity?

Given the increasingly onerous duties placed on directors and officers and their

vulnerability to proceedings and financial exposure, the role of D&O insurance and

indemnification has become more important in recent times.

Typically a D&O policy contains two separate insurance components. The first usually

consists of a company reimbursement component which provides for the company to seek

reimbursement for those amounts which it is obliged (or in some cases permitted), under

its articles, to indemnify its directors and officers. The second usually consists of a direct

cover component which provides indemnification to directors and officers where the

company itself is unable to do so.

Sections 199B and 199C of the Law provide that a company (and a related body corporate)

is prohibited from paying, or agreeing to pay, the premium for insurance of an officer

(including a director) or an auditor of the company against a liability (other than for legal

costs) arising out of:

• conduct involving a wilful breach of duty in relation to the company; or

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• a contravention of section 182 or 183 (which relate to directors’ use of position and

use of information).

Provided that there matters are excluded from the cover under the D&O policy, which they

usually are, there are no restrictions on the ability of a company to pay for an insurance

premium for their directors and officers.

There are also a number of standard exclusions from D&O policies which significantly

restrict the ambit of their operation. These include:

• prospectus-type liability exclusion which will often be of importance to directors

of companies who propose to embark on a public offering;

• professional indemnity exclusion which excludes cover for claims alleging a

breach of duty other than the professional duties owed by a director.

• insured versus insured exclusion which excludes claims brought by one person

covered by the insurance against another, including by the company against a

director. This is a significant exclusion because a directors’ duties are owed to the

company itself and actions thus brought by the company are a significant potential

source of liability. Many D&O policies contain an exception to the insured versus

insured exclusion. This is to prevent the manufacturing of a claim for example by

the directors of a company breaching a duty and voting to sue themselves to get

damages for which the company is insured. D&O policies normally include an

exclusion to extend cover to claims brought in the name of the company:

(i) as a shareholder derivate action;

(ii) by ASIC; or

(iii) at the instigation of a receiver, administrator or liquidator.

Unless the policy contains such an exception, a D&O policy is unlikely to provide

relief for an action brought by the company/liquidator against a director for

insolvent trading as the action would be brought on behalf of the company. This is

discussed below.

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It is important to note that the definition of ‘officer’ within the Law was expanded last year to

include all persons who have the capacity to significantly affect the company’s financial

standing. This new definition is somewhat uncertain in scope and differs from the old

definition which listed various roles as falling within the definition. Without subject to

careful review by insurers, many D&O policies may now unwittingly include a broad range

of persons within their purview.

In some circumstances a company may also be able to indemnify its directors or officers

for liability they have incurred. There are a number of restrictions placed on this ability

which are explored below in Part 3.

3. Recent Developments in Directors’ and Officers’ Insurance andIndemnity

A number of changes were made to the Law last year, that came into effect on 13 March

2000, which substantially modified provisions directly impacting D&O insurance and

indemnities.

As discussed above, sections 199B and 199C were redrafted to expressly provide that a

company must not pay an insurance premium for a director or officer of the company

against a liability arising out of conduct involving a wilful breach of duty. Provided that the

D&O policy excludes such claims a company able to pay a premium for D&O insurance.

As well as paying for a premium for D&O insurance, a company can indemnify a director or

officer for certain liabilities incurred. The new provisions which deal with the

indemnification of directors and officers (s199A) deal separately with when an indemnity for

liability for legal costs, and one other than for legal costs, will be allowed.

A company, or related body corporate, is prohibited from providing an indemnity, other than

for legal costs, in a number of circumstances. This prohibition applies to an indemnity

against liability incurred as a director, officer or auditor of the company which is:

• owed to the company or a related body corporate;

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• for a pecuniary penalty order or a compensation order for a breach of certain

provisions (including the insolvent trading provisions); or

• owed to someone other than the company (or related body corporate) and arose

out of bad faith.

A company must not indemnify a director, officer or auditor for legal expenses incurred:

• in defending proceedings in which the person is found to have a liability for which

the company could not indemnify the person;

• in defending or resisting criminal proceedings in which the person is found guilty;

• in defending or resisting proceedings brought by ASIC or a liquidator for a court

order if the grounds for making the order are established; or

• in connection with proceedings by the person for relief under the Law which are

denied by the court.

In all other cases the company is able to indemnify the director, officer or auditor for his or

her legal costs.

Interestingly, these new provisions allow an indemnity for legal costs to be provided before

the outcome of the proceedings is known. If an indemnity is advanced but an adverse

decision is given by the court the costs already paid must be refunded. In addition, a

company can provide a loan or advance to a director, officer or auditor in respect of legal

costs. Again, if an adverse decision is reached such a loan or advance must be repaid.

4. How Useful is D&O Insurance in the context of Insolvent Trading?

As discussed above, sections 199B and 199C of the Law provide that a company must not

pay an insurance premium of the company against a liability arising out of conduct

involving a wilful breach of duty. So long as the D&O policy excludes such claims from its

ambit a company is able to take out effective D&O insurance for its directors and officers.

As indicated earlier, there are a number of sanctions which may be imposed on a director

by the court for insolvent trading. These fall into two categories: civil penalty provisions

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and criminal penalty provisions. Basically a criminal offence is committed by insolvent

trading where it is done with wilful deceit.

Section 199A of the Law prevents a company from indemnifying a director against liability

incurred for a pecuniary penalty order or a compensation order under section 1317H. This

is because such a fine or compensation is payable to the company as a result of wrongs

committed against it. It would be against the policy of the Law to allow a company to

indemnify a director or officer in such circumstances. As a result it will often be difficult, if

not impossible, for a company to indemnify a director or officer for liability incurred for

insolvent trading and to then seek reimbursement itself from its insurer under its company

reimbursement policy. In such circumstances a director or officer will usually seek direct

cover under the D&O policy.

However, because D&O policies must not cover a director or officer for liability incurred as

a result of a wilful breach of duty (section 199B), a D&O policy will not cover a director or

officer for liability incurred for insolvent trading where such a contravention is a criminal

offence. This is because a criminal offence is committed as a result of a wilful reach of

duty, or wilful deceit.

Accordingly, most D&O policies will only cover the liability of directors or officers which is

incurred under a civil penalty provision, such as an imposition of a fine or the requirement

to pay compensation to the company. Whilst this could be seen to restrict the

effectiveness of D&O policies in the context of insolvent trading, a criminal offence is

difficult to prove and thus will rarely be made out. Most insolvent trading actions will seek

civil penalty remedies and would thus be covered under the direct cover component of a

D&O policy.

However a far greater risk to the effectiveness of D&O policies is the ‘insured versus

insured’ clause which was discussed above.

4.1 Will the policy respond to a claim by one insured against another?

As discussed above, many D&O policies provide that the policy will not respond to claims

brought by or on behalf of the company or any of the company’s directors or officers

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against any other director or officer. Most such policies however provide an extension

which means that the exclusion will not prevent cover for claims bought by a shareholder,

ASIC or an insolvency practitioner appointed to the company.

4.2 What if there is not a full and proper disclosure of the company’s circumstances atthe time the D&O policy was taken out?

The failure of a director or officer to disclose the insolvency of the company, the possible

insolvency of the company or other circumstances which may give rise to a claim (such as

the possibility of insolvent trading proceedings being commenced against them) at the time

of taking out the D&O policy may lead to the insurer avoiding the insurance contract and

refusing to insure of indemnify the director and/or the company.

4.3 General duties

Essentially, an insured has two duties in respect to providing an insurer with accurate

information as to the risk to be insured under an insurance policy, namely:

• duty not to misrepresent material facts; and

• duty to disclose material facts.

With respect to contracts of insurance which fall within the ambit of the Insurance Contracts

Act 1984 (Cth) (the ICA), these duties are solely contained within ss21 and 26 of the ICA.

(a) Duty of disclosure

Section 21 of the ICA relevantly provides:

(1) Subject to this Act, an insured has a duty to disclose to the insurer, before the

relevant contract of insurance is entered into, every matter that is known to the

insured, being a matter that:

(a) the insured knows to be a matter relevant to the decision of the insurer

whether to accept the risk and, if so, on what terms;

(b) a reasonable person in the circumstances could be expected to know to be a

matter so relevant.

(2) The duty of disclosure does not require the disclosure of a matter:

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(a) that diminishes the risk;

(b) that is of common knowledge;

(c) that the insurer knows or in the ordinary course of the insurer’s business as an

insurer ought to know; or

(d) as to which compliance with a duty of disclosure is waived by the insurer.

(3) Where a person:

(a) failed to answer; or

(b) gave an obviously incomplete or irrelevant answer to;

a question included in a proposal form about a matter, the insurer shall be deemed

to have waived compliance with the duty of disclosure on relation to the matter.

Section 13 of the ICA imposes a duty of utmost good faith on the insured. However, such

duty does not impose any further duty of disclosure on an insured than that contained in

s21 of the ICA.1

The duty of disclosure under s21 ICA is limited to matters “known to the insured”. This

encompasses knowledge which is imputed to the insured.2 However, it does not appear

that it would encompass constructive knowledge of the insured, that is information which

the insured ought to know.3

(b) Misrepresentations

Section 26 of the ICA states that:

(1) Where a statement that was made by a person in connection with a proposed

contract of insurance was in fact untrue but was made on the basis of a belief that

the person held, being a belief that a reasonable person in the circumstances

would have held, the statement shall not be taken to be a misrepresentation.

1 Section 12 ICA.

2 For example, knowledge of an agent of the insured if the agent is responsible for the business in respect of whichthe insurance is taken out. However, such knowledge will not be imputed to the insured where the agent is actingoutside the scope of its authority or where the knowledge is a fraud committed on the insured.

3 Kelly and Ball, Principles of Insurance Law at 2.0130.30.

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(2) A statement that was made by a person in connection with a proposed contract of

insurance shall not be taken to be a misrepresentation unless the person who

made the statement knew, or a reasonable person in the circumstances could be

expected to have known, that the statement would have been relevant to the

decision of the insurer whether to accept the risk and, if so, on what terms.

(3) This section extends to the provision of insurance cover in respect of:

(a) a person who is seeking to become a member of a superannuation or

retirement scheme; or

(b) a person who is a holder, or is applying to become a holder, of an RSA.

The burden of proof rests on the insured in respect of establishing that the insured’s belief

was one that a reasonable person in the circumstances would have held. 4

A person shall not be taken to have made a misrepresentation merely because the person

failed to answer a question included in the proposal form or gave an obviously incomplete

or irrelevant answer to such a question. 5

Where a statement is made in answer to a question asked in relation to a proposed

contract of insurance and a reasonable person in the circumstances would have

understood the question to have the meaning that the person answering the question

apparently understood it to have, that meaning shall, in relation to the person who made

the statement, be deemed to be the meaning of the question.6

4 Plasteel Windows Australia Pty Ltd v CE Heath Underwriting Agencies Pty Ltd (1990) 19 NSWLR 400

5 Section 27 ICA.

6 Section 23 ICA.

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(c) Time for compliance with duty of disclosure

As provided for in ss21 and 26 ICA, the insured must comply with the duty of disclosure

and duty not to misrepresent before entry into the insurance contract. Section 11(9) ICA

defines entry into a contract of insurance to include:

(a) in the case of a contract of life insurance---the making of an agreement by the

parties to the contract to extend or vary the contract;

(b) in the case of any other contract of insurance---the making of an agreement by the

parties to the contract to renew, extend or vary the contract; or

(c) the reinstatement of any previous contract of insurance.

4.4 Obligation on insurer to warn insured of duty of disclosure

Section 22 ICA imposes a duty on an insurer to inform the insured of the nature and effect

of the duty of disclosure.

Section 22 ICA states that:

(1) The insurer shall, before a contract of insurance is entered into, clearly inform the

insured in writing of the general nature and effect of the duty of disclosure and, if

section 21A applies to the contract, also clearly inform the insured in writing of the

general nature and effect of section 21A.

(2) If the regulations prescribed a form of writing to be used for informing an insured of

the matters referred to in sub section (1) the writing to be used may be in

accordance with the form so prescribed.

(3) An insurer who has not complied with sub section (1) may not exercise a right in

respect of a failure to comply with a duty of disclosure unless that failure was

fraudulent.

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To comply with s22 ICA, an insurer must inform the insured of the consequences of breach

of the duty of disclosure in addition to the content of the duty of disclosure.7

Forms for notifying an insured of the duty of disclosure are prescribed by reg. 3 of the

Insurance Contracts Regulations. However, use of such forms is not mandatory.

Failure by an insurer to comply with s22 ICA deprives the insurer of its rights to rely on an

innocent non-disclosure.

The burden of proving satisfaction of the obligation under section 22 of the ICA is born by

the insurer. 8

To establish compliance with this notification requirement, the insurer must prove not only

that it sent the relevant notification to the insured but that the insured received the

notification. The burden of proof is on the balance of probabilities. Depending on the

circumstances of the case, a court may draw an inference of receipt of the notification by

the insured from evidence of dispatch by the insurer. 9

An insurer is not required to warn the insured of the duty of disclosure in respect to a

renewal, extension, or reinstatement of the insurance contract provided the insurer has

complied with the obligation when the contract was first entered into.10 Similarly, an insurer

is not required to provide such warning before varying the contract unless the variation is

involved in a renewal, extension or reinstatement of the contract.11

4.5 Remedies for breach

The ICA provides for exclusive remedies which are available to an insurer in respect of a

failure by the insured to disclose the matter to the insurer before the contract was entered

into and in respect of a misrepresentation or incorrect statement.

The relevant provision for contracts of general insurance is s28 of the ICA which provides:

7 Australian Associated Motor Insurers v Ellis (1990) 54 SASR 61; Burns v MMI-CMI Insurance Limited (1994) 8 ANZ InsCas 61-228 at 75,502.

8 Lumley General Insurance Ltd v Derphin (1990) 6 ANZ Inscas 60 986 at 76, 565.

9 Delphin v Lumley (1986) 6 SR (WA) 161.

10 Section 11(10)(a) ICA.

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(1) This section applies where the person who became the insured under a contract of

general insurance upon the contract being entered into:

(a) failed to comply with the duty of disclosure; or

(b) made a misrepresentation to the insurer before the contract was entered

into, but does not apply where the insurer would have entered into the

contract,

for the same premium and on the same terms and conditions, even if the insured

had not failed to comply with the duty of disclosure or had not made the

misrepresentation before the contract was entered into.

(2) If the failure was fraudulent or the misrepresentation was made fraudulently, the

insurer may avoid the contract.

(3) If the insurer is not entitled to avoid the contract or, being entitled to a void to the

contract (whether under sub section (2) or otherwise) has not done so, the liability

of the insurer in respect of a claim is reduced to the amount that would place the

insurer in a position in which the insurer would have been if the failure had not

occurred or the misrepresentation had not been made.

The onus of proving a breach of the duty of non-disclosure rests on the insurer.12

With respect to a fraudulent non-disclosure or fraudulent misrepresentation, the court has

the discretion to disregard any avoidance of the contract of insurance by the insurer if it

would be harsh and unfair not to do so. In such circumstances, the insured will be allowed

to recover the whole, or such part as a court thinks just and equitable in the circumstances,

of the amount that would have been payable if the contract has not been avoided. The

court is only entitled to exercise this power where it considers the insurer has not been

prejudiced by the non-disclosure or misrepresentation or, if any such prejudice exists, the

prejudice was minimal or insignificant. This power only applies in relation to the loss that is

11 Section 11(10)(b) ICA.

12 Commercial Union Assurance Company of Australia Ltd v Beard & Ors [1999] NSWCA 422

hxcs S0110743659v1 150314 2.7.2001 Page 18

the subject of the proceedings before the court and does not otherwise operate to reinstate

the contract.13

The ability of an insurer to avoid an insurance contract on the basis of non-disclosure was

highlighted in the 1992 case involving the former directors of Compass Airlines14. The

directors were defendants to insolvent trading proceedings commenced against them in the

Federal Court by the ASC, as it was then known. The directors claimed that their insurer

was obliged under their D&O policy to cover their legal costs and commenced proceedings

in the Federal Court. The relevant D&O policy included both a company reimbursement

policy and a direct cover component. The insurer sought to avoid the contract on the basis

of non-disclosure of the insolvency of the company at the time the insurance was taken

out. The directors argued that they were not parties to the contract of insurance and that

they were therefore not under any duty of disclosure.

The NSW Court of Appeal decided that the directors were parties to the D&O policy. This

was because the directors and probably paid the insurance premiums and also because

the terms of the particular policy led to that conclusion. The court was unsure of whether

each individual director was aware that the insurance was being taken out for their benefit

and that what was being done was being done with their general authority. Regardless of

whether they were called upon to contribute to the cost of the premium, and thus arguably

should have been so aware, the policy was effected with the knowledge of the chief

executive officer and company secretary. As a company has no mind of its own and can

only perform through the acts of its directors, the court looked to the actions of those within

the company who were responsible for the management of the company and who were the

‘directing mind and will’ of the company. In this case it could be said that at least the Chief

Executive Officer was in such a position and ought to have disclosed all matters to the

insurer as were known to him, such as the possible insolvency of the company at the time

the insurance was taken out. Accordingly, the Chief Executive Officer at least was under a

duty of disclosure. One judge went as far as to say that even those directors who may

13 Section 31 ICA.

hxcs S0110743659v1 150314 2.7.2001 Page 19

have had no such knowledge but were beneficiaries under the D&O policy may be under a

duty of disclosure. Accordingly, the insurance company was able to avoid the D&O policy

and avoid paying the legal costs of the directors in the Federal Court insolvent trading

proceedings.

This judgment was appealed but was finally settled out of court. Despite this, the Compass

Airlines case highlighted that the courts are willing to take a strict view of the duty of

disclosure as it relates to D&O policies. After this judgment many insurers developed the

practice of requiring each director to sign the insurance proposal form and complete a

declaration stating that they were unaware of circumstances which may give rise to a claim

against them. This practice avoids the complexities of the Compass Airlines case and

ensures that all directors and officer who are beneficiaries under the D&O policy are

subject to the duty of disclosure.

5. What is the Likelihood of an Insolvent Trading Action being broughtAnyway?

As noted in the Introduction, ASIC is a corporate watchdog increasingly on the prowl to enforce the

insolvent trading provisions. This regulatory attitude is likely to lead to a substantial increase in the

number of actions commenced by ASIC against delinquent directors. In addition the relatively

recent development of litigation insurance funding by third parties, usually insurance companies,

also signals the start of a new era in which liquidators seek to crack down on insolvent trading.

5.1 Ability of liquidator to bring proceedings in the name of the company

In addition to the primary right of the liquidator to bring proceedings for insolvent trading, a

liquidator has the general ability to bring or defend proceedings in the name of the

company (section 477(2)(a)). Generally the liquidator will seek the approval of the

creditors before commencing proceedings, particularly where it is likely to involve

substantial expense.

14 CE Heath Casualty &General Insurance Ltd v Grey (1993) 32 NSWLR 25.

hxcs S0110743659v1 150314 2.7.2001 Page 20

There are usually insufficient funds left in a company to commence proceedings. If this is

the case and there are substantial prospects of success the liquidator may seek an

advance or indemnity from creditors. If a creditor provides such finance the liquidator can

seek orders from the Court to permit him or her to treat the funds creditor more favourably

than other creditors in the distribution of any property or funds that are recovered by the

proceedings because of the risk assumed by them in financing the proceedings (section

564). The liquidator may also seek litigation funding or insurance from a third party as part

of his or her ability to sell or assign the ‘property of the company’ (section 477(2)(b)). This

is discussed below in Part 5.2.

When a liquidator is defending proceedings brought against the company he or she is not

usually liable for legal costs. However, where the proceedings are commenced by the

liquidator he or she may be held liable for legal costs if the proceedings are ultimately

unsuccessful and there are insufficient funds within the company to provide for

reimbursement. Usually a liquidator will not commence proceedings unless there are large

prospects of success or there is available funding.

5.2 Significance of litigation insurance funding for liquidators by third parties

Until the mid-1990’s funding of insolvency litigation by third parties was prevented by the

rules known as ‘champerty and maintenance’. These rules made it illegal to financially

assist a party to litigation without lawful justification. In particular it made it illegal to provide

such funds in return for a share of the proceeds of any successful action. This effectively

precluded insurance companies and other private funders from providing funds to

liquidators to commence proceedings in the case of insolvency. If there were not enough

funds available within the insolvent company to commence proceedings liquidators would

simply be unable to do anything about it.

However in 1982 the position began to change in England where the House of Lords

decided that a liquidator could assign a cause of action which the company possessed,

such as an action against directors for insolvent trading, to a third party if the assignee had

a genuine commercial interest in accepting the assignment and enforcing it for its own

hxcs S0110743659v1 150314 2.7.2001 Page 21

benefit15. The ‘genuine commercial interest’ in the litigation had to be an interest separate

from the benefit that the outsider would seek to gain from supporting the litigation, such as

making a profit. This decision opened up the possibility of liquidators assigning a cause of

action held by the company to a third party, such as an insurance company, who would

receive a cut of any proceeds recovered.

Liquidators began to see that they could commence proceedings and recover funds for the

benefit of creditors if they were able to receive financing from outside sources. This led to

the development of litigation insurance funding arrangements between an insolvency

practitioner, usually a liquidator, and an insurance company where the insurer funds the

relevant action, indemnifies the liquidator for any cost orders made against him or her in

return for a share in the proceeds of a successful action. In this way, the liquidator is not

exposed to any liability for legal costs if the action is unsuccessful and the insurer will be

liable for the amount of any legal costs order which outweighs the proceeds recovered.

Generally, a liquidator will prepare a proposal for the insurance company outlining the

nature of the relevant action, the risk and the proceeds which are likely to be recovered.

The liquidator then gives the proposal to the insurer for consideration. Further negotiations

may take place, but when the proposal is accepted in the final form the liquidator will

usually, and is well advised to, seek the approval of creditors before accepting the

proposal. Much of the law relating to litigation insurance funding arrangements have

resulted from liquidators applying to the court to get its ‘okay’ that such arrangements do

not breach the rules of champerty and maintenance.

In 1996 the liquidator of Movitor Pty Ltd sought a direction from the court as to whether or

not he was able to enter into a litigation insurance funding arrangement to bring an action

against Movitor’s directors for insolvent trading16. Although some of Movitor’s creditors

were willing to provide funding to the liquidator they were not willing to indemnify the

liquidator if that action was unsuccessful. Under the arrangement the insurer would pay

15 Trendex Trading Corporation v Credit Suisse [1982] AC 679 (HL).

16 Movitor Pty Ltd (in liq) v Simms (1996) 14 ACLC 587.

hxcs S0110743659v1 150314 2.7.2001 Page 22

half of the legal fees, indemnify the liquidator for half of any costs order awarded against

him and allow the liquidator to instruct the solicitors regarding the conduct of the action. If

the action was successful the insurer would receive 12% of the share of the proceeds

received.

The court considered that such an arrangement would in fact breach the rules of

champerty and maintenance because the insurer had no ‘genuine commercial interest’ in

the litigation other than the share of the proceeds it would receive if the action was

successful. However, the court looked beyond these principles and considered the

liquidator’s powers of sale under section 477(2)(b) of the Law. The court decided that a

right of action possessed by a company, such as the right to bring an action for insolvent

trading, fell within the definition of ‘the property of the company’ and, accordingly, the

liquidator had the right to sell the right of action to an insurance company despite that fact

that it would otherwise breach the rules of champerty and maintenance. The power of the

liquidator to sell the property of the company is conferred by statute and it did not matter

that the property could include either the ‘fruits of the action’ (such as a share in the

proceeds recovered) or the action itself so long as the action was a genuine asset of the

company. The court suggested that if the insurance company made a grossly excessive

profit out of the litigation then the sale may not be a ‘bona fide’ exercise of the liquidator’s

power of sale and any such agreement may be valid. The court will look to the particular

circumstances of each case and the magnitude of the risk assumed by the insurer in

deciding whether or not the profit made is ‘grossly excessive’. Of course such

complications can usually be eliminated if the liquidator has the approval of creditors to

enter into the arrangement.

These sentiments were reiterated by the court in 1997 when the liquidator of Tosich

Construction Pty Ltd applied to the court for permission to enter into a litigation insurance

funding arrangement 17. Originally the arrangement would not have involved the actual sale

of the action to the insurer but this was later amended to incorporate a sale of the action to

17 Re Tosich Construction Pty Ltd (1997) 23 ACSR 126.

hxcs S0110743659v1 150314 2.7.2001 Page 23

the insurer in return for the insurer funding the proceedings and indemnifying the liquidator

against any legal costs order. Without this amendment the arrangement would not have

fallen within the Movitor principle of the liquidator’s power of sale of the property of the

company. The court decided that the liquidator was able to enter into the arrangement.

The court also commented that the purchaser of any action should not be allowed to

intervene in the conduct of the proceeding as this may affect the ‘bona fides’ of the

proceedings.

These, and a number of subsequent, cases clearly provide for a liquidator to sell a right of

action possessed by the company to a third party, usually an insurance company, in

consideration for the insurer funding the proceedings and often providing an indemnity to

the liquidator in return for receiving a reasonable share of the proceeds recovered18. In

order for the arrangement to be valid, some or all of the action must be sold to the third

party, the third party should not have a role in the actual running or conduct of the

proceedings and the arrangement must generally constitute a bona fide exercise of the

liquidator’s powers. If these steps are not taken the liquidator runs the risk of having the

arrangement declared invalid and having to finance any legal costs incurred him or herself.

This development means that liquidators are now more likely to bring an action against

directors of an insolvent company for insolvent trading and that this trend is likely to

continue well into the future. Of perhaps equal importance liquidators can now threaten

such proceedings more forcefully as a director can no longer simply assume that a

liquidator of a company without funds of its own is a “toothless tiger”.

In 1998 there were media reports of the possible establishment by entrepreneur Rene

Rivkin of the so-called ‘Justice Corporation’ which would fund all forms of civil litigation.

Such a development may well be quite a development in litigation funding, providing

funding in cases other than insolvency, but the courts seem reluctant to allow such a

development at this stage. Whilst many judges see the benefits in litigation funding for all

actions due to the inability of many companies and persons to bring actions for lack of

18 See, for example, Ultra Tune (1997) 1 VR 667.

hxcs S0110743659v1 150314 2.7.2001 Page 24

resources, the courts are hesitant to condone trafficking in litigation. The court’s current

position could well change in the near future.

What then are the policy and practical implications of litigation insurance funding

arrangements in the context of insolvency? The main benefit is obvious – it allows the

recovery of funds for the benefit of creditors in circumstances where recovery would

otherwise not be possible. By encouraging liquidators to take action against rogue

directors without incurring further expense for creditors it may relieve creditors from a

substantial financial burden in circumstances where they have often already lost funds.

Litigation insurance funding potentially increases the number of actions to be taken against

delinquent directors and may act as a greater deterrent. It is possible that it may also

increase the likelihood of settlement as the plaintiff is less involved emotionally in the

proceedings. Settlement may also occur earlier if the plaintiff has sufficient funds as the

plaintiff could continue the litigation until the hearing itself and thus, if the defendant wants

to settle the litigation he or she may have to make a realistic offer of settlement earlier than

he or she would otherwise have to if the plaintiff had no prospects of being able to continue

the litigation in any event. It also has a considerable benefit for liquidators and insolvency

practitioners themselves, allowing for a recovery of remuneration, costs and fees in cases

where there would not otherwise be any funds to pay them.

There are, of course, concerns over litigation insurance funding arrangements. The main

concern is that in practice the liquidator’s control over the conduct of the proceedings could

be thwarted if he or she, as a practical matter, feels inclined to take the interests of the

insurer into account when making decisions as to the conduct of the proceedings. This is

no more obvious than in relation to settlement negotiations where the liquidator may feel

obliged to reject offers of settlement which may cover his or her costs and fees and provide

a minimal return for creditors but not a substantial return to the insurer. In this case the

liquidator may wish to settle if there is little chance that more proceeds would be recovered

for creditors if the litigation continued, however the insurer may wish to make a greater

profit out of the litigation. Whilst taking such considerations into account could arguably

mean that the liquidator is not exercising his or her powers bona fide, it is not yet known

hxcs S0110743659v1 150314 2.7.2001 Page 25

what effect such pressures may be having on liquidators in their conduct of proceedings.

Another concern is that liquidators may feel obliged to enter into funding arrangements as

part of their duty to realise all the property of the company for the benefit of creditors, even

where there is no prospect of a substantial return to creditors, and thus inadvertently ‘line

the pockets’ of the insurance industry.

Regardless of these public policy considerations, litigation insurance funding arrangements

are becoming a tool increasingly utilised by liquidators and other insolvency practitioners.

This trend is resulting in a growing number of actions taken against rogue directors for

insolvent trading.

5.3 Can the liquidator find out if there is D&O insurance?

The Law confers on a liquidator the power to question relevant persons as to the

“examinable affairs” of the company in liquidation. Examinable affairs includes the

property of the company which extends to choses in action. The courts have held that

information concerning the company’s prospects of successfully litigating a claim and the

likelihood that any judgment obtained would be met by payment, is information about the

“property” of the company in liquidation.19

The examination powers under the Law effectively places the liquidators in a special

position compared with the “normal” plaintiff. This was recognised by the High Court of

Australia in Hamilton v Oades 20 in that:

The very purpose of [the examination provisions under the Corporations Law] is to

create a system of discovery. This …gives to the liquidator rights not possessed

by an ordinary litigant.

This advantage granted to a liquidator offsets the disadvantages faced by a liquidator when

contemplating commencing proceedings. As the Queensland Court of Appeal in Adler

Group v Quintex Group Management Services Pty Ltd (in liq)21 observed:

19 Grosvenor Hill (Qld) Pty Ltd v Barber (1994) 48 FCR 301; In the matter of Interchase Corporation Ltd and in the matter ofan Application by Barber, unreported decision of Kiefel J Qld registry of Fed Crt, 2 August 1996

20 (1989) 166 CLR 486 at 497-498

hxcs S0110743659v1 150314 2.7.2001 Page 26

In the nature of things, liquidators when they are appointed labour under the

particular disability of not knowing as much about the examinable affairs as former

directors and officers, and that they often cannot obtain reliable information about

suspicious transactions. Generally the only source available to them is the records

of the company such as books and documents if still available, and the information

they contain is always vulnerable to contrived explanations and even to distortions

to persons not anxious to disclose what they really know about events which took

place when they were in charge of the company’s affairs.

A plaintiff in civil proceedings is bound to prove his case and generally must do so

by oral evidence. Directors and senior officers of the company in liquidation, even

if they have not absconded, are often unwilling and uncooperative witnesses

…Few other litigants suffer to that disadvantage, or to the same extent, as

liquidators.

A party is entitled to claim legal professional privilege on an examination.

Access to the insurance documents allows a liquidator to assess the merits of proceeding

with (most likely costly) litigation.

Some case studies will assist here:

In the matter of Interchase Corporation Ltd and in the matter of an Application by

Barber22

The liquidators of Interchase commenced proceedings in the Queensland Supreme Court

against valuers in relation to their alleged negligent valuation of premises.

Pursuant to the examination powers conferred by the Law, Kiefel J in the Federal Court

had issued summons for examination of certain people including the claims officer for the

insurer of one of the defendant valuers and a representative for the excess insurer. The

scope of the examination included the results of any investigations conducted by the

21 (1996) 22 ACSR 446 at 449

22 Unreported decision of Kiefel J, Fed Crt (Qld registry), 2 August 1996

hxcs S0110743659v1 150314 2.7.2001 Page 27

insurer and whether the insurer had a present view as to whether indemnity would be

extended.

This case concerned an application by the insurer and excess insurer to have the

summons discharged.

In upholding the summons in relation to the claims officer of the defendant valuer’s insurer,

Kiefel J stated that:

An examination as to whether a judgment will likely be met is a practical and

realistic one for liquidators facing the outlay of very substantial funds, which might

otherwise be used to pay the company’s creditors.

While Kiefel J conceded that where the insurer had had little time to investigate a claim or

was able to indicate when a decision would be forthcoming, it would be premature to allow

an examination. However, in the present case. His Honour stated that the insurer had had

more than 18 months to reach a decision on indemnity.

The insurer submitted that the court ought to respect the privacy and confidentiality of

communications between insurer and insured and that the examination could prejudice the

insurer’s ongoing investigations. However, Kiefel J stated that these concerns could be

addressed by allowing the examination to be held in private.

On the issue of legal professional privilege, Kiefel J commented that:

Whilst I am prepared to infer that some of the communications may be subject to

legal professional privilege I am not prepared to assume that all, or even a great

number of, relevant documents are likely to be found to have been prepared for

the dominant purpose of provision of legal advices to the client merely because

they were obtained by solicitors.

In relation to the examination of the excess insurer, the evidence adduced disclosed that

the excess insurer had made no investigations of its own and consequently, Keifel J held

that it would be pointless to pursue an examination of the excess insurer.

hxcs S0110743659v1 150314 2.7.2001 Page 28

Gerah Imports Pty Ltd v The Duke Group Ltd (in liquidation)23

In this case, the liquidator of The Duke Group asserted that a Perth accounting firm

retained to prepare a report and valuation relating to a proposed takeover of a company,

negligently and incorrectly grossly overvalued the company resulting in a $85 million loss

to The Duke Group.

The liquidator sought access to documents detailing the nature and extent of relevant

professional indemnity held by the accounting firm in order to assess the likely possibility of

recovering any judgement obtained.

In addition, the liquidator also sought orders for examination of certain persons pursuant to

s596B of the Law including a direction to produce documents relating to the insurance

position of the firm.

The Court of Appeal upheld the examination order stating that it was legitimate to use an

examination to decide whether proceedings already commenced should be continued.

The Court considered that the commercial reality of pursuing long and expensive legal

proceedings for a very large sum of money against individuals with finite resources is

clearly a matter for which a liquidator needs to make a judgment based on the likelihood or

otherwise of ultimately recovering from the relevant insurer.

An application for special leave was refused by the High Court. In reaching this decision,

Dawson J accepted that the power conferred by s596 was wide.

Pegasus Gold v Kilborn Engineering24

In this recent decision of the NSW Supreme Court of New South Wales, Windeyer J

considered whether a corporation has “power” over an insurance policy taken out by its

parent company under which it may be a beneficiary.

The deed administrators of Pegasus Gold (Pegasus) had commenced proceedings in the

Federal Court against Kilborn and two other joint venture companies.

23 (1994) 12 ACLC 116

24 [2000] NSW SC 183 (21 March 2000)

hxcs S0110743659v1 150314 2.7.2001 Page 29

Pursuant to Part 36 Rule 12 of the NSW Supreme Court Rules (dealing with orders for

production of documents in proceedings) Pegasus obtained an order for production of,

amongst other documents, any professional indemnity policy “in the name of, or noting the

interest of Kilborn, either specifically by name or as a member of a class or group of

companies related to SNC-Lavalin Group Inc [the Canadian parent company of Kilborn]”

for a particular period.

No documents were produced by Kilborn in relation to this aspect of the order.

Subsequently, Pegasus brought a notice of motion seeking, amongst other issues, an

order that Kilborn inform the Court whether Kilborn had requested its parent company to

produce the relevant insurance policy, on the basis that Kilborn had a legal entitlement to

production of the policy as a third party beneficiary of a relevant insurance policy, and if so

the substance of any response received. If no such request had been made, Pegasus

sought an order that Kilborn be directed to make such a request in terms proposed by

Pegasus.

Windeyer J noted that Pegasus sought the information on Kilborn’s insurance cover

“because they want to know whether they would be justified in expending a very large sum

of money in the Federal Court proceedings. …For that reason they are concerned to obtain

details of insurances benefiting [Kilborn] in the Federal Court proceedings. No doubt the

Canadian parent of Kilborn is anxious that the action against its subsidiary not proceed and

therefore is in no way anxious to assist the administrators in their inquiry.”

Windeyer J held that an order for production of documents under Part 36 Rule 12 NSW

Supreme Court Rules was limited to documents within a party’s possession or custody and

was to be contrasted with an order for discovery which extends to documents within a

party’s control or power. Windeyer J held that the parent company’s insurance policy was

not a document within the possession or custody of Kilborn.

In obiter, Windeyer J stated that even if the rule in question extended to documents within

the power of a party, he would still not allow the request. According to Windeyer J:

hxcs S0110743659v1 150314 2.7.2001 Page 30

It is clear that Kilborn has not the power to require the actual policy to be

produced. The reason for this is that Kilborn does not own it and if it exists other

persons have an interest in the policy. The best argument that could be put

forward would be an argument that Kilborn had power to require its parent to

furnish it with a copy of the policy, it being one of the beneficiaries under the policy

and the policy to that extent being held on trust for it. I do not understand how it

could be said that the order for production could give rise to a requirement that

Kilborn require its parent to produce for it a document not shown to be in

existence, namely a copy of the policy assuming its existence.

Further, Windeyer J held that the Court did not have power to order Kilborn to inform the

Court if it had requested its parent company to produce the policy as this would require

disclosure of information rather than production of documents. Finally, Windeyer J held

that the court did not have power to order Kilborn to make a request to its parent company

as this requires the Court to make an assumption which it is not entitled to make without

further evidence as to the rights under the policy which it has sought to have produced.

6. Conclusion

The insolvent trading provisions impose an onerous duty on directors. A breach of these

provisions may result in a substantial liability being imposed on directors personally. However, in

pursuing such rogue directors, liquidators may often find that their success in litigation is an empty

and fruitless exercise as such directors often don’t hold property in their own name and there may

be insufficient funds left in the company to cover the liquidator’s costs, fees and remuneration, thus

not practically providing any benefit of return to creditors. In such circumstance liquidators and

other insolvency practitioners will often be loathe to take action.

Unless there has been a relevant non-disclosure which disentitles a director to rely on his or her

D&O insurance the existence of D&O insurance may overcome this concern.

D&O insurance may provide a source of funds for liquidators, ASIC and creditors where the

remedy sought is a civil remedy, such as a fine or compensation. Where the proceedings allege a

criminal offence, consisting essentially of wilful deceit, D&O insurance is unlikely to prove useful as

hxcs S0110743659v1 150314 2.7.2001 Page 31

such insurance policies are precluded by the Law from covering directors and officers for criminal

penalties. However, as criminal offences for insolvent trading are difficult to prove, most insolvent

trading actions commenced will seek a civil remedy. In fact the difficulty of making out a criminal

offence, combined with the possibility of recovering under D&O policies may encourage liquidators

to seek litigation funding, bring proceedings against directors for insolvent trading and seek a civil

remedy.

Each policy needs to be carefully considered to ensure that there are no relevant exclusions. The

knowledge of the directors at the time the relevant policy commenced must also be considered in

determining the likelihood of the policy responding.

Developments in the field of litigation funding mean that liquidators are increasingly likely to take

action against directors for insolvent trading. Combined with ASIC becoming a corporate watchdog

progressively on the prowl against directors for insolvent trading, delinquent directors should

beware!

Perhaps those directors who should be most cautious are directors of new economy and dot com

companies. Recent commentary and figures suggest that many new economy companies may be

trading whilst insolvent and, if the trends established in 2000 continue into the near future, a

number of corporate collapses are likely to occur in 2001 and the years ahead. The recent inquiry

by ASIC into the reporting practices and procedures of new economy companies, the investigation

into many new economy companies failure to properly and adequately report and disclose to ASIC

and the recent proceedings undertaken against Mr John Elliot indicate that ASIC is ‘cracking down’

on insolvent trading and may itself launch a fresh round of proceedings for insolvent trading.

Before deciding whether or not to commence proceedings for insolvent trading, liquidators should

investigate the existence of a D&O policy, and particularly if there are insufficient funds in the

company itself, consider a proposal to an insurer or other third party for litigation funding.

If the recent actions by ASIC are any indication, directors of new economy companies should be

increasingly wary of being prosecuted for insolvent trading.

hxcs S0110743659v1 150314 2.7.2001 Page 32

Helen Horsington

Lawyer

Allens Arthur Robinson

This paper is intended only to provide an alert service on matters of concern or

interest to readers. It should not be relied on as advice. Matters differ according to

their facts. The law changes. You should seek legal advice on specific fact

situations as they arise.