Question

Ahmed (accountant), Ben (entrepreneur) and Chen (operational skills) formed Drastic Designs Pty. Ltd. in 2006. They were executive directors and equal shareholders. The company’s focus was initially on designing and selling handbags. Progress Bank lent them funds and took a security interest by way of a floating charge over the company’s stock in trade.

In June 2009 Ben heard that the organisers of the Autumn Fashion Show were calling for tenders (bids) to design the stage for the fashion parade. Ben was excited at the prospect of bidding and thought it would assist the company’s growth. Ahmed advised against putting in a tender (bid) for such a large project that was completely different to anything the company had done before. Chen thought it would be a good challenge. A resolution was passed (2:1) that the company would make a bid. Ahmed resigned from the Board in protest and Ben took over the role of managing director. Ben’s girlfriend, Nula, joined the Board as a non-executive director to replace Ahmed. As she had some financial skills, she helped with the tender details. Drastic Designs won the tender.

Since Ahmed was not available to help with the financial side of the business, Ben hired Sam, a recent Bachelor of Commerce graduate, as book-keeper and generally to advise them on the accounting side of the business. Ben and Chen relied heavily on Sam. When asked by suppliers when they were going to be paid, Chen just told them to ‘see Sam – he is in charge of that sort of thing’.

By November 2010 it was apparent that the Autumn Fashion Show tender had been underpriced and that the project had lost $150,000. Sam made a list of outstanding debtors and paid those who were the most demanding.

In December 2010 Drastic Designs signed a one-year contract to redesign several office buildings. This meant that Drastic Designs had to employ more staff and buy more equipment. At the January 2011 Board meeting Nula expressed her concern that there was inadequate financial information being produced by Sam.

In February and March 2011 Drastic Designs was late paying its interest payments to Progress Bank, which threatened to take action if payment was late again. The bank refused Ben’s request for further finance. Several unsecured creditors wrote expressing their concern with the fact their accounts were more than 90 days overdue. It is now May 2011.

Required:

(a)?Discuss whether Ahmed, Ben, Chen, Nula and/or Sam are in breach of their insolvent trading duties under the Corporations Act 2001 (Cth).

(b)?It is apparent that Drastic Designs is in financial distress – briefly identify and then explain the options for the directors and creditors and the potential impact of those options on Drastic Designs.??? ??

Refer to relevant sections of the Corporations Act 2001 (Cth) and to relevant cases, if any, in your response.

Answer 1

Answer to a)

Ahmed – previous accountant of the company

Ben – managing director

Chen – operations employee

Nula – non executive director

Sam – in the position of Ahmed.

In this case, we can’t consider Ahmed as breached the trading duties as he already left the organization and already

Ahmed had advised the firm not to take the bid as it was a large project. In this case, it can be said that he fulfilled his responsibilities for his assigned role.

Whereas Ben, Chen, Nula & Sam has breached their duties. This is because it is the duty of the managing directors to control & coordinate the overall operations of the organization especially the financial side & they can’t rely entirely on Sam for the financial position of the company. Similarly, Ben’s approach to bank for further finance also can’t be considered as a lawful act because the company is already liable to many creditors.

Answer to b)

Directors must take all the necessary steps to minimize losses for creditors. This may require for immediate insolvency procedure or continued business in conjunction with adoption of one or more restructuring options.

The director’s goal must be to ensure that the company’s obligations to the creditors don’t increase further. One way to do this is to “rule off” the account & pay for all further supplies & services or follow the policy of “cash on delivery basis”.

Creditors’ role will be to pave the way for unsecured creditors rather than the secured creditors. Or if the company wishes to go in for liquidation, it can assist the company to vote on the choice of the liquidator by giving weight age to the vote on the basis of their respective claims.

The impact of drastic designs on the above decision will be on the positive side as the directors role will be to assist the creditors on their payment or if it wants to continue with its business further, it must act accordingly by selecting the cash on delivery basis option.