Sample product as sold by Boniface Kyalo Mutinda

1. Legal Report- Liquidation 1
Legal Report – Liquidation
Introduction
The essay gives an analysis of the legal issues that are related to corporate situation in
the liquidation of a corporate company. It gives the rules and the procedures that are used in
liquidation according to the law and as presented in corporate company Act. The rules are
applied to the corporate legal situation in question.
Summary
Liquidation as presented in law can be caused by different things and it can be
compulsory or voluntary. Voluntary liquidation can originate from the shareholders of the
company or from the directors of the company. Liquidation can also be compulsory or
through a court order. A petition can be made by the creditor to liquidate a company and if
the court is satisfied it issues a winding up order.
Application/Analysis
The directors of the Best Dressed Home Ltd are significant shareholders of the
company and so they have a great interest in the company’s affairs. The company had a chief
operating officer named Mitchell and he provided the directors with profit forecast and
monthly budgets. If the company used less than the agreed amount of expenses, the chief
operating officer received an annul bonus. The business started to decline due to decrease in
sales while two directors of the company were away for an extended holiday. The cash flow
of the company was affected by an advertising campaign that was ordered by the director
who was present.
The company was late in remitting the taxes that were collected from the customers.
The major suppliers were not paid and solicitor’s letters in demand for the debts were sent to

2. Legal Report- Liquidation 2
the company. The suppliers refused to supply services and goods unless the goods were paid
for on delivery. The cheques issued to the suppliers by the chief operating officer were
dishonoured by the bank.
The directors of the company did not know about the financial difficulties because
they were supplied with false financial information and they thought that the company was
doing well. Mitchell was sacked after the directors discovered the true financial situation.
There was a large amount that was owed to unsecured creditors and the bank was one of
them.
Dividends to the shareholders were paid by the directors despite the financial position
of the company. The Tasmania part of the business was also sold to David’s family company
and the contract price was the market value of the business and was to be paid in 50 equal
annual instalments over 50 years. One of the unsecured creditors of the company obtained a
court order of winding up the company on the grounds of insolvency and a liquidator was
appointed.
Legal rules on Liquidation
According to Australian Securities & Investments Commission, (2008), corporate
companies are put into liquidation because of different reasons and in different situations.
One of the situations that may lead a company to be liquidated is when the shareholders of
the company decide to pass a special resolution of winding up. The creditors of the company
may also pass a resolution to wind up a company or to liquidate a corporate company at a
watershed meeting which is allowed by the corporate law. As Hudson, (1987, p. 199-213),
states, due to an event that may be specified in the constitution, the board of a company may
decide to pass a resolution of liquidation.

3. Legal Report- Liquidation 3
Before liquidation by the court order takes place, a liquidator is appointed to the
company with the aim of investigating the financial affairs of the company and establishing
what caused the failures. The liquidator also has a duty to investigate the offences that are
possible and later identify the assets of the company that are supposed to be sold and the
proceeds are used to pay the creditors.
The directors of the company are not liable for the debts of the company because the
company is a separate legal entity and it has its own rights. The director can only be liable if
he acts outside his authority and when insolvent trading occurs. Insolvent trading is when a
debt occurs that the company is unable to pay when the directors should have known that the
company is insolvent and could not pay the debt. The director may be held liable for the
amount of the unpaid debts.
As stated in section 588G of the Corporations Act, the directors of a company are
supposed to take an action if the company is not able to pay its debts when they fall due and
on time. They can decide to refinance the company or put forward a Company Voluntary
Arrangement that will help pay its creditors. If the two options are not available, the directors
of the company are supposed to cease trading to stop incurring further debts. It is the
obligation of the directors to make sure that the position of the company does not deteriorate
further and the amount of debt does not increase. The directors have a duty of protecting the
interest of the creditors of the company and not the interest of the shareholders or directors.
The directors are also liable for the losses that are incurred by the company in case of
unreasonable director related transactions such as payment of the money that is made by the
company without direct benefit to the company. For the payment of money to be director
related, it involves the directors of the company and the people who are close to them.

4. Legal Report- Liquidation 4
The secured creditors and the unsecured creditors of the company are affected by
liquidation of a corporate company. The unsecured creditors are not allowed to continue with
any legal proceedings against the company or any of its property after the company is
liquidated without the permission of the official Assignee or the court. They also cannot
enforce any rights against the property of the company which is under liquidation.
The creditors of the company are supposed to provide the information of the debts
that are owed by the company before they are paid. Together with the details of the debts, the
creditors are supposed to provide documentation copies that show the existence of the debts.
As suggested by Keith and Hudson, (1996, p 298-399), some of the documentation that are
required include bank statements, court orders, receipts, invoices and any acknowledgements
of debts.
As Company Rescue, (2011), puts it, in a compulsory liquidation where the creditor
applies to the court for liquidation, one of the rules that must be applied is that the creditor
must have pursued their debts for a significant period. The court accepts the petition to
liquidate a company only if the company refuses to pay the creditors after an agreement. If
the company demonstrates inability to pay or refuses to communicate with the creditors, then
the creditor is supposed to use a solicitor or a debt collector. If the solicitor and debt
collectors fail to collect the debt, a statutory demand is issued. The statutory demand lasts for
21 days and the company is supposed to pay the debt within 21 days. If the days are over and
the debt is not paid, a winding up petition is issued by the creditor.
As MetLife Guarantees, (2011), puts it, in liquidation, the first debts that are paid by
the liquidator are taxes that are owed by the company. The wages of the workers are also paid
before the other creditors including the secured and unsecured creditors.
Relevant to defendant

5. Legal Report- Liquidation 5
In the case of Best Dressed Homes Ltd, a creditor who is unsecured has managed to
obtain a court order for liquidating the corporate company. The court has appointed a
liquidator of the company to carry on the liquidation process. The creditors to the company
are not secured. The company owes $10 million to unsecured creditors and they are
supposed to prove that the company owes them.
As illustrated by Corporations Act 2001, (Sect 541), the company that is being wound
up must show in all its documents which may be negotiable instruments or public documents
that it is under liquidation. This is a requirement of every company and failure to include the
name liquidation in all documents will result to offence of strict liability. The company was
sold to David’s family at the market value and the decision was made by the shareholders of
the company.
The company engaged in a director related transaction by paying the dividends to the
shareholders despite knowing the financial situation of the company. The payment of the
dividends was director related because the directors were also paid the dividend since they
were shareholders of the company. The non-executive director was supposed to protect the
interest of the minority and the shareholders by not allowing the dividends to be paid.
The company could not meet its debts when they fell due and the bill was not paid in
time. This was enough to declare the company insolvent, but the company incurred additional
debts despite being insolvent.
Advice/ Conclusion
Being that the directors of the company are separate from the company, the liquidator
is not supposed to claim money from the directors of Best Dressed Homes Ltd. A company is

6. Legal Report- Liquidation 6
a separate legal entity and it is liable for its own debts. The directors can only be liable if they
had a wrongful trading when the debts owed by the company increased. The directors are not
liable for the debt that was owed by the company before they discovered the true financial
status of the business.
A defence available for the directors is that when they discovered that there was a
problem in the finances of company, they took the relevant action and tried to refinance the
company by negotiating with the bank to borrow some amounts that could help in refinancing
the company. They also made efforts of having a Company Voluntary Arrangement by
selling a Tasmania part of the business to David’s family company. This would generate
income for the company and the income can be used to pay the creditors. The directors and
the shareholder accepted the 50 equal yearly instalments because the Tasmania part of the
business was big. The non-executive director can prove that he acted in good faith and was
genuine for the interest of the company.
The three executive directors and one non-executive director of Best Dressed Homes
Ltd can use the defence in Section 588H of the Corporations Act and establish that they had a
reasonable ground to expect that the company was solvent because they were in the cause of
negotiation with the bank when the debt of the company increased. The aim of the
negotiation was to borrow money for the company to service its debts. The bank also
contributed to the increase of the debt because the directors expected to receive money from
the bank but the bank failed them after one month of negotiation. Due to the director related
transaction which also can be referred to as conflict of interest, the statutory defence that is
available for the directors is that they paid the dividends in good faith.
Concerning the false statement of accounts that were presented to the directors, the
directors can rely on section 189 of the corporation Act which permits them to rely on
information presented to them by delegates. One of the delegates could be an employee

7. Legal Report- Liquidation 7
whom the directors believe that he is reliable and competent. In this case, the directors of best
Dressed Homes Ltd did not know the true financial status of the company because they relied
on the information they received from Mitchell who was the finance manager. Mitchell is
liable for the false financial information that was given.
They can also rely on the section by proving that two of the directors were not in the
management of the company at the time the company became insolvent because they had
gone to a long holiday in overseas and they did not know the true status of the company.
The directors can also establish that they took reasonable steps to prevent the
company from incurring further debts and they even tried to pay some of the debt owed to the
bank by using diminishing cash reserves.
Best Dressed homes Ltd can prevent the liquidator from claiming funds from them by
opposing the winding up application under s 459(3) Corporations Act 2001. This is a strong
defence because it was assumed that the company was insolvent by failing to comply with the
statutory demand and it was presumed to be insolvent. The directors of the Best Dressed
Company can prove that the company is solvent and the liquidators will not claim money
from them.
Another defence that can be relied on by the company in proving its solvency is by
showing that it has money and it used the diminishing cash reserves to reduce the loan owed
to the bank as in the case: Deputy Commissioner of Taxation v De Simone Consulting Pty Ltd
where the directors of the company produced a suitcase that was full of cash and the winding
up application was withdrawn. They can use the cash reserves to pay all the debtors without
liquidating the company. On the contrary, the directors of the company can decide to wind up
the company voluntarily which could dismiss the creditors winding up.
The company can also argue that they have plans on how to pay the creditors without
winding up as in the case of Re Presha Engineering (Aust) Pty Ltd, where there was a better

8. Legal Report- Liquidation 8
prospect of payment and the court acknowledged an adjournment. Being that a substantial
part of the business was sold, the directors can rely on that evidence and argue that it was
sold to get ways of paying the creditors.
References
Australian Securities & Investments Commission, (2008), Liquidation: a guide for creditors
(online) Available from
<http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/Liquidation_guide_for_creditor
s.pdf/$file/Liquidation_guide_for_creditors.pdf> Viewed on 5 may 2011.

9. Legal Report- Liquidation 9
As Company Rescue, (2011), "A creditor is trying to wind up our company! What does that
mean?"( online), Available from <http://www.companyrescue.co.uk/company-
rescue/options/compulsory-liquidation >Viewed on 5 may 2011.
Corporations act 2001 - Sect 541 (online) Available form
<http://www.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s541.html> Viewed on 5 May
2011.
Hudson, J., (1987), The age , regional, and Industrial structure of company liquidation, Vol
14, iss 2, pp 199-213
Keith, C., and Hudson, J., (1996), The determinants of compulsory liquidations in the U.K.
Journal. Vol. 64 Issue 3, p298, 11p
MetLife Guarantees, (2011), In a corporate liquidation, why are unpaid taxes and wages paid
before general creditors but after secured bondholders? (online) Available from
<http://www.investopedia.com/ask/answers/09/corporate-liquidation-unpaid-taxes-
wages.asp> Viewed on 5 May 2011.
Cases
In Deputy Commissioner of Taxation v De Simone Consulting Pty Ltd (2006) 24 ACLC 726
Re Presha Engineering (Aust) Pty Ltd (1983) 1 ACLC 675 at 677