In the given case, two people being the directors of the company have done certain acts. The issue of the case is to check whether these two have breached their duties as directors. If yes, what are the consequences of such a breach?
A company is an artificial person that can do all the business transactions and can enter into a contract with third parties similar to a natural person, but the same cannot think similar to a natural person. This is the reason that some people are there to work on behalf of the to carry the business activitiess. Such people are known as directors and officers of a company. Neither a director nor an officer can be held liable for the act of a company. As per the case of Salomon v A Salomon & Co Ltd [1896] UKHL 1, a company has a separate legal status from the directors and members.
To control the misuse of the separate legal entity principle, some of the provisions have been inserted in the law. In Australia, Corporations Act 2001 (Cth) is there which provides provisions related to various aspects of companies. Section 180 to 183 of the act states the general duties which every officer, as well as director of an Australian company, needs to consider while performing their jobs. Directors have a trustworthy relationship with the company and therefore the duties prescribed under aforementioned sections are also known as fiduciary duties.
Firstly, to discuss the section 180 of the act, this is to mention that the same requires every officer and director of the corporation to discharges their liabilities with a degree of care and diligence similar to a reasonable person. The position of a director is a very significant one and therefore the same is required to carry a level of care while acting on behalf of a company. Many of the times it has been seen that because of the separate legal status of the company, directors acts negligently and later on the company has to face some serious consequences. To prevent such issues, section 180 has been developed. Section 181 of the act says it is the obligation of every director and officer of the company to work for the best interest of the company in addition to doing the same for a proper purpose. Now the question, which needs to be answered, is the meaning of best interest. How the same will be defined? The duty has been consider as an objective factor in the case of ASIC v Adler [2002] NSWSC 171, and the same is deemed to be breached if no reasonable director has a reason to believe that the particular act is for the best interest of the organization. According to the decision of the case of Bailey v Mandala Private Hospital Pty Ltd (1987) 12 ACLR 641, conduct cannot be understood as in the best interest of the company where personal interests of the directors are involved. In addition to the best interest, the proper purpose is also equally important term as given in the case of Hogg v Cramphorn Ltd [1967] Ch 254. As per the facts and decision of the case of Howard Smith v Ampol Petroleum Ltd [1974] AC 821 and, an act cannot be treated purposeful only because directors find the same in the best interest of the company and to prove the same purposeful, there must be valid reasoning.
Section 183 of the act also define some limitations. According to the provisions of section 183 of the act, neither a director nor any officer of a corporation must use the available information in an inappropriate manner to develop the personal benefits or to cause detriment to his/her corporation (Ishak, 2018). In the case of ASIC v Adler, the director marked as liable to use the company information for the personal benefits. The discussed sections provide general duties, which a director and an officer need to keep in consideration while performing their duties.
In addition to these sections, some other sections are also there which provide the manner according to which such director and the officer must act in a specified situation. Section 588G is one of the examples of such section, which provide provisions related to insolvent trading. As per this section, a person is personally liable for the debt of a company if:-
The aforesaid points are some of the requirements that need to be fulfilled in order to make a person liable under section 588G of the act. It was held in the case of Metropolitan Fire Systems Ltd v Miller (1997) 23 ACSR 699, that to make a person liable under 588G, the court must review the financial condition of a company in overall. A person can only be held liable if there are enough reasons to believe about the insolvency of the company. To make a person liable under 588G, a there must be some reasonable grounds to suspect the insolvency on the part of the director. Section 588H provides some defenses to directors that they can use in against of an allegation made under section 588G. Section 588H (4) says that a director who did not take part in the affairs of the company at the time of trading because of illness, leave or any good reasons stated under section 195 of the act, cannot be held liable for the insolvent trading (Keay, 2007). The logic behind this section is an assumption that a director who was taking part in the company’s affairs cannot expect to be aware of the insolvent situation of the company.
While discussing the duties of directors, penalties are another aspect, which needs to be discussed. Corporations Act 2001 provides different penalties for breach of different sections. Many of the cases such as ASIC v Cassimatis (No 8) [2016] FCA 1023, Cassegrain v Gerard Cassegrain & Co Pty Ltd [2015] HCA 2, Diakyne Pty Limited v Ralph [2009] FCA 721; 72 ACSR 450 and many others have happened there, where directors have faced huge penalties to breach the provisions of corporations Act 2001.
If to start from general duties, this is to state that section 180-183 lead provisions of a civil penalty under section 1317J of the act. According to section 1317J (1), ASIC can make an application to the court of law for the declaration of the contravention. Further, it also has the power for applying for pecuniary penalty order. In addition to this, ASIC also has the power to obtain a disqualification order as per section 206C. This is to mention that section 185 of the company says that general duties mentioned under this act do not replace the common law, hence ASIC and company can apply for compensation order as per section 1317H in order to recover damages from the director on behalf of the company. According to section 184 of the act, criminal liabilities will be there in case of breach of the duty to act in the
Further, for breach of the provisions stated under section 588G, civil (1317E(1)) as well as criminal proceedings provisions are there. However, criminal proceedings can only initiate if such director proves to be dishonest. In conjunction with this, in cases of civil orders, court can order such director to pay damages in form of compensation to the company of the amount, that a creditor suffered with due to the insolvent status of the company (Australia, 2011).
In the given case, two of the directors of different companies are involved. Firstly, Lilian is a director of the company named All Mine Pty Ltd. Being a director Lilian was concerned about the requirements of computers in her company. In order to fulfill these requirements, Lilian has developed a contract with Gumpta, who is managing director of another company named Greedyas Pty. Ltd. The contract has done for a consideration worth $100,000.00. Now, this is to mention that Lilian has made this transaction on behalf of the company. As per the doctrine of a separate legal entity given in the case of Salomon v A Salomon, Lilian cannot be held personally liable for this transaction in general. Another party of the transaction i.e. Gumpta was aware of the poor financial condition of All Mine Pty Ltd, yet the same sold computers to this company irrespective of the bad financial situation in order to fulfill the sale target. The issue in the case arose when All Mine Pty Ltd became unable to make the payment of bill raised by Greedyas Pty. Ltd because of insolvency and went into liquidation. Here, both Lilian and Gumpta have breached their director duties. Applying the provisions of section 588G, Lilian will be held liable for the insolvent trading as being the director of the company, the same might have knowledge about the fact that company is going to be insolvent soon while incurring debt. All the requirements of section 588G are being fulfilled here. Irrespective of her attendance at board meetings, she will be held responsible. Further, she cannot take defense under section 588H (4) as no reasonable reason for her non-involvement in the affairs of the company is given. She has not taken any reasonable steps to check the financial condition of the company before entering a contract with a third party on behalf of the company. In this mode, she has also breached the duties under section 180 and 181 of the act. Applying the provisions of Bailey v Mandala Private Hospital Pty Ltd, the act of Lilian will not be understood in the best interest of the company because of her opinions only.
Gumpta on another side breached the duties stipulated under section 180 and 181 of the act. He was aware of the poor financial condition of All Mine Pty Ltd. and yet became ready to make a sale. He has not acted with the due care and diligence as was required under section 180 of the company. Further, the act of Gumpta was neither in the best interest of the company nor for the proper purpose. Because of this transaction, Greedyas Pty. Ltd faced the issue in the recovery of debts. In such a manner, Gumpta breached the duties under section 181 of the act too.
Further, this is to state that Gumpta being a director of Greedyas Pty. Ltd was aware with the prospective merger of this company with another one named as Cheap As Pty Ltd. Gumpta and Lilian were old friends and therefore Gumpta informed Lilian about the subjective merger. He advised Lilian to purchase the shares of Greedyas Pty Ltd in order to earn the profit out of the result of the merger of two companies. He also purchased some shares. Both Lilian and Gumpta earned a profit of $20,000.00 each of them. Here, Gumpta has breached the provisions of section 183 as he misused of the information of the company and used the same for his personal benefits. Applying the provisions of the case of ASIC v Adler, Gumpta will be held liable to generate personal profits using the company information in an inappropriate manner.
As Lilian and Gumpta have breached their duties, they will be held liable under different sections. Firstly, they both have breached the general duties mentioned under section 180 and 181 of the act and hence are liable for the civil penalties mentioned under section 1317J. Gumpta can also be liable for criminal proceedings as per section 184 of the act as he breached the provisions of section 181 and 183 knowing all the facts.
In addition to this, to breach the provisions of section 588G, Lilian will be held liable for civil as well as criminal proceedings. Further, the court can also giver her order to pay the debt of $100,000.00 which has incurred due to insolvent trading done by her.
Conclusion
To conclude the issue of the case, this is to be stated that both of the directors have breached their duties and not acted in the best interest of the companies. Lilian is liable for the insolvent trading and breach of general duties. Gumpta is liable for the breach of general duties only and will be penalized accordingly.
References
ASIC v Adler [2002] NSWSC 171
ASIC v Cassimatis (No 8) [2016] FCA 1023
Austlii. (2018) Corporations Act 2001 – Sect 588G. [online] Available from:https://www5.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s588g.html [Accessed on 29/12/2018]
Australia. (2011) Australian Corporations & Securities Legislation 2011: Corporations Act 2001, ASIC Act 2001, related regulations. Australia.: CCH Australia Limited.
Bailey v Mandala Private Hospital Pty Ltd (1987) 12 ACLR 641
Cassegrain v Gerard Cassegrain & Co Pty Ltd [2015] HCA 2
Corporations Act 2001 (Cth)
Diakyne Pty Limited v Ralph [2009] FCA 721; 72 ACSR 450
Hogg v Cramphorn Ltd [1967] Ch 254
Howard Smith v Ampol Petroleum Ltd [1974] AC 821
Ishak, R. (2018) Directors’ Duties. [online] Available from: https://www.williamroberts.com.au/News-and-Resources/News/Articles/Directors–Duties [Accessed on 29/12/2018]
Keay, A. (2007) Company Directors’ Responsibilities to Creditors. Oxon: Routledge.
Legislation.gov.au. (2018) Corporations Act 2001. [online] Available from: https://www.legislation.gov.au/Details/C2018C00424 [Accessed on 29/12/2018]
Metropolitan Fire Systems Ltd v Miller (1997) 23 ACSR 699
Salomon v A Salomon & Co Ltd [1896] UKHL 1
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