Question

The liquidator of Smollett Pty Ltd (Smollett) claims that Robert Earnst (RE) and a company he controls, Earnst Engineering Pty Ltd (EE), were acting as shadow directors of Smollett from July 1, 2017 to September 30, 2019 when the company was placed into liquidation. The liquidator further alleges that the company was trading whilst insolvent during this entire period.

1. Required: Explain the concept of a shadow director and how the liquidator would prove these claims against RE and EE.

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2. Required: Explain the concept of ‘trading whilst insolvent’ and how the liquidator would prove that the directors of the company had allowed the company to engage in this activity.

The liquidator of Smollett Pty Ltd (Smollett) claims that Robert Earnst (RE) and a company he controls, Earnst Engineering Pty Ltd (EE), were acting as shadow directors of Smollett from July 1, 2017 to September 30, 2019 when the company was placed into liquidation. The liquidator further alleges that the company was trading whilst insolvent during this entire period.

1. Required: Explain the concept of a shadow director and how the liquidator would prove these claims against RE and EE.

Click or tap here to enter text.

2. Required: Explain the concept of ‘trading whilst insolvent’ and how the liquidator would prove that the directors of the company had allowed the company to engage in this activity.

Answer 1

A. Company directors take on specific fiduciary, common law and statutory duties and responsibilities when they are appointed, and their status is registered at Companies House. If you are not officially a director, but provide advice and guidance to the board which is regularly acted upon, you could be viewed as a ‘shadow director.’ To establish that a defendant is a shadow director Millett J said it is necessary to allege and prove: who are the directors of the company, whether de facto or “de jure” [ie validly appointed]; that the defendant directed those directors how to act in relation to the company.

B. Trading whilst insolvent refers to when a company continues to trade despite the fact directors know the company has no future and has become insolvent. There are two ways of defining insolvency, either when a company can no longer keep up with day to day payments, or if liabilities on the balance sheet outweigh assets. The liquidator can prove this by verifying the below deatils of the directors

• Taking money out of the company in order to fund personal luxuries such as cars or holidays.
• Collecting an unreasonably high salary when the company cannot afford it.
• Transferring assets from the insolvent company for free or for significantly less than valued in an attempt to exclude it from any future insolvency proceedings.
• Paying creditors in preference to others.
• Collecting deposits from clients, knowing that works won’t be completed.