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DE FACTO DIRECTORS AND INSOLVENT TRADING – A DANGEROUS COMBINATION FOR SOLE DIRECTOR’S SPOUSE

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by Paul Gidley30.11.18

The sole-director applying their skills onsite while their spouse or partner ‘manages the books’ is a common Australian small business structure[i].

A recent judgement in the Queensland District Court, Tremco Pty Ltd v Thomson [2018] QDC 101, is a cautionary tale for sole-director businesses. It pays to be aware that a person, other than the director, managing the business’s activities may be acting as a de facto director and director’s liabilities, such as those for insolvent trading, will apply.

A familiar small business structure

Mr Thomson operated a waterproofing business (Kadoe Pty Ltd) as sole director and Mrs Thomson, the defendant in the case, managed the business activities, including ordering supplies, negotiating prices, tendering, payroll, BAS statement preparation and liaising with suppliers and accountants on behalf of the company.

Tremco Pty Ltd (Tremco) sought to recover compensation for unpaid invoices and interest from Mrs Thomson who, they alleged, was a de facto director and continued to trade while Kadoe Pty Ltd (Kadoe) was insolvent.

In her defence, Mrs Thomson asserted that she was not a validly appointed director, acted on instruction from Mr Thomson, managed the company’s affairs on a short-term, emergency basis, and, had reasonable grounds to believe that the Company was solvent and relied on advice from a competent person.

What is a de facto director?

The Corporations Act 2001 (Cth) definition of director extends to persons acting as a director though not formally appointed. Whether or not a person is a de facto director is determined on a case-by-case basis by several factors as laid out in Chameleon Mining NL v Murchison Metals Limited [2010] FCA 1129 including:

  • The nature and extent of the functions and powers that are exercised
  • the size of the company
  • the company’s internal practices and structure, and
  • how the person is perceived by outsiders who deal with the company.

Because of the ‘Jack of all trades’ nature of much small business administrative work and the shared labour and authority between spouses/life-partners, there may be a higher risk within sole-director companies of someone unknowingly acting as a de facto director. The consequences can be costly as this case demonstrates.

As de facto director, spouse found personally liable for insolvent trading debt.

The judgement was entered against Mrs Thomson to the tune of $372,016.10 plus interest.

The findings against her included that she shared management and control of the Company, having responsibility for the operational and administrative activities (including setting up the Company and a Trust) and was therefore a de facto director. It was evident from Mr Thomson’s cursory knowledge of operational and administrative activities that Mrs Thomson handled company matters on her own authority.

There was also ample evidence that she had done so for many years including the period when the Tremco debts were incurred, and, there was no emergency during the period that the unpaid Tremco debts accumulated.

Evidence from a Balance Sheet Test, Cash Flow Test and failure to pay ATO and other liabilities showed that Kadoe incurred the debts to Tremco while insolvent.

Further, Mrs Thomson had reasonable grounds for suspecting Kadoe was insolvent because not only was she familiar with the bank accounts and funds available but had, in fact, negotiated payment plans for other outstanding debts.

Understanding directors’ duties and liabilities

To safeguard your small business clients, educate early regarding the risks of de facto directorship, insolvent trading and the liabilities they could be exposed to. Emphasise the need for clear delegations in managing the company’s business activities.

Encourage them to act early and seek advice if insolvency flickers on the horizon.

Shaw Gidley insolvency specialists have experience in all sectors of commerce and industry. Please do not hesitate to contact one of our experienced insolvency professionals for the right advice for your clients’ insolvency needs.

[i] Australian Small Business and Family Enterprise Ombudsman (2016). Small Business Counts. Small Business in the Australian Economy [report]. Retrieved 14/11/18 from  https://www.asbfeo.gov.au/sites/default/files/Small_Business_Statistical_Report-Final.pdf