Consequences of the ‘Veil of Incorporation’ Being Lifted for Insolvent Trading

Question

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

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

OHS Solutions Pty. Ltd. is a company formed by three friends (Des, Satish and Emma) who bring different skills and abilities to the business.  Emma is an accounting graduate, Des has expertise in occupational health and safety (OHS) and Satish has an IT degree.  They decided to start up a business which would provide a portal through which the public and businesses could access (for free) information on all aspects of OHS.  OHS Solutions would finance its business, and make profits, by charging businesses to advertise via their website. 

The directors of OHS Solutions are: 

Managing Director – Des

Finance Director – Emma (non executive)

Director – Satish (executive – employed also to run the technological side of the business)

Director – Ying (non executive) – a friend of Des’ and director of Support Pty. Ltd.  (Support Pty. Ltd. has gone guarantor for a $50,000 loan from the Business Bank Ltd. to OHS Solutions)

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

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

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

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

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

Questions:

Part A                                                

Write a brief explanation about why the directors’ duty to prevent insolvent trading exists and the circumstances and consequences of the ‘veil of incorporation’ being lifted for insolvent trading.(Do not just repeat the words of the relevant sections in the Corporations Act).

And

Part B                                                

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

Summary

This question belongs to corporations law and discusses about directors’ duty to prevent insolvent trading exists and the circumstances and consequences of the ‘veil of incorporation’ being lifted for insolvent trading.

Total word count: 2647

 

 

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