Canterbury Law Review
Corporate governance in a troubled company provides the acid test of management skills. By troubled company is meant a company which is suffering a liquidity crisis and is insolvent or nearly insolvent. This topic raises questions of directors' fiduciary duties in a near insolvency situation and their statutory duties faced with insolvency and the various options open to them. These options will require cooperation with an insolvency practitioner who will look critically at their previous conduct with the advantage of perfect hindsight. At the same time decisions in such circumstances often involve making a distinction between legitimate and non legitimate risk taking. Australia and New Zealand arguably adopt too draconian an approach to the governance issues involved, and subvert that distinction.
Management, because of its strategic position, has a greater opportunity to forecast insolvency than investors. Investors can, however, reduce some of the risks for them of company failure by diversification. Nevertheless, they have to rely on financial data provided by companies which will fall short of all the information in the hands of management. Creditors will either depend on security or high interest charges and careful monitoring. Trade creditors will often rely on knowledge of the company's business and adjust their credit terms accordingly.
Attempts have been made to develop formulas or ratios for predicting business failure to aid all three groups but most of the empirical work has been based on a population of failed companies which gives an immediate bias to the findings. The early work was based on univariate analysis whereas the later work such as that of Edward Altman makes use of multivariate analysis. using this technique Altman concentrates on the following ratios:
working capital/total assets;
retained earning/ total assets;
earnings before interest and taxes/total assets;
market value of equity/book value of long term debt;
To these he assigned weights to give an overall score known as the Z factor. A variation on this theme has been produced in the UK by RJ Taffler.
Without going into the detailed operation of these ratios or the resulting analysis, the following general points can be made. First, there is no unanimity amongst the studies as to which ratios offer the best guide. Secondly, the predictive accuracy of the models improves as the failure approaches. Thirdly, there seems to be a time about one or two years ahead of the predicted failure after which management is unlikely to be able to reverse the decline. Fourthly, while they provide information the models do not necessarily aid the decision on the appropriate strategy. They are based on static or comparative static, not dynamic, calculations but Altman argues that this is because the science is underdeveloped.
Apart from such work, the causes of business failure have been inadequately studied. Most insolvency practitioners have their own theories but there is usually little settled consensus.
It is interesting to note that the first Report of the united Kingdom Select Committee on Joint Stock Companies in 1844 divided what it described as "bubble companies" into three categories:
1. those which, being faulty in their nature, in as much as they are founded on unsound calculations, cannot succeed by any possibility;
2. those which, let their object be good or bad, are so ill constituted as to render it probable that the miscarriages or failures incident to management will attend them; and
3. those which are faulty, or fraudulent in their object, being started for no other purpose than to create shares for the purpose of jobbing in them, or to create, under pretence of carrying on a legitimate business, the opportunity, and means of raising funds to be shared by the adventurers who start at the company.
We may regard this as an apt description of business failure before the introduction of the modern form of incorporation. Remarkably little seems to have changed with the introduction of incorporation under general Companies Acts and limited liability.
Clearly, inadequate capital is a common failing. Many businesses are started up with insufficient working capital. Bank finance, which is usually sought, has its drawbacks. The interest has to be found whether or not the company makes profits, unlike dividends on ordinary shares which are only paid out of profits. Bank surveillance and the changes in banking policy from time to time can inhibit the company's freedom to manoeuvre. Buying goods on hire purchase is a great temptation but the true cost of such goods is rarely taken into account. Another factor is inadequate control over working capital. Imprudent business judgment in one form or another is another common failing which in fact covers a multitude of sins. One has only to walk regularly through any shopping mall in any town to see the rise and fall of small businesses.
Fraud is another factor although its incidence is often exaggerated. Some businesses are fraudulent by nature; others are basically lawful but are carried on fraudulently. Others again are lawful and are carried on in a lawful manner but there are management frauds committed against the company.
In a survey carried out in the USA, Dun and Bradstreet, the commercial intelligence specialists, identified "management inexperience and incompetence" as the major cause of failures. Fraud accounted for a mere 2%. In a survey of 100 UK private companies which had been wound up and almost all of which were small incorporate businesses, 71% failed due to mismanagement. A high proportion had a low share capital of £100 or less in 52% of the cases, and of £1000 or less in 78% of the cases.
The most interesting and thorough analysis of company failure in the UK was done twenty five years ago by a financial journalist and management consultant, John Argenti, in his book Corporate Collapse. Argenti listed the following causes or symptoms - management shortcomings, lack of accountancy information, failure to respond to change, constraints, recession, big expensive projects, "creative" (ie cosmetic) accountancy and excessive gearing. Let us examine each of these in turn.
Under management shortcomings, Argenti listed one-man rule, a non- participating board, unbalanced top team, lack of management depth, weak financial function and where there is a combined office of chairman/chief executive. He instances the former Rolls-Royce as having five out of six of these shortcomings. These are all pretty self-explanatory.
As examples of accountancy failings he instanced lack of budgetary control, cash flow forecasts, costing systems and unrealistic valuation of properties.
He gave five examples of change - competitive trends, political change, economic change, social change and technological change. A company must be capable of responding to change. Included under economic and social change would now be changes in industrial relations.
Constraints cover a wide range of things. Some matters such as monopolies and restrictive practices are caught by legal and administrative mechanisms. Some corporate activities may be penalised by tax provisions. Trade unions also represent a powerful constraint on a company's freedom of manoeuvre. Again, public opinion, especially through the media or in the form of organised pressure groups, operates as an increasingly powerful check on companies. This is particularly true in the area of the environment. Recession and inflation both represent considerable threats to business. The big project often brings a company down. It is frequently accompanied by little or not realistic costing of research and development. Rolls-Royce was a classic case. Royston Industries, manufacturers of the Midas black box for aeroplanes, was another. In both cases, profitable aspects of the group were brought down by over-ambitious research projects.
Creative accounting is usually a symptom rather than a cause. It has frequently occurred in the past with the over-valuation of properties or work in progress. The accountancy profession is seeking to establish controls over this kind of activity.
Excessive gearing, i.e. excessive loan capital in relation to share capital, again is usually a symptom rather than a cause. In some cases the blame can be laid at the door of the banks for encouraging this kind of improvidence but for small incorporated businesses, it can be the only available source of finance.
In a survey published in the Bank of England Quarterly Bulletin two other factors were mentioned - low and declining profitability often marked by historic cost accounts which may show a steady but in reality inadequate return, and increased import penetration of home markets.
In the useful Australian work Corporate Collapse - Regulatory, Accounting and Ethical Failure,, Professors FL Clarke, GW Dean and KG Olivier review the failures of the accounting profession in Australia to monitor creative accounting and the abuse of group structures in Australia. Their book covers the 1960s, 1970s and 1980s as three separate periods and includes case studies of the major collapses. As such it is valuable reading for all those concerned with corporate governance.
In a solvent situation the legal position is that directors owe their fiduciary duties to the company which is normally equated with the shareholders as a general body. The duties are not owed to individual shareholders in the absence of special facts or express statutory provision. The company is not equated with its creditors until insolvency but it has been held in recent years that in a near insolvency situation directors must also consider the creditor interest. One unorthodox view is that this engenders a duty of care in negligence to creditors but the weight of authority is against this.
To this extent the directors are obliged to serve two masters and will also be concerned to protect themselves from potential personal liability. The introduction of the Business Judgment Rule in Australia will not protect them here if their action or inaction fails to prevent insolvent trading. It is arguable that more is expected of directors who serve on the Audit Committee because of the nature of an Audit Committee and general concepts of the duty of care.
The main policy concerns are to curb excessive risk taking, obtaining credit on the brink of insolvency and deceiving creditors about solvency.
When insolvency occurs it has an impact on the company's assets and the directors' authority to manage the company. We will consider this later.
Let us now examine in some detail the impact of insolvency. First, we must consider whether the directors are personally liable for failing to prevent insolvent trading. secondly we shall consider the impact of voluntary administration and a formal scheme of arrangement and thirdly we shall consider the impact of receivership and winding up. Since the laws of Australia and New Zealand differ we shall deal with them separately.
The present law dates back to the UK Companies Act 1929 when it was limited to fraudulent trading. This was adopted in Australia and New Zealand and still survives in s592(6) of the Corporations Act. The main provision of the present law in Australia is now contained in s588G of that Act under which a director has a duty to prevent insolvent trading by his or her company. Subject to four defences which are reasonably generous, a director who contravenes the section can be made personally liable to pay compensation to the company and may face a civil penalty. There is also criminal liability if the additional criminal intent can be proved.
The onus of proof rests on the person seeking to make the director liable and the standard of proof in civil penalty and compensation proceedings is the civil standard of proof on a balance of probabilities. The same standard applies to proof of defences but here the onus obviously rests on the director. in the criminal proceedings the ordinary standard of criminal law applies.
Unlike s592 and its predecessors, s588G is limited to directors but directors as widely defined by s9. This includes validly appointed directors but also de facto and shadow directors.
Section 588G(1) focuses on incurring a debt when the company is insolvent or will become insolvent as a result of incurring that debt. This raises the question of what is meant by incurring a debt and when a debt is incurred.
In Hawkins v Bank of China the Court of Appeal of New South Wales said that the meaning depended on the context and the purpose of the statute. In Russell Halpern Nominees Pty Ltd v Martin it was held that a company must do a positive act.
On the question of when a debt is incurred there are a number of cases dealing with different kinds of debts and s588(1A) sets out an operative table which deals with a number of examples concerning share capital. Giving a guarantee also constitutes incurring a debt since the concept includes a contingent liability.
This is defined by s95A in terms of commercial insolvency in the sense of company's inability to pay all its debts as and when they became due and payable. In Metropolitan Fire Systems Pty Ltd v Miller in 1997 the Court stressed the need to consider all the company's resources including its access to credit and current and future debts. Apart from this it is largely a matter of cash flow and the timing of when debts fall due and when the company's debtors are likely to pay. Thus lack of liquidity, while relevant, may not be conclusive.
Sections 588E(3) and (4) set out two rebuttable presumptions of insolvency - winding up where the company was insolvent during the 12 months ending with the filing of the winding up application, and contravention of ss286(1) and (2). Section 286(1) deals with the failure to keep adequate financial records and s286(2) deals with a failure to retain them.
Section 588G(1)(c) requires that there were reasonable grounds for suspecting that the company was insolvent or would become so at the time the debt was incurred.
The phrase "reasonable grounds for suspecting" has been the subject of judicial analysis. In Queensland Bacon Pty Ltd v Rees Justice Kitto held that suspicion requires positive feeling of actual apprehension, amounting to a slight opinion but without sufficient evidence. A reason to suspect that a fact exists is more than a reason to consider or look into the possibility of its existence.
In Metropolitan Fire Systems Pty Ltd v Miller it was held that the test of reasonable grounds was objective, which seems obvious from the wording, and a similar view was expressed in Quick v Stoland. It is also assumed that the wording will be interpreted to make directors more accountable.
Just what this means in practical terms is less clear. In Quick v Stoland and the unreported Victorian case of Fabric Dyeworks (Australia) Pty Ltd v Benaharon the Courts seem to consider balance sheet insolvency, then cash flow and then the trading relationship between the plaintiff creditor and the defendants. It has been suggested that directors should query solvency on a daily basis. This seems to promote a risk adverse culture.
Section 588G(2) defines contravention as failing to prevent the company from incurring the debt if
(a) the person is aware at that time that there are grounds for suspecting insolvency; or
(b) that a reasonable person in a like position in a company in the company's circumstances would be so aware.
The Corporations Law Amendment (Employee Entitlements) Act 2000 made the entering into of an uncommercial transaction (as defined in s588FB) a debt for the purposes of s588G. The test is objective. In addition there is a new s596AB which creates an offence of entering into agreements or transactions to avoid employee entitlements. The aim is to prevent asset stripping to the detriment of employees. There has been a strident objection by business interest groups but it should be noted that there are more draconian provisions in force in Canada and ss 4, 5 and 6 of the US Uniform Fraudulent Conveyances Act seem equally stringent. The United Kingdom deals with the matter by a redundancy payments fund with rights of subrogation against the company.
Section 588H sets out 4 defences. These are:
(1) having reasonable grounds to expect that the company is solvent;
(2) delegation and reliance on another person for information as to solvency;
(3) not taking part in management; and
(4) taking all reasonable steps to prevent the incurring of the debt. Let us look at each in turn.
Section 588H(2) uses the word "expect" solvency which is to be contrasted with "suspect" insolvency in s588G(1)(C).
In Metropolitan Fire Systems Pty Ltd v Miller it was held that to expect something is a higher test than to suspect something. It suggests a measure
of confidence in the company's solvency which is objectively justifiable. This involves taking into account the facts about the debtors and creditors ascertainable by enquiry and facts actually known to any of the directors. This defence predicates action by the director.
Section 588H(3) states that it is a defence if it is proved at the time the debt was incurred that
(a) the director had reasonable grounds to believe and did believe
(i) that a competent and reliable person was responsible for providing adequate information about solvency; and
(ii) the other person was fulfilling that responsibility; and
(b) the director expected that the company was and would remain solvent on the basis of information so provided.
This links with the general provisions on delegation and reliance in ss 189 and 190 of the Corporations Act 2001. The delegation must be reasonable and to a competent and reliable person who must be monitored.
Section 588H(4) provides a defence if the director did not take part in the management of the company because of illness or some other good reason. Presumably attendance at a funeral of a relation would constitute an example of a good reason.
Section 588H(5) provides that it is a defence if it is proved that the person took all reasonable steps to prevent the company from incurring the debt and s588H(6) states that in determining whether that defence has been proved the Court will take into account any action to appoint an administrator, when that was taken and what was the result.
This is a crucial defence and highlights the necessity for a director to get the board to consider this procedure, to minute this and to resign if necessary if the advice is not followed. Merely expressing reservations and not agreeing to further debt is not enough.
The contravention of s588G(2) gives rise to the possibility of:
(a) civil penalty proceedings under Part 9.4B;
(b) criminal proceedings under s1317P if the additional criminal intent required by s588G(3) is proved (this requires a dishonest failure to prevent the incurring of the debt);
(c) compensation orders under s588M(1) in respect of losses resulting from insolvent trading whether or not (a) and (b) have been brought.
Compensation orders can be brought by a liquidator and in certain circumstances by a creditor but the proceedings must be brought within 6 years after the beginning of a winding up (s588M(2), (3) and (4)).
Relief by the Court is possible under s1317S.
Although there has been a national enforcement of the Australian Securities and Investments Commission program targeting insolvent trading since 1996 and there are currently some high profile investigations being carried out, these provisions have not necessarily been successful in practice, partly due to budget cuts.
If the company goes into voluntary administration the administrator takes over the affairs of the company with a view of developing a deed of company arrangement. The object of this procedure is stated by s435A to be:
(a) the maximisation of the chances of the company or as much as possible of its business to continue in existence.
(b) if this is not possible, a better return for creditors and members than would result from an immediate winding up.
This raises the question of the role of the directors in the process.
In an insolvency the creditors' interest assumes greater significance. The directors will be worried about potential liability under s588G and may have received a notice requiring them to initiate voluntary administration or be liable for unremitted tax deductions. They will also be worried about personal liability on guarantees.
Unlike the US Chapter 11 procedure where control remains with the management subject to supervision by the Court, administration represents a loss of control, the investigation of their affairs by an outside insolvency practitioner and thus something of a threat. On the other hand it also represents the possibility of salvaging the company.
During administration directors are not removed but their powers are suspended (s437C(2)). They can only act if authorised by the administrator under s437C(1). If they act without authority the act is void and they can be prosecuted for an offence under s437D(5) and may be liable for compensation under s437E(1).
The administrator can remove them and appoint others in their place (s442A).
In case the relationship between the administrator and the directors is too cosy ASIC and the creditors have powers to apply to the Court to terminate the administration or to protect creditors' interests (s447A and B).
Directors must assist the administrator under Part 5.3A.
The directors' powers may revive in whole or in part under a deed of company arrangement. The procedure is very flexible and allows a number of possibilities.
Obviously much depends on the creditors' perception of the conduct of directors prior to the administration and the good sense and professionalism of the administrator in the carrying out of the administration. It is possible for companies to survive troubled times by the use of this procedure. New Zealand does not currently have this procedure although it has been under consideration for some time.
If the company is a large public company it may consider a more formal scheme of arrangement under Part 5.1 of the Corporations Act 2001. This enables a company to enter into compromise with creditors as an alternative to winding up, vary its share capital, transfer its assets to a new company in consideration for the issue of shares in the new company to members or amalgamate with one or more companies.
The procedures necessitate application to the Supreme Court which is given wide powers provided certain safeguards are in place. Much depends on whether the scheme involves a solvent or an insolvent situation.
From the point of view of corporate governance the significance of the procedures lies in the necessity for management to work closely with specialist legal and accounting advisers to produce a scheme and documentation which will satisfy the Court. Schemes are less common since the introduction of the administration procedure but are still useful for large companies for reasons other than insolvency. The breadth of order which the Court can make can be very useful in mergers and their aftermath.
Receivership is normally a debenture holder's remedy to enforce the security under a debenture or a debenture stock trust deed. Receivers can be appointed by the Court but more usually are appointed by the debenture holder or trustee under an express power in the charge.
The appointment of a receiver usually takes the form of appointment as receiver and manager.
As with the appointment of an administrator the appointment of a receiver and manager puts the powers of the directors in suspense during the receivership. From the point of view of corporate governance the position is very similar to an administration.
Winding up can be for reasons of solvency or insolvency. There are two types - winding up by the Court under s461 and s459A and voluntary winding. Voluntary winding up can be either creditors voluntary winding up or members voluntary winding up.
A winding up order by the Court does not remove an officer from office (s471A(3)). However their powers are suspended during the winding up and the liquidator assumes control of the company. The officers are required to help the liquidator under s530A.
In a voluntary winding up all the powers of the directors cease except so far as their continuance is approved by
(a) any committee of inspection; or
(b) in the absence of any committee of inspection, by the creditors (s499(4)).
The company is to cease to carry on business except so far as required for the beneficial winding up of the company (s493(1)).
Winding up is not the corporate equivalent of death. This comes with deregistration under Chapter 5A.
There is no exact equivalent of s588G of the Corporations Act 2001. Sections 135 and 136 of the Companies Act 1993 deal with reckless trading and incurring obligations. Both create duties on directors which are owed to the company. Director, as in Australia, can cover a de facto and shadow director.
Section 135 provides that directors must not
(a) agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company's creditors; or
(b) cause or allow the business to be carried on in a manner likely to create a substantial risk of serious loss to the company's creditors.
The section departs from the Law Commission's draft which would have given protection for business judgment in cases of reasonable risk taking and seems to be based on statements in the case law interpreting the old s320 of the Companies Act 1955. Section 320 only applied in winding up whereas s135 applies before winding up. Recklessness as such only appears in the heading to the section which is a bit odd.
In Thompson v Innes, Justice Bisson said:
Was there something in the financial position of this company which would have drawn the attention of an ordinary prudent director to the real possibility not so slight as to be negligible risk, that his continuing to carry on the business of the company would cause the kind of serious loss to creditors which [the former section 320(1)(b) of the Companies Act 1955] was intended to prevent?
As regards the interpretation of "substantial risk" and "serious loss", Mike Ross in his useful work Corporate Reconstructions - Strategies for Directors states:
The first phrase, 'substantial risk', requires a sober assessment by directors as to the company's likely future income stream. Given current economic conditions, there are reasonable assumptions underpinning the directors' forecasts of future trading revenues? If future liquidity is dependent upon one large construction contract or a large forward order for the supply of goods or services, how reasonable are the directors' assumptions regarding the likelihood of the company winning the contract? Even if the company wins the contract, how reasonable are the prospects of performing the contract at a profit?
Creditors are likely to suffer 'serious losses' if future cash outflows exceed cash inflows the same period. If there is no profit margin on goods being sold or services provided, the company will reach a stage where shareholders' risk capital has been exhausted and directors are instead continuing to trade at a time when the company cannot meet all creditors' claims. Those creditors who are paid get preferential treatment, to the exclusion of others. In these circumstances, the company should have stopped trading: to continue is to risk creditors' money.
In a useful recent decision in Fatupaito v Bates O'Regan J held that the test under s135 is objective and the section appears to impose a stringent duty on directors to avoid substantial risks of serious loss to creditors and does not appear to allow for balancing risk and reward, even where the potential for great rewards exists. When a company has negative shareholders' funds the decision to keep trading necessarily involves risk for both existing and future creditors. While there may be circumstances where continued trading is justified by the prospect of collecting pre- existing debts or generating significant income from a reasonably minor expenditure, directors must be very cautious before embarking on that course. The defendant was also held liable for breach of s136. His Honour said it was hard to say with absolute confidence that the sections did not undermine the principle of limited liability to some extent. It is submitted, however, that it is not so much limited liability of members so much as the principle of separate legal personality which is undermined.
Section 136 provides that a director must not agree to the company incurring an obligation unless the director believes at that time on the reasonable grounds that the company will be able to perform the obligation when it is required to do so.
Whereas s135 deals with debts on revenue account, s136 deals with obligations on capital account such as major investments.
In Re Wait Investments Ltd (in liq); McCallum v Webster a shell company was used to enter into an unconditional contract for the purchase of a building for $1.6 million. The company defaulted, the vendor resold and claimed the shortfall. The directors were held liable. A similar result occurred in the undefended hearing in Ocean Boulevard Properties Ltd v Everest where a shelf company entered into an agreement for a lease which it did not complete. It was held that the directors had no basis for believing that the company would be able to pay the rent.
In Fatupaito v Bates the defendant was in breach of s136 because he was aware that the company was insolvent and it was not reasonable for him to believe that obligations incurred would be able to be met as they fell due.
It is arguable that directors can rely on the general provision about use of information and advice in s138, although this is not expressly stated.
There are no separate defences, only those contained in the statutory wording.
There is no equivalent of civil and criminal penalties under these sections but a general power in the Court under s301 to order repayment of money or return of property and this is effective even though the conduct may constitute an offence.
This has not yet been introduced in New Zealand.
In an Advisory Report to the Ministry of Economic Development Insolvency Law Reform: Promoting Trust and Confidence the Law Commission outlined a proposed business rehabilitation scheme with the following characteristics:
(a) entry into the scheme to be by Court order where the proponent will need to satisfy the Court
(i) that the business records will enable a prompt assessment of its future viability;(b) after an order is made, there will be a 14 day stay on all creditors' claims with the possibility of a further 14 day extension; and
(ii) that there is a real prospect that creditors will accept the proposal; and
(iii) that once the proposal is implemented, the business will be able to satisfy the solvency test.
(c) an impartial administrator will be appointed to carry out an investigation, negotiate with creditors, protect the assets and oversee the management.
These recommendations have been criticised by consultants, Charles River Associates (Asia Pacific) Ltd in a review of the Advisory Report. The review states:
We do not find convincing the rationale for a moratorium provided by the Law Commission, and we doubt that the target firms that they have identified actually require a moratorium to promote rehabilitation rather than liquidation when rehabilitation is efficient. Unless further work is undertaken to identify the precise market failure that any moratorium would be designed to address, there is a danger that the regime may not be appropriately designed to assist those segments of the market actually requiring it. Whatever the rationale for the introduction of the moratorium regime, and despite the existence of a statutory management regime, we consider it highly likely that a moratorium will increase the cost (defined to include all terms of the contract) of secured credit.
New Zealand now has more modern provisions for compromises with creditors in Part XIV, amalgamations in Part XIII and Court approval under Part XV of the 1993 Act. These are based on Canadian legislation. The Advisory Report of the Law Commission thought that Part XIV did not require alteration but its provisions should be synthesized with Part XV of the Insolvency Act 1961. On the other hand Part XV should be repealed since its operation is too uncertain and it permits compromises to be imposed on creditors where a significant number do not agree.
New Zealand has modern provisions in the Receiverships Act 1993.
The Corporations (Investigation and Management) Act 1989 makes provision for a form of statutory receivership and management and enables swift intervention by Government in cases of major corporate collapses. This was used in the case of the DFC and Equiticorp collapses. The Law Commission favours its retention as a matter of last resort in cases which cannot be dealt with adequately by any other regime or where the public interest requires it.
There are simplified provisions for liquidations in Part XVI of the Companies Act 1993. These are similar to Australian Law.
The New Zealand law is incoherent and strangely incomplete. The relationship between ss 135 and 136 of the Companies Act 1993 is odd, probably due to the vagaries of the legislative process. There are no defences as such. The Australian provisions are more rational but probably too draconian. They lead naturally into consideration of voluntary administration, a procedure which New Zealand still lacks, due to its increasingly odd method of law reform.
Both systems are (on paper at any rate) more rigorous for directors than US corporate and bankruptcy laws. Together they represent the most extreme form of piercing the corporate veil, and inhibit entrepreneurism. Because of this they have an inevitable effect on corporate governance, motivating reputable management towards a policy of caution and avoidance of risk taking, while at the same time, due to erratic enforcement, not inhibiting the truly reckless or fraudulent. Professor Dale Oesterle, a US corporate law professor who has spent time in New Zealand, recently wrote: "Insolvent trading provisions are well intentioned but, in the end, not helpful." As someone who argued for the introduction of a statutory business judgment rule in New Zealand and Australia and against the Australian civil penalty regime, I agree with him. Fraud, recklessness and misrepresentation are one thing; honest business judgment which balances risk and return is another. To inhibit the latter is to go too far, and subvert the difference between Company Law and insurance.
[*] LLD, PhD, Barrister of the High Courts of New Zealand and Australia, Professor of Law, Bond University and Professorial Fellow, University of Melbourne.
 Altman E, Corporate Bankruptcy in America (Lexington, Heath, 1971); Corporate Financial Distress, (New York, John Wiley & Sons, 1983), p 339.
 Finding those firms in danger using discriminate analysis and financial ration data: a comparative UK-based study (City University Business School, Working Paper 4); RJ Taffler and HJ Tisshaw "Going, Going, Gone: Four Factors Which Predict" (1977) 88 Accountancy 50. For a very detailed technical study see PB Alexander, "The Failure of Corporate Failure Models to Classify and Predict: Aspects and Refinements" (MComm thesis, University of Canterbury, 1991). See also J Argenti, Corporate Collapse (New York, McGraw-Hill, 1976).
 J Freear , The Management of Business Finance (London, Pitman, 1980), ch 14.
 Freear, op cit n 3 at 349.
 R Brough , (1967) Business Ratios 8.
 J Argenti , Corporate Collapse ( New York, McGraw-Hill, 1976). See also S Slatter and D Lovett, Corporate Turnaround — Managing Companies in Distress, ( London, Penguin Books, 1999), p 49. For an Australian study based on Argenti see A McRobert and R Hoffman, Corporate Collapse, ( Sydney, McGraw Hill, 1997).
 (1980) 20 Bank of England Quarterly Bulletin 430.
 Melbourne, Cambridge university Press, 1997.
 See Mills v Mills  HCA 4; (1938) 60 CLR 150; Greenhalgh v Arnerne Cinemas Ltd  1 Ch 286.
 Coleman v Myers  NZHC 5;  2 NZLR 225.
 Nicholson v Permakraft (NZ) Ltd  NZCA 15;  1 NZLR 242. Cf Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 ACLC 215; Spies v The Queen  HCA 43.
 Nicholson v Permakraft (NZ) Ltd  1NZLR 242 at 249.
 Section 180(2) of the Corporations Act 2001.
 See JH Farrar, Corporate Governance in Australia and New Zealand (Melbourne, OUP, 2001), ch 14.
 There is a growing literature on this. See, for instance, J Dabner, "Trading Whilst Insolvent - A Case for Individual Creditors Rights Against Directors" (1994) 11 UNSW LJ 546; J Dabner, "Insolvent Trading - Recent Developments in Australia, New Zealand and South Africa"  BondLawRw 1; (1994) 6 Bond LR 1; J Dabner , "Insolvent Trading: An International Comparison" (1994) 1 CBLJ 49; J Dabner, "Insolvent Trading - Recent Developments in Australia, New Zealand and South Africa"  JBL 282; R Goode, "Insolvent Trading Under English and Australian Law" (1998) 16 C&SLJ 110; A Herzberg, "Insolvent Trading" (1991) 9 C&SLJ 285; A Herzberg, "Why Are There So Few Solvent Trading Cases?" (1998) 6 Insolvency LJ 11; R Lyons, "Insolvent Trading - When Should Directors be on Guard?" (1999) 1 Insolvency LJ 45; BH McPherson, "The Liability of Directors for Company Debts" (1996) 1 Insolvency LJ 133; B Mescher, "Personal Liability of Company Directors for Company Debts" (1996) 10 The Australian Law Journal 831; B Mescher, "Company Directors' Knowledge of Insolvent Trading Provisions" (1998) 6 Insolvency LJ 186; J Mosley, "Insolvent Trading: What is a Debt and When is One Incurred?" (1996) 4 Insolvency LJ 155; for a recent collection of essays see Company Directors' Liability for Insolvent Trading (Centre for Corporate Law and Securities Regulation, University of Melbourne, IM Ramsay (ed), 2000).
 See JH Farrar, "Fraudulent Trading"  JBL 336.
 (1992) 10 ACLC 588. See also Credit Corp Pty Ltd v Atkins (1999) 11 ACLC 156.
 (1986) 4 ACLC 393.
 See NF Coburn, "Insolvent Trading in Australia: The Legal Principles" in Ramsay (ed), op cit n 15, ch 4 at 94 - 99
 Hawkins v Bank of China, op cit n 17.
 (1997) 23 ACSR 699.
 Melbase Corporation Pty Ltd v Seganoe Ltd  FCA 1225; (1995) 13 ACLC 823 at 832. See also Cuthbertson & Richards Sawmills Pty Ltd v Thomas  FCA 315; (1999) 17 ACLC 670 at 676.
 Re Timbatec Pty Ltd (1974) 4 ALR 12.
  HCA 21; (1966) 115 CLR 266 at 303.
 (1997) 23 ACSR 699.
  FCA 1200; (1998) 157 ALR 615. See also Credit Corp Pty Ltd v Atkins  FCA 335; (1999) 17 ACLC 756.
  FCA 1200; (1998) 157 ALR 615 at 622.
 Supreme Court of Victoria, 29.5.1998, Smith J.
 See DA Hope, "The Duty of Directors to Prevent Insolvent Trading" (unpublished LLM research paper, University of Melbourne, 1999), 20.
 R Lyons, "Insolvent Trading - When Should Directors be on Guard?" (1999) 7 Insolvency LJ 50.
 Cf Colburn op cit n 19, at 100-101.
 For a useful recent decision on the meaning of this, see J Austin in Lewis v Cook  NSWSC 191; (2000) 18 ACLC 490. See also DB Noakes "The Recovery of Employee Entitlements in Insolvency" in Company Directors' Liability for Insolvent Trading (Centre for Corporate Law and Securities Regulation, University of Melbourne, IM Ramsay ed, 2000), ch 5.
 See eg Ontario Business Corporations Act, s131 directors jointly and severally liable for all debts not exceeding six months wages of employees. See too the New Zealand Employee Relations Bill clause 245 to similar effect.
 See Clark RC, Corporate Law, Little Brown & Co, Boston (1986) para 2.2.
 See Colburn in Company Directors' Liability for Insolvent Trading (Centre for Corporate Law and Securities Regulation, University of Melbourne, IM Ramsay ed, 2000), p107-113.
 (1997) 23 ACSR 699. See also Tourprint International Pty Ltd v Bott (1999) 17 ACLC 1543.
 Standard Chartered Bank v Antico  NSWSC 31; (1995) 18 ACSR 1.
 B Mescher, "'Company Directors' Knowledge of the Insolvent Trading Provisions" (1998) 6 Insolvency LJ 191.
 See Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699. See Colburn in Ramsay (ed) op cit n 35, at 113 - 114.
 See Colburn in Ramsay (ed) op cit n 35, at 115. See Tourprint International Pty Ltd v Bott (1999) 17 ACLC 1543 where concentrating on sales and debt collection was held not enough.
 Byron v Southern Star Group Pty Ltd (1997) 15 ACLC 191. (NSWCA on the old wording). See Colburn in Ramsay (ed) op cit n 35, at 115 - 116.
 See Colburn in Ramsay, op cit n 35, at 140.
 See Ford's Principles of Corporations Law (North Ryde, Butterworths, 9 ed, 2001), ch 26.
 For a very useful survey see A Keay, "Corporate Governance During Administration and Reconstruction Under Part 5.3A of the Corporations Law" (1997) 15 C&SLJ 145 on which this relies.
 See Ford, op cit n 43, at paras 24.020 et seq.
 Ibid at ch 25.
 Ibid at ch 27.
 For a useful discussion see D Goddard, "Directors' Liability for Trading While Insolvent. A Critical Review of the New Zealand Regime" in Ramsay, op cit n 35, at ch 7.
 See Fatupaito v Bates (2001) 9 NZCLC 262 at 583 (accountant purporting to act as receiver when not validly appointed held to be a shadow director).
 (1985) 2 NZCLC 99,463 at 99,472. For the background to the present sections see Justice Tompkins, "Directing the Directors: The Duties of Directors Under the Companies Act 1993" (1994) 2 Waikato LR 13 at 26. See also the very interesting discussion by Justice Sian Elias, "Company Law After Ten Years of Reform" and RB Perkins, "Corporate Governance and the Companies Act of 1993" in The Company Law Conference of the New Zealand Law Society (1997). See pages 1-12 and in particular pages 9-10 for Justice Elias' paper and pages 77-91, especially 79- 81 for Mr Perkins' paper. Justice Elias shows how the final version differs from the Law Commission's draft and Mr Perkins shows how it is inconsistent with a business judgment rule.
 Auckland, CCH New Zealand Ltd, 1999, p 40.
 (2001) 9 NZCLC 262, 583.
 Ross, op cit n 51, at 44.
  3 NZLR 96.
 (2000) 8 NZCLC 262, 289.
 (2001) 9 NZCLC 262, 583.
 Study Paper 11.5. 2001, Wellington, xiv-xv.
 Review of the Law Commission's Report "Insolvency Law Reform: Promoting Trust and Confidence", Wellington, 8.6.2001, Executive Summary, para. 5.
 See Goddard in Ramsay (ed), op cit n 35, at 185 et seq.
 Oesterle in Ramsay (ed), op cit n 35, at 42.