The Role and Responsibilities of De Facto and Shadow Directors by TurksLegal

The Role and Responsibilities of De Facto and Shadow Directors A PAPER BY PIETER OOMENS OCTOBER 2007

The Role and Responsibilites of De Facto and Shadow Directors by Pieter Oomens

The Role and Responsibilities of De Facto and Shadow Directors

Summary The sub-prime mortgage crisis underlies the volatility of economic conditions. If interest rates rise or credit becomes tight there will be a consequent increase in the number of liquidations. This will result in an increase in recovery actions by liquidators and creditors. An obvious potential target for a recovery action arising from the failure of a company is its directors. The Corporations Act gives an expansive meaning to the word “director” to embrace those whose names are not necessarily on the ASIC record of the company. This paper explores the concepts of de facto and shadow directors and distils the guidelines that have been developed by courts for determining if someone should fall into either category.

Who Does This Impact? The paper has obvious relevance for liquidators, administrators and large creditors. It sounds a warning for secured creditors, especially second tier lenders, who might just get too close to the action in trying to recover their advances.

What Action Should be Taken? In the case of liquidators, administrators and large creditors: go beyond the ASIC search. Who really made the decisions? Was there a stakeholder such as a secured creditor who ﬁgured prominently in the affairs of the company, especially as it was in terminal decline? In the case of secured creditors: do you have protocols to determine just how far your staff should go to ensure they don’t expose you to the risk of an allegation that you have acted as a de facto or shadow director? Are your staff trained to know when to be extra careful when monitoring a debt that is going very bad?

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The Role and Responsibilites of De Facto and Shadow Directors by Pieter Oomens

Contents:

Introduction

The Three Categories Of Director

The Importance To Creditors

De Facto Director

Case Study No.1 – Mistmorn

Case Study No.2 – Forkserve

Case Study No.3 – Austin 5

De Facto Director – Is There A Unifying Test?

Shadow Director – Meaning

Shadow Director – Case Study No.1 – Giant Resources

Shadow Director – Case Study No. 2 – Akai

Shadow Director – Is There A Unifying Test?

Application No. 1 – Insolvent Trading

Application No. 2 – Unreasonable Director-related Transaction

Application No. 3 – Unfair Preferences – Extending The Time Limit

Application No. 4 – Related Entity And Insolvent Transactions

Application No. 5 – Breach Of Director’s Duties

Conclusion

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The Role and Responsibilites of De Facto and Shadow Directors by Pieter Oomens

Introduction The recent sub-prime mortgage crisis has underscored the volatility of economic conditions. It takes little imagination to think of the ramifications if the availability of credit were to significantly contract or if interest rates were to rise. When negative economic pressures develop and especially if they combine with the problems that may afflict individual companies (eg poor management, a slowdown in cash receipts or the loss of a major contract) the number of liquidations naturally increases. If there is to be an increase in the number of liquidations, there will inevitably be increased focus by creditors and liquidators on the directors of failed companies. With this in mind it is timely to remember that a director is not simply the person who has his or her name so recorded at ASIC. Creditors and liquidators need to consider how cases have developed tests and guidelines for identifying directors whose names may not appear in ASIC records. The aim of this paper is to outline those tests and guidelines.

The Three Categories Of Director Section 9 of the Corporations Act, 20011 deﬁnes director as follows: (a)

a person who: (i) is appointed to the position of a director; or (ii) is appointed to the position of an alternate director and is acting in that capacity; (iii) regardless of the name that is given to their position; and

(b)

unless the contrary intention appears, a person who is not validly appointed director if: (i) they act in the position of a director; or (ii) the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes

Subparagraph (b)(ii) does not apply merely because the directors act on advice given by the person in the proper performance of functions attaching to the person’s professional capacity, or the person’s business relationship with the directors or the company or body. As a result, one looks to directors falling into the following categories: •

properly appointed directors;

•

de facto directors;

•

shadow directors.

The Importance To Creditors If it is the case that the deﬁnition of a director extends beyond referring to those whose names appear on ASIC records, why does that beneﬁt creditors (and those who represent their interests in liquidations namely, liquidators)? The simple fact is that directors are a potential target for recovery actions which may be brought by liquidators (and sometimes creditors directly). If the number of targets for recovery action in the case of a company expands then there is inevitably an increased likelihood of a return to creditors. Here are some examples

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The Role and Responsibilites of De Facto and Shadow Directors by Pieter Oomens

of why the expanded deﬁnition of “director” is important: •

Actions may be maintained against directors for the insolvent trading of their companies.

•

Actions may be brought against directors who obtained the beneﬁt of unreasonable director related transactions involving their companies.

•

The time zone for transactions which have the character of unfair preferences and which beneﬁt directors is greater than in the case of transactions with unrelated parties.

•

Recovery actions may be pursued against directors of companies which engaged in an insolvent transaction even though the transactions directly beneﬁted other persons.

•

Actions will lie against directors for breach of their duties to their companies.

Each of these examples will be examined in detail later in the paper.

De Facto Director The first example of the expanded definition of the term “director” is that of the de facto director namely, the person who is not validly appointed to be a director but who acts as a director. When does a person act as a director rather than say as a consultant to or a senior manager of a company? In some circumstances, the differences between the acts of a director and those of a person playing another significant role in relation to a company may seem subtle. Case studies will assist in determining the attitude of the courts and what types of conduct creditors and liquidators should look out for.

Case Study No.1 – Mistmorn

Mr Yaseen managed a duty free shop owned by Mistmorn Pty Limited. Mr Yaseen’s de facto spouse, Mrs Hamad, was the sole beneﬁcial shareholder of Mistmorn and was recorded at ASIC as a director. Although Mr Yaseen was not appointed a director of Mistmorn he was responsible for all the relevant decision making that related to the duty-free operations of Mistmorn. (Mistmorn had another business operation that was also run from the same premises. This other business was smaller than the duty-free business of Mistmorn). At issue was whether the acts of Mr Yaseen were sufﬁcient to allow the court to determine that he was de facto a director of Mistmorn. The judge noted the following acts as being of importance in his deliberations on this issue: •

A business card was printed which seems to have been the only business card ever printed with respect to the businesses of Mistmorn. The business card contained reference to the duty-free business on one side and the other business on the reverse. It contained the following to identify the cardholder: M Faour Yasseen Managing Director

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Mrs Hamad’s full name was “Maha Faour Hamad”. There was evidence that Mrs Hamad was variously referred to as “Mrs Yasseen”, “Maha Faour” and “Maha Hamad”. Yasseen’s ﬁrst name was “Michael”. The evidence showed that the business card was used by both Mrs Hamad and Mr Yasseen. The judge found that the letter “M” could equally refer to “Maha” or “Michael”. In the case of one of the people with whom Mr Yasseen dealt, that person’s organisation subsequently addressed a letter to “M Faour Yasseen” but used the salutation “Dear Michael”. •

The court found that Mr Yasseen had been the principal representative of the company in dealings with its landlord, its insurer, suppliers, legal advisors and regulatory authorities (in particular, the Customs Department). In those dealings, correspondence by some of these parties when dealing with the company was directed to “Mr Yasseen”, “Mr M Yassine Mistmorn P/L” and “Mr Michael Yassine”. The local council had ﬁle notes of dealings with Mr Yasseen in which he was referred to as the “proprietor” of the store. Mr Yasseen signed letters to several of these parties on behalf of the company over the name “Michael Yasseen” without showing any title attaching to him. Mr Yasseen was the person who engaged in face-to-face meetings with various of these parties.

•

The judge found that Mr Yasseen controlled the security of the company’s premises in that he had keys and access to the security codes used at the store and had at one time changed the code without informing Mrs Hamad.

•

Mr Yasseen was in charge of the printing of promotional material for the company and it was he who arranged for the local mayor to open the duty free business conducted by the company. In his speech, the mayor congratulated both “Michael” and “Maha”.

•

Mr Yasseen was the person who hired staff who worked at the company’s premises.

•

It was Mr Yasseen who negotiated the sale of the business of the company.

Mr Yasseen gave evidence that he acted only as a “consultant” to Mistmorn and Mrs Hamad. The judge said that his overall impression was that Mistmorn was run as a husband and wife company and that Mr Yasseen and Mrs Hamad were each involved in the day-to-day operations and business affairs of the company. The judge drew a distinction between a consultant and a director: the former is engaged to perform speciﬁc functions while the latter is engaged in the affairs of the corporation generally.3 In the result the judge determined that Mr Yasseen fell into the category of a director notwithstanding that he did not devote his attentions full time to the affairs of Mistmorn and regardless of the tiel he used for himself.

Case Study No.2 – Forkserve

Mr Jack faced a claim by his former employer, Forkserve Pty Limited. He was alleged to have made improper use of his position as a director of the company. Mr Jack was recorded at ASIC as a director of Forkserve. The plaintiff contended that the ASIC record constituted prima facie evidence that Mr Jack was a director. While this was true the presumption was capable of rebuttable if Mr Jack was able to show that he had never consented to be a director whether expressly or by necessary implication as a result of this conduct. The judge, referring to two previous cases, said: Thus as McLelland J stated in Hedges v NSW Harness Racing Club Limited (1991) 5ACSR 291 at 293, “The status of director of a company, which involved signiﬁcant statutory and ﬁduciary obligations, cannot be imposed on any person without his consent.” Hayne J A added

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in Knight v Bulic (1994) 13ACSR 553 at 560, “It may be accepted that no person may be appointed as a director unless that person consents to act. Although it may be prudent always to obtain evidence of that consent in writing, that is not required. The judge noted that neither party had produced to the court a written consent and thus the question emerged: did Mr Jack otherwise consent to becoming a director expressly or by necessary implication from his conduct? In other words, had Mr Jack acted as a director? The judge referred to a number of documents which had been executed by Mr Jack in the apparent capacity as a director. They were as follows: •

a contract for the purchase of the business conducted by Forkserve;

•

application for the provision of credit facilities by a potential supplier to Forkserve;.

•

a quotation for the provision of services by Forkserve;

•

a document for the use in legal proceedings to which Forkserve was a party; and

•

the director’s report for the year end accounts of Forkserve.

With respect to at least one of the documents, Mr Jack had himself added the description “director” in connection with is signature. Mr Jack gave evidence that he paid little attention to documents which he signed. The judge accepted that Mr Jack had never consented in writing to becoming a director of the company but that even if he did not expressly consent to act as a director, through his actions he represented himself to third parties as a director. The judge went on to say that even if Mr Jack had not given much thought to those actions, and even if he had signed the documents merely for convenience as he submitted in the trial, Mr Jack must have been aware that he was being represented to the recipients of those documents as a director as he did knowingly sign in that capacity. The judge concluded that Mr Jack’s position fell within the category of a de facto director.

Case Study No.3 – Austin

Austin’s case involved a claim by the Deputy Commissioner of Taxation6 for an indemnity against Mr Austin in his capacity as a director of Talljade Pty Limited. Talljade had been placed into liquidation and a claim had been made by its liquidator against the Deputy Commissioner for recovery of an unfair preference. Under section 588FGA the Commissioner is entitled to indemnity against directors of a company for amounts recovered from him as unfair preferences by a company’s liquidator. Mr Austin had been recorded as a director of Talljade but had resigned. Mr Austin’s resignation was to have been lodged with ASIC by the company’s accountant. The accountant overlooked this task. The Deputy Commissioner, in reliance on the ASIC records served Mr Austin with a notice under the Income Tax Assessment Act for the payment of a penalty equal to the company’s then outstanding group tax. Payments were made to the Deputy Commissioner by the company. The liquidator sued the Deputy Commissioner for recovery of an unfair preference equivalent to the amount so paid. The Deputy Commissioner cross-claimed against Mr Austin for recovery under section 588FGA. Mr Austin contended that he had resigned as a director and that as a consequence of the principle referred to in Forkserve the prima facie evidence of his directorship appearing on the ASIC record was rebutted by the fact of his resignation. He contended that he

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was thus relieved from having to indemnify the Deputy Commissioner. The Deputy Commissioner contended that Mr Austin had acted as a director – notwithstanding the purported resignation. The evidence showed that after his resignation, Mr Austin had undertaken a number of functions with respect to the company: •

Mr Austin negotiated on behalf of the company with the Deputy Commissioner and had made decisions to arrive at an agreement for repayment of outstanding tax plus penalties.

•

Following Mr Austin’s negotiations with the Deputy Commissioner an agreement was prepared between the Deputy Commissioner and the company. Mr Austin co-signed the agreement on behalf of the company with another person whose name was recorded as a director of the company at ASIC. The company seal was afﬁxed to the agreement. Mr Austin asserted that he had signed the agreement for repayment “as a private citizen”. The judge held that Mr Austin would certainly have understood that by signing the agreement he intended to bind the company to its terms and that he was suggesting that he was either a director or secretary of the company and that he knew that he had never been appointed secretary.

•

The judge considered it clear that Mr Austin had the authority to negotiate the agreement with the Deputy Commissioner on behalf of the company without first seeking the concurrence of the other person recorded as a director of the company. The judge noted the significance of the agreement as one which went to the very essence of the solvency of the company and with this in mind said: Mr Austin’s authority is something which, in the circumstances of this company, one would expect only of a person acting as a director or of a person specifically granted such authority by all those who might conceivably have been thought to be directors.

As to the second part of the quote, the judge noted that the other persons included the wives of Mr Austin and the other person recorded as a director. There was no evidence that those women had authorised Mr Austin to act in connection with the Deputy Commissioner which would be surprising unless in they were in no real sense directors. •

In addition to dealing with the Deputy Commissioner Mr Austin negotiated payment arrangements with trade creditors of the company.

•

Mr Austin countersigned company cheques payable to trade creditors and authorised a “stop notice” to the company’s bank to prevent payment of some of those cheques.

•

Mr Austin negotiated the sale of the business in respect of which the company incurred debts. Even if the company did not own that business the judge said: That is a matter of signiﬁcance for the nature of Mr Austin’s relationship with the company because of the use of the company to incur debts for the business and the use of company assets to meet those debts.

•

Mr Austin was the person who mainly dealt with the company’s accountant.

There was evidence that tragedies had befallen Mr Austin and his wife and the other couple who were involved in the company and the related business. Mr Austin submitted that having ceased to be a director he had continued to play a part in the company as a result of his sense of obligation as a friend and that he was not acting as a director as such.

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The Role and Responsibilites of De Facto and Shadow Directors by Pieter Oomens

The judge, in referring to the concept of a de facto director, noted the following: Thus it seems to be a necessary condition of acting as a director, whether properly appointed or not, that one exercises what might be called the actual (and statutorily extended) top level of management functions. However, that is not necessarily a sufficient condition for such a conclusion, nor is it the same as saying that one must do things that only a director can do… If, in the case of a small company, a person has, with full discretion, “acted as the company” in relation to matters of great importance to the company, and other than as an arm’s length expert engaged for a limited purpose, the conclusion that that person has acted in the capacity of a director may well be justified. The extent to which and the circumstances in which the person has so acted will nevertheless be of importance. The variety of commercial and corporate life is such that it seems to me unprofitable to attempt a general statement as to what is meant by “acting as a director”. Whether a person does so act will often be a question of degree, and requires a consideration of the duties performed by that person in the context of the operations and circumstances of the particular company concerned. The judge accepted that although there was some irregularity in the process of notifying ASIC which was beyond his control, Mr Austin had, in effect, formally resigned. However, the judge held that there was objective evidence to contradict Mr Austin’s assertions that he was not acting as a director. The judge did not accept that Mr Austin was acting in circumstances of emergency or as a friend of those legally bound to run the company so as to put him beyond the reach of what is defined to be a director. The judge noted that the length of time Mr Austin so acted put the matter beyond the realm where it could be said that, because of an informal act of assistance, he was not “occupying or acting in the position of” a director. The judge also noted the variety of actions undertaken by Mr Austin and said that because of the breadth of those activities undertaken by him on behalf of the company, it could not be said that he was merely a specialist aide or consultant.

De Facto Director – Is There A Unifying Test? As stated in Austin, there is no general test to determine if a person is a de facto director. In determining whether a person so acted will often be a question of degree requiring a consideration of the duties performed by that person in the context of the operations and circumstances of the company. Even if there is no general test to determine whether a person has acted as a director, a useful question to ask is “Does the person control or share control over the general conduct of the affairs of the company?” In considering that question and the activities which might support the contention that the person acted as a director, it is helpful to remember that judges have characterised those found to have acted as directors as being “the driving force”7 of the company and exercising “top level management functions”.8

Shadow Director – Meaning The general proposition is that if a person is a shadow director then that person will be one, in accordance with whose instructions or wishes, the directors are accustomed to act. It is important to note that this general proposition refers to the shadow director on one hand and the directors on the other hand, being the persons who do the bidding of the shadow director.

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The statutory deﬁnition has two exceptions to that general proposition: •

The person who, in the proper performance or functions attaching to that persons professional capacity, provides advice to the directors who in turn act on that advice; and

•

A person who has a business relationship with the directors or the company and provides advice upon which the directors act.

An example of the former is the accountant engaged by the company to provide advice. An example of the latter relationship is the case of the company and its bank.9 Note that it is the giving of advice which may be protected.

Shadow Director – Case Study No.1 – Giant Resources

Giant Resources is one of the earliest and perhaps the most important of the cases in Australia dealing with the concept of the shadow director. The target for attack was another company (Pioneer). Three persons who had been nominated by Pioneer were appointed to the board of Giant Resources. It was alleged by a creditor of Giant Resources that Giant Resources had traded whilst insolvent and as a consequence an action was maintainable by that creditor against the three persons who acted as directors and against Pioneer as a shadow director of Giant Resources. Pioneer was not the holding company of Giant Resources but it had effective control of the company. It had this by virtue of its 42% shareholding, where there were only four other significant share holders who each held between 3% and 10% of the shares. Pioneer imposed on Giant Resources requirements for financial reporting which were consistent with the financial reporting required for companies within the Pioneer Group. These requirements included the actual forms to be used when reporting. Moreover, Pioneer had full access to all of Giant Resources’ financial records. Pioneer delayed a sale transaction involving Giant Resources even though the ultimate proceeds of that sale, which were for the benefit of Giant Resources were substantially reduced. Major strategic decisions involving Giant Resources were effectively taken by Pioneer. For example, mineral assets of Pioneer were to be acquired by Giant Resources with finance to be obtained externally. Pioneer, through its representatives, negotiated with the financiers and it was the Pioneer board who received the proposal from those financiers. The Pioneer board authorised a committee to approve the terms on which the asset sale could go ahead and it was more than two weeks thereafter that the Giant Resources board resolved in principle to acquire those assets. Subsequently a decision was made not to proceed further with the acquisition and the recommendation for that decision went to the board of Pioneer, not Giant Resources. It was Pioneer that resolved that it was not in the best interests of either company to proceed, thereby apparently making a decision not only as to what was in Pioneer’s interests but also what were the interests of Giant Resources. There was no further consideration of the matter by the Giant Resources board. The judge found that in these circumstances it was Pioneer who was really developing and ultimately abandoning the transaction on behalf of both parties. The Pioneer board made a decision to make funds available to Giant Resources on the condition that Giant Resources instructed outside consultants. Pioneer was closely involved in the briefing of those consultants and its representative made the decision as to the identity of those consultants. The brief of those consultants was discussed at a meeting in Pioneer’s office attended by Pioneer’s representative who in turn reported to Pioneer’s directors that he had instructed the executive general manager of Giant Resources to make all information available to the consultants. The decision to fund Giant Resources and the basis of security to be provided by Giant Resources was effectively made by Pioneer and

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simply accepted by Giant Resources. The negotiations with the ﬁnanciers was attended to by Pioneer’s representatives. It was Pioneer who resolved the terms of the facility. The three nominated directors of Pioneer gave evidence that they recognised their duty as directors of Giant Resources to act in the interests of all Giant Resources shareholders. The judge, however, held that having carefully considered, in their capacity as directors of Pioneer, the strategic decisions concerning the affairs of Giant Resources; they had not given any separate consideration to these matters in their capacity as directors of Giant Resources. In the judge’s view, the directors of Giant Resources, including the Pioneer nominee directors, simply accepted the decisions which had effectively been made by Pioneer.

Shadow Director – Case Study No. 2 – Akai

The Akai group of companies entered into financial difficulties. The group’s parent (Akai Holdings) came to an arrangement with Grande Holdings Limited (“Grande Holdings”) for the latter to provide a rescue package or acquire the Akai brand. As part of the deal a company within the Grande group – Grande Group Limited (“GGL”) – agreed to take over the management of the business of Akai Holdings and its subsidiaries, including Akai Australia. Mr Ho was the chief executive officer of Grande Holdings and had indirect control of 75% of the shares in the company. At issue was whether Grande Holdings and Mr Ho were (arguably) shadow directors of Akai: the case concerned an interlocutory application to set aside the application for relief against Mr Ho, GGL and Grande Holdings in respect of alleged insolvent trading. Because it was an interlocutory application the only issue before the court was whether the liquidator of Akai Holdings had established a prima facie case for relief. Given that the application was an interlocutory one, the amount of evidence before the court was not as great as would be the case in the event of a final hearing – there having been no discovery and the affidavit evidence being incomplete. It was held at first instance and on appeal that there was ample evidence, if accepted, to establish that the directors Akai Australia acted upon the instructions from the senior management members of the Grande group which had at its corporate apex, Grande Holdings. The next issue concerned Mr Ho and, to the extent there was evidence of his having given instructions, he was doing so in an individual capacity or as chief executive of Grande Holdings. One of the Grande Holdings directors who had given instructions to Akai Australia acted on the instructions of and reported to Mr Ho in connection with the affairs of Akai Australia. Mr Ho had appointed an officer to the management group with responsibility for Akai Australia and explained to him his responsibilities. That officer reported to Mr Ho monthly at operational meetings. Mr Ho had a direct and controlling involvement in decision making relating to two transactions concerning the possible acquisition of the Akai brand in Australia. Mr Ho was also effectively in charge of negotiations concerning the refinancing and restructuring of the whole Akai group, including Akai Australia. The Full Court of the Federal Court noted that the purpose of the definition of director in section 9 is to identify those persons, other than professional advisors, who have real influence in, or indeed control of, the corporate affairs of a company. The court also noted that it is not necessary that such influence or control should be exercised over the whole field of the company’s activities.12 Further, the influence or control exercised by a shadow director may be strategic in character, defining the context in which, or conditions upon which, the company operates, or else contriving the transactions of significance of the company.13 The court found that the evidence was not suggestive of Mr Ho having been involved in Akai Australia’s day-to-day management. However, the evidence lent support to the possible inference that his involvement in the company’s affairs was of a strategic character in relation both to its affairs and to the company’s participation and place in the rescue package involving the Grande Group and the Akai group.

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The court concluded that there was an arguable case that Mr Ho was a shadow director. Further, there was insufﬁcient evidence to show that he was merely acting as an agent of Grande Holdings.

Shadow Director – Is There A Unifying Test? While there may not be a unifying test, the Federal Court in Akai has helpfully surveyed the law and shows us that in determining whether a person is a shadow director the primary issue to consider is the existence of a real inﬂuence or control of the corporate affairs of the company. That inﬂuence does not have to extend to every aspect of those affairs.

Application No. 1 – Insolvent Trading If a director fails to prevent a company from incurring a debt at the time it is insolvent then that person contravenes the Corporations Act: section 588G. By the application of section 588M the liquidator of the company or a creditor of the company may recover from the director an amount equal to the amount of loss or damage occasioned as a result of the contravention. To prove a claim for insolvent trading the plaintiff must show that the person in question was a director at the time the company incurred the debt: that the company was insolvent at that time or became insolvent as a result of incurring the debt; and that at the time there were reasonable grounds for suspecting insolvency or that the company would become insolvent.

Application No. 2 – Unreasonable Director-related Transaction Pursuant to section 588FDA a transaction of a company is an unreasonable director-related transaction of the company if and only if: (a)

the transaction is: (i) a payment made by the company; or (ii) a conveyance, transfer or other disposition by the company of property of the company; or (iii) the issue of securities by the company; or (iv) the incurring by the company of an obligation to make such a payment, disposition or issue; and

(b)

the payment, disposition or issue is, or is to be, made to: (i) a director of the company; or (ii) a close associate of a director of the company; or (iii) a person on behalf of, or for the beneﬁt of, a person mentioned in subparagraph (a) or (b); and

(c)

it may be expected that a reasonable person in the company’s circumstances would not have entered into the transaction, having regard to: (i) the beneﬁts (if any) to the company of entering into the transaction; and (ii) the detriment to the company of entering into the transaction; and (iii) the respective beneﬁts to other parties to the transaction of entering into to; and (iv) any other relevant matter.

The obligation referred to in subparagraph (a)(iv) may be contingent obligation. A close associate of a director means a relative or de facto spouse of a director and a relative of a spouse or de facto spouse of a director.

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If an unreasonable director-related transaction has occurred and it was entered into or an act was done for the purpose of giving effect to it during the four years ending on the relation-back day14, or after that day but on or before the day when the winding up began, then the transaction is voidable: section 588FE(6)A. If a voidable transaction occurs then amongst other things the court may make an order directing a person to pay the company an amount equal to some or all of the money that the company has paid under the transaction: section 588FF(1)(a)

Application No. 3 – Unfair Preferences – Extending The Time Limit Most claims for recovery of unfair preferences concern dealings by the company with unrelated parties such as trade creditors, financiers and statutory bodies. In such circumstances the transaction is voidable if it was entered into or an act was done for the purpose of giving effect to it during the six months ending on the relation back day; or after that day but before the day when the winding up began: section 588FE(2). If a transaction has occurred which may be characterised as an unfair preference and the person obtaining the benefit of the transaction was a related entity of the company then the time zone extends back four years ending on the relation back day: section 588FE(4). A related entity is defined in section 9 to include the following: •

A director of a company or of a related company;

•

A relative, or de facto spouse, of such director; and

•

A relative of a spouse, or of a de facto spouse, of such a director.

Application No. 4 – Related Entity And Insolvent Transactions The term “insolvent transaction” refers to an unfair preference or an uncommercial transaction of a company which was insolvent at the time of the transaction or became insolvent as a result of the transaction: section 588FC. When a company has entered into an insolvent transaction which is voidable (that is, it occurred during the relevant time zone referred to in section 588FE) and had the effect of discharging, to the extent of a particular amount, a liability (whether under a guarantee or otherwise or whether contingent or otherwise) of a related entity of the company, the liquidator may recover from the related entity, as a debt due to the company, an amount equal to the amount of the discharge of the related entity’s liability. Assume, for example, that a company owed a debt to a trade creditor and within the six months before a summons was presented for the winding up of the company, a payment was made to that trade creditor. Assume also that, at all material times, the trade creditor had the beneﬁt of a personal guarantee by a director of the company. The payment to the trade creditor naturally had the effect of reducing the amount for which the director was liable to pay under the guarantee. In these circumstances the liquidator could look not only to the trade creditor for the recovery of the unfair preference but also to the director because of the beneﬁt the director obtained as a result of the unfair preference.

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Application No. 5 – Breach Of Director’s Duties Both at general law and under the Corporations Act, directors are charged with duties to the company. These duties include the obligations to: •

Exercise duties of director with reasonable care and diligence: section 180;

•

Act in good faith in the best interests of the corporation and for a proper purpose: section 181;

•

Not improperly use the position as director to gain an advantage for the director or someone else or cause detriment to the company;

•

Not to make improper use of information to gain advantage for the director or someone else or cause detriment to the company: section 183.

Conclusion After such a lengthy period of economic prosperity there seems little doubt that there will be an increase in the number of liquidations. The only question is, when? Creditors and liquidators should be aware of the expanded concept of “director”. Assisted by the statutory deﬁnition and its interpretation by the courts, it is inevitable that there will be an increase in the number of recovery claims arising out of liquidations.

Endnotes 1

Unless otherwise indicated all section references will be to this Act. Mistmorn Pty Limited (In Liquidation) v Yasseen 14 ACLC 1387 3 Australian Securities Commission v AS Nominees Limited 1995 133 ALR1; Standard Chartered Bank of Australia Limited v Antico [1995] 131 ALR 4 Forkserve Pty Limited v Jack [2000] NSW SC 1064 5 Deputy Commissioner of Taxation v Austin [1998] 28 ACSR 565 6 Although in the proceedings the Deputy Commissioner was named as the party it should have been the Commissioner – see s 588FGA. 7 Emanuel Management Pty Limited v Foster’s Brewing Group Limited [2003] QSC 205 8 Austin; Natcomp Technology Australia Pty Limited v Graiche [2001] NSW CA 120 9 See RP Austin, Hip-pocket injuries in workouts, (2007) 15 Insolv LJ 6 10 Standard Chartered Bank of Australia Ltd v Antico [1995] 38 NSW NLR 290 11 Ho v Akai Pty Limited (In Liquidation) [2006] FCAFC 159, 24 ACLC 1526 12 Secretary of State for Trade and Industry v Deverell [2001] Ch 340 13 Australian Securities Commission v AS Nominees Limited [1995] 133 ALR1 14 For example, in the case of a company not already the subject of administration under Part 5.3A, the relation-back day will be date of the commencement of the winding up proceedings which gave rise to the appointment of the liquidator. 2

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The Role and Responsibilites of De Facto and Shadow Directors by Pieter Oomens

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