Workshop Revision Question Oracle Manufacturing Ltd

Workbook Submission #2 instructions
Tips for completing the assessment
1. You must use the ILAC method when answering the question.
2. There is no absolutely right or wrong answer to this assessment.
3. You are given extensive materials (and a framework) for completing a section
588G question in your Week 9 Workbook.
4. The facts, times and persons are “mixed up” for a reason – clients do not
approach you with the perfect set of facts that answer each of the issues
neatly. You need to pull the facts apart (deconstruct), and attach the relevant
facts to the key features of a section 588G action (refer section 588G
framework). This is an analytical skill. Drawing up a timeline of events may be
a good start.
5. There is no word count limit on this assessment.
Additional Research
If you wish to conduct additional research for your answer, I would suggest the
following texts and online resources (in addition to your prescribed text): CCH Intelliconnect suite of databases, in particular: “Australian Company Law
Commentary Premium”; and “Australian Insolvency Management Practice
Commentary”. You may also wish to search for relevant cases in the CCH
databases. Type ‘CCH intelliconnect’ when conducting a library catalogue
database search.
Pamela F. Hanrahan, Ian M. Ramsay, Geof Stapledon, Commercial
Applications of Company Law (17th edition), CCH Australia Limited, 2016
Recommended and further readings under the “Readings” tab on L@G. Facts
You are employed as an accountant for a leading insolvency, restructuring and turnaround
firm. You have been asked by the Liquidator to prepare a section 533 report on Phoenix Pty
Ltd (In Liquidation) (the Company), which went into liquidation in August 2017. The
Liquidator asks that you advise her on the liability of the Company’s key management and
directors for insolvent trading, pursuant to sections 588G and 588M of the Corporations Act
2001 (Cth) (the Act).
Greg (CEO) and two independent directors (Lisa and Wendy) have been on the board of the
Company for many years. The board meets every 6 weeks. Sam (CFO) is not on the board,
but has been employed as the CFO since 2015. Sam is CPA qualified and reports weekly to
the CEO. In May 2017, Mark (Chief Restructuring Officer or CRO) joined the board on a shortterm engagement, to restructure the Company. He is a partner of a rival insolvency firm.
The report as to the Company’s affairs, that the CEO provides the Liquidator on
appointment, says that the causes for the Company’s failure were due to the loss of financial
support from their banking syndicate, a lack of management oversight and poor record
keeping. Your investigations reveal: Sam and his team recorded financial information in MYOB, but only reconciled bank
accounts half-yearly (at bank covenant reporting time), allocated inventory purchases
directly to the COGS account, and only tested for depreciation of assets yearly. The Company was reliant on the banking syndicate to pay its debts, and to reinvest in
new assets. Net cash flows from financing activities for FY17 was $1million, yet net cash
flows from operating activities was negative ($2million). The Company’s banking
covenants were: net assets greater than $zero, liquidity ratio greater than 1.5x and net
operating cash flows greater than $zero. The Company’s draft management accounts for December 2016 showed that none of
these covenants had been met. Due to the poor record keeping, the Company only
reported the covenant breaches 3 months late (in March).
The banking syndicate engaged Mark to perform an investigative accounts report on the
Company to determine whether the Company was viable and what the banking syndicate
should do. Whilst the report was being prepared, the banking syndicate refused to provide
further funding. In early May 2017, Mark reported to the banking syndicate on the basis that
the underlying business of the Company could be restructured and recommending that he
be appointed as CRO. The banking syndicate agreed to this, but required the consent of the
Company’s Board. At the May 2017 board meeting, Greg finally informed the board of the
funding issues and recommended that Mark be appointed as CRO. The board agreed. Lisa
and Wendy claimed that they were unaware of the funding issues until the May 2017 board
meeting.
Between December 2016 and May 2017, total liabilities owed to unsecured creditors
increased from $1.5million to $4million. Greg took 20 sick leave days during this period for
the common cold. Sam’s team was inundated with angry creditors, refusing to supply goods
until payment in full was received. Employee wages were met, but PAYG tax (totaling $500k) and superannuation ($100k) remained unpaid. The ATO remained in regular contact with
Sam, during which time the Company defaulted on 4 repayment arrangements with the ATO.
Between June 2017 and August 2017, total liabilities owed to unsecured creditors increased
another $250k. Although the banking syndicate had agreed to Mark’s appointment, they still
refused to provide further funding, believing that Mark would sell the business of the
Company to an interested private equity firm. That deal never came to fruition, leading to
your appointment.
Advise the Liquidator on what action (if any) she can take against Greg, Lisa, Wendy, Sam
and Mark for breach of the duty to prevent insolvent trading (s 588G of the Act) and the
remedy (if applicable).

Workshop Revision Question
Oracle Manufacturing Ltd (Oracle) is a medium-sized ASX listed entity with approximately
100,000 shareholders. The Board of Oracle at all times consists of Alex (CEO), Amy (CFO)
and Anwar (non-executive director). The company secretary and general counsel is Steven
who is in charge of legal compliance. The Board has fixed meeting dates at the end of each
quarter of the financial year.
Oracle has several major clients including Acme (a large international industrial firm) which
accounts for approximately 30% of its revenues and has been a long-time client. A credit
crunch in January 2014 caused problems for many of Oracle’s clients including Acme, which
resulted in reduced or cancelled orders. This put significant pressure on the company’s cash
flows and management began looking for alternative sources of working capital.
Unfortunately, all of the company’s assets were already secured by a floating charge to the
bank, and the bank refused a request to extend the company’s overdraft in February 2014.
By early September 2014 the company’s financial position deteriorated due to the collapse
of its major client Acme into liquidation. The liquidator of Acme lodged a section 533(1)
report with ASIC in September 2014 stating that unsecured creditors were unlikely to receive
more than 50 cents in the dollar. Oracle Manufacturing is an unsecured creditor. Board
papers containing Oracle’s financial statements as at 30 September 2014 revealed that
current assets (including Acme as a debtor) were $9,000,000 and current liabilities were
$10,000,000.
The financial situation of Acme put further pressure on Oracle’s cash flows and the company
managed its creditors by delaying payment for as long as possible between February and
September 2014, in most cases until the creditors threatened legal action. As a result, many
of its suppliers in the period October to December 2014 changed their payment terms from
30 days credit to cash on delivery (COD).
In January 2015, ATO (an unsecured creditor) lodged a director penalty notice on the
company’s board of directors for failure to pay the company’s taxes (which means the
directors may be personally liable for the company’s tax obligations). The PAYG withholding
tax payments were due on 31 October and 30 November 2014. On 1 March 2015, a
liquidator was appointed by the Court to wind up Oracle Manufacturing. Advise the liquidator
as to what action (if any) it can take against Alex, Amy, Anwar and Steven for breach of the
duty to prevent insolvent trading (section 588G) and remedy (if applicable)
Question adapted from J Harris, A Hargovan and M Adams, Australian Corporate Law, LexisNexis Butterworths,
Sydney, 2009 Workshop Revision Answer
Issue: Does s588G apply to Alex, Amy, Anwar and/or Steven?
Law and Application:
The Board of Directors at all times consists of Alex, Amy, and Anwar. Section 588G does not
apply to Steven because he is a company secretary and general counsel only. Debts were
incurred to the ATO and suppliers at the following times according to the principle in Hawkins
v Bank of China: Suppliers: At least from February 2014 - the company was delaying payment of debts for as long as possible from that date to September 2014 hence debts were being
incurred during that time.
ATO: PAYG withholding tax payments due at end of October and November. I would
argue that the PAYG debt is incurred when Oracle withholds the amount for payment
not when the amount is due for payment. Students do not need to know this. Applying section 588G(1)(a), Alex, Amy and Anwar were all directors at the time the ATO and
supplier debts were being incurred from February 2014.
Applying section 588G(1)(b), Oracle was insolvent from February 2014 at the earliest and
October 2014 at the latest. One would suggest there is enough evidence as at February
2014 – the excellent students will explain why. Using the cash flow test in Powell v Fryer,
there is some evidence as at February 2014 to suggest that Oracle did not have sufficient
cash to pay debts due (s 95A). Oracle’s revenue dropped because of reduced and cancelled
orders, Oracle could not liquidate current assets to pay debts as the assets are subject to a
floating charge in favour of the bank and it was unlikely that Oracle would be able to borrow
to raise cash resources given the bank’s refusal to extend the company’s overdraft and the
floating charge.
Insolvency indicators set out in ASIC v Plymin also exist. As at February 2014, there was a
poor relationship with the bank and inability to access finance – plus the floating charge
would make obtaining further finance more difficult. Creditors were also being paid outside
trading terms and creditors were threatening legal action. As at September 2014, there was
a section 533(1) report concerning ACME and conversion of accounts receivable into bad
debts, further reducing the liquidity ratio. As at October 2014, the liquidity ratio is less than 1
and as at November 2014 there were overdue taxes.
The ‘grounds’ or evidence of insolvency under section 588G(1)(c) include: the reduced and
cancelled orders from Acme; the banks refusal to extend Oracle’s overdraft; the liquidator’s
section 533(1) report; Oracle’s financial statements which pointed to a liquidity ratio less than
1; Documentation on behalf of creditors threatening legal action from Feb 2014;
Communications from suppliers changing credit terms from 30 days credit to COD in
October 2014; and the ATO director penalty notice in January 2015. Students should mention that a competent and diligent CEO and CFO, responsible for the
day to day operations of the company and company’s financial position respectively, would
likely have had the evidence supporting insolvency earlier than the non-executive director
who attends the Board meeting at the end of each quarter (Daniels v Anderson). Students
need to argue at what point in time the CEO and CFO would have had the evidence and
why. Anwar (the non-executive director) may not have had the evidence supporting
insolvency until after the 30 September board meeting (note: meeting dates at the end of
each quarter). Shortly after that time Anwar should have accessed additional financial
information and made inquiries of the CFO about Oracle’s financial position (i.e. from
October 2014). There is enough evidence for the directors to suspect that the company was
insolvent as at February 2014 at the earliest (Alex and Amy) and perhaps October 2014 at
the latest (Anwar).
Issue: Did J,B,S breach s588G?
Law and Application:
The facts do not confirm that the directors were actually aware of the evidence pointing to
insolvency. However, a competent and diligent director would have been aware of the
evidence pointing to insolvency for the reasons discussed in the application of section
588G(1)(c). Students need to state the date the directors were in breach which will be the
same date as the date students state the directors had reasonable grounds to suspect
insolvency.
Issue: Are there defences available?
Law and Application: There are no available defences to the directors because there are
no reasonable grounds to expect solvency – students should briefly explain why (s 588H(2)).
Even if Amy the CFO was a competent and reliable person providing adequate information
about the company’s solvency, the other directors could not have expected that the company
was solvent based on her information (s 588H(3)). There is no evidence that the directors
were absent from management due to illness or for some other good reason (s 588H(4)) and
there is no evidence that the directors took reasonable steps to prevent debts from being
incurred. In fact the “company managed its creditors by delaying payment for as long as
possible” from February 2014. This suggests that the company was incurring further debts
despite Oracle’s cash flow situation (s 588H(5), (6)).
Issue: What are the remedies?
Law and Application: Under section 588M(2), the liquidator may apply to the Court to
recover compensation from directors which are incurred through breach of section 588G.
Students’ answers will depend on when the directors were in breach but their answer should
mention how the compensation is calculated (e.g. all unsecured debts which were incurred
whilst X was in breach of section 588G, which is between [insert date of breach] and 1
March 2015 [the date the liquidator was appointed].
Conclusion: The Board has breached s 588G and the liquidator is entitled to compensation
representing all debts incurred whilst Anwar, Alex and Amy were in breach of section 588G. Directors’ Duties: What to put in your Law and Application
You can use the points below to help you prepare notes for the final exam as well as for
preparing answers to the workshop exercises. Remember the more you justify your answer
by applying the relevant law to the facts of the case, the better your answer will be. After
completing your Law and Application ask yourself, would a reader be convinced that what I
am saying is correct? What makes a great answer on duty of care and diligence?
You need to explain, with reference to the relevant law:
1. The standard of care and diligence expected of the officer exercising the power. The
standard is dependent on you explaining:
a. The circumstances of the company;
b. The position occupied by the officer; and
c. The responsibilities of the officer.
2. The power or duty of the officer which does not meet the standard of care you set in
point 1 and why it does not meet the standard.
3. The business judgment exercised by the officer and why or why not the officer can
rely on the defence under section 180(2).
4. Any cases that have similar facts and why and the use of the principle(s) from the
case to strengthen your argument. What makes a great answer on duty to prevent insolvent trading?
Remember the duty to prevent insolvent trading involves a series of timing issues requiring
you to explain when something happened. You need to explain, with reference to the
relevant law:
1. That the persons were directors and why and when they were directors;
2. The debts which were incurred and when they were incurred;
3. When the company was insolvent and why by applying the:
a. Cash flow test;
b. Indicators of insolvency; and
c. The presumptions of insolvency (if applicable)
4. The evidence (grounds) that a competent and diligent director would have had of
insolvency and when they would have had the evidence;
5. When the directors were actually aware (subjective test) or when a competent and
diligent director would have been aware (objective test) of the grounds for suspecting
insolvency in breach of section 588G and why. You need to pick the earlier of the two
dates;
6. Whether any of the defences under s 588H apply and why or why not.
7. The remedies that the person you are advising can obtain and how, in particular, the
compensation would be calculated.
8. Any cases that have similar facts and why and the use of the principle(s) from the
case to strengthen your argument.