Insolvency Update December 2013 www.barrettwalker.com.au For more information please contact: Ray Barrett on (03) 9428 1033 DIRECTORS DUTIES AND POWERS WHEN A COMPANY IS IN LIQUIDATION A question that arises from time to time in the context of the winding up of companies is as to whether and to what extent do directors continue to owe duties to the company in liquidation? A follow-up question is, if the answer to that question is unsatisfactory or unclear, is there any need for reform. Summary Notwithstanding the fact directors are precluded from exercising their powers, upon the appointment of a liquidator during a court-ordered and voluntary winding up, they continue to be officers until the company is deregistered. This suggests that the directors remain under statutory and fiduciary duties. To therefore avoid breaching these continuing duties, directors cannot engage in certain conduct without first obtaining informed consent. Insolvency practitioners in a compulsory winding up are likely to be in a position to give this informed consent on behalf of the company. The situation is less clear with respect to a voluntary winding up and such consent may require approval by a properly informed and constituted meeting of the company s creditors and members, irrespective of the size of the transaction. The Legislative Framework Section 471A of the Corporations Act 2001 ( the Act ) provides: SECTION 471A POWERS OF OTHER OFFICERS SUSPENDED DURING WINDING UP 471A(1) [Winding up in insolvency or by Court] While a company is being wound up in insolvency or by the Court, a person cannot perform or exercise, and must not purport to perform or exercise, a function or power as an officer of the company. It should be noted that S471A sits in Chapter 5, Part 5.4B of the Act which is headed Winding Up In Insolvency or by Court In a voluntary winding up the relevant provisions are S495 (2) and 499 (4) which provide: 495(2) [Cessation of directors powers] On the appointment of a liquidator, all the powers of the directors cease except so far as the liquidator, or the company 1
in general meeting with the consent of the liquidator, approves the continuance of any of those powers. 499(4) [Cessation of directors powers] On the appointment of a liquidator, the powers of the directors cease except so far as the committee of inspection, or, if there is no such committee, the creditors, approve the continuance of any of those powers. Before turning to case law and other considerations, it is best to start with the language of the legislation and where particular provisions sit within the framework of the Act. As mentioned S471A sits within that part of the Act directed towards the regulation of winding up in insolvency or by the Court and in particular, sits in Div1A which is headed Effect of Winding Up Order. So clearly, S 471A is directed toward compulsory winding up being both insolvent and solvent (See Div 5.4A Applications winding up on other grounds). The Suspension of Powers S 471A directs itself to more than just the directors of the company. It provides that other than those persons authorised by S471A(1A) no person can perform or exercise a function or power as if that person was an officer of the company. In a sense it clears the decks and makes it clear who is in control. However, quite obviously the persons that the prohibition is most likely directed are the directors. Does the Office of Director Continue during Liquidation? Court-ordered liquidations Notwithstanding the suspension of director s powers 1, the Corporations Act makes it clear that this does not mean the officer is removed from their position. 2 Voluntary liquidations While s 471A expressly applies to compulsory winding ups there is no similar provision in Part 5.5 or 5.6 of Chapter 5 of the Act in similar terms to S471A nor is there any reference back to S471A in Part 5.5 or 5.6, so arguably S471A does not apply and so the precise language of S471A does not extend to voluntary liquidations. On appointment of a liquidator in a voluntary winding up, the powers of the directors cease except so far as the liquidator, the company in general meeting with the consent of the liquidator, or (in a creditor s voluntary liquidation) a committee of inspection approves the continuance of any of those powers.³ Interestingly, S499(4) does not include a proviso requiring the consent of the liquidator that is contained in S495(2). Arguably a committee of inspection and the creditors can 1 See Effect on company officers: s 471A Australian Company Law Commentary [146-040]. 2 Corporations Act 2001 (Cth) s 471A(3). 1 Corporations Act 2001 (Cth) ss 495(2) and 499(4). 3 See Corporate power and directors: ss 444A, 493, 495, 499, 4Australian Corporation Law Principles & Practice [5.5.0025]. 2
give back to the directors such lawful powers as the meeting decides. Notwithstanding there is no equivalent to S471A(1) or S471A(3) in Part 5.5 (Voluntary Winding Up). It is submitted that even though there is a cessation of director s powers (See S495(2) and S499(4)),the office of directors does continue after the appointment of a liquidator in a voluntary liquidation. This conclusion is supported on the basis of: The directors during both court-ordered and voluntary liquidations must comply with statutory obligations to assist the liquidator. 4 One example is S530A. If the office of directors did not continue during voluntary liquidations these provisions would be ineffective. There is no discernible reason why Parliament would intend to continue the office of directors in relation to court-ordered liquidations, but remove the office in relation to voluntary liquidations. Nothing in the EM and second reading speech for the Corporate Law Reform Act 1992 (Cth) which introduced s 471A indicates such a distinction. If Parliament did intend that the office of director not continue upon the appointment of a liquidator in a voluntary winding up why do ss 495(2) and 499(4) provide that members and creditors have authority to enliven the powers of directors. If the powers can be reinstated it pre-supposes that the office of director continues to exist. Prevailing Australian jurisprudence in this area of insolvency law prior to the introduction of s 471A did not distinguish between court-ordered and voluntary liquidations with respect to the continuation of the office of directors 6. Cases from other common law jurisdictions such as Measures Brothers Lt v Measures 7 and Attorney-General v Blumenthal 8 that held the office of director ends upon the appointment of a liquidator were disregarded by the NSW Supreme Court in Austral 9 as going further than the mainstream of authority. 10 However, it is important to note that all the cases dealing with s 471A that have been reviewed involve court-ordered liquidations, 11 leaving open the possibility that an Australian court could hold that the office of director does not continue once a company is in voluntary liquidation. Does the Continuation of the Office of Director imply the Continuation of their Duties? The question then becomes whether the continuation of the office of directors necessarily implies that a director continues to owe duties to the company? In other words, for what reason was s 471A(3) introduced if not to ensure the continuation of directors duties? 5 See Andrew Keay, Does the Office of Director Cease on the Advent of Voluntary Liquidation? (1998) 16 Company and Securities Law Journal 492, 492. 6 See, eg, Austral (1990) 21 NSWLR 389; McAusland (1993) 47 FCR 369, 379 (French J) ( McAusland ); Re Pollnow (1994) 12 ACLC 88. 7 [1910] 2 Ch 248. 8 [1961] 4 SA 313. 9 (1990) 21 NSWLR 389 ( Austral ). 10 Austral (1990) 21 NSWLR 389, 391 (Young J) 11 See, eg, Brolrik v Sambah [2001] NSWSC 1171; HPM Pty Ltd v Fear [2002] FCAFC 403; ASIC v Australian Investors Forum Pty Ltd [2002] NSWSC 130; Buckland Products Pty Ltd v DCT [2002] VSCA 85; Manton International Pty Ltd (in liq) v DCT [2006] FCAFC 76; Web Wealth Pty Ltd v Helimount Pty Ltd [2006] FCA 1376; Chalmers v Redwood Anti-Ageing Pty Ltd [2007] NSWSC 1186; Re Klaur Maertin Pty Ltd (in liq) [2009] NSWSC 618; Apostolou v VA Corporation Aust Pty Ltd [2010] FCA 64; Workers Compensation Nominal Insurer v Detailed Flooring Pty Ltd [2010] NSWSC 1056; Lollback v Brakepower Pty Ltd [2010] NSWSC 1457; Fisher v Divine Home Pty Ltd [2011] NSWSC 8; Binetter v DCT [2011] FCA 184; Re Golden Plantation Pty Ltd [2011] NSWSC 1610. 3
One potential reason other than the continuation of directors duties for introducing s 471A(3) is for a matter of practicality. That is, if a court where to stay a winding up order the director s powers could simply revest in the pre-winding up directors 12. In McAusland, French J noted that the continuation of the office: leaves open the possibility that a permanent stay or termination of the winding up may be ordered [which] militates against the unnecessary inconvenience of automatic vacation of the directors offices upon the making of the order 13. The continuation of duties thesis is favoured when the relevance of a directors statutory and fiduciary duties after the appointment of a liquidator are assessed. Continuation of statutory duties: In court-ordered and voluntary liquidations, obligations are imposed on the officers to assist the liquidator. The continuation of the office of directors ensures that these obligations can be effectively enforced. Cases such as Measures and Blumenthal link the removal from office with precluding the former director from being prosecuted under any of the statutory directors duties. To adopt the converse, this would suggest that the Australian cases supporting the continuation of the office are implying that it has the opposite effect the directors can be prosecuted for breach of the directors duties, notwithstanding that the company is in liquidation. Continuation of fiduciary duties: Canadian cases establish authority for the proposition that directors may contract with a company in liquidation without breaking their fiduciary duties 14 : can be explained merely on the basis that a company in liquidation is properly protected by an independent liquidator. This being so, there is no purpose in imposing on the former directors any fiduciary obligation when dealing with the liquidator, at least in such cases where they do not use inside information acquired before liquidation. These cases do not proceed on the basis that the directors have ceased to hold office. 15 Cohen J in Lord Corporation Pty Ltd v Green 16 which was decided before the introduction of s 471A but is still authoritative 17 remarked: The basis of a fiduciary duty which restricts the purchase of company's assets by directors and their sale at a profit arises because of the powers which directors have over the assets and actions of the company The powers of the directors having ceased, so too have their fiduciary powers, that is their capacity to misuse their position which arises from their having control over the company's actions and the dealing with its assets. 18 12 See Re Country Traders Distributors Ltd & The Companies Act [1974] 2 NSWLR 135, 139 (Mahoney J), cited in McAusland (1993) 47 FCR 369, 385 (French J). 13 McAusland (1993) 47 FCR 369, 385 (French J). 14 See, eg, Re Mabou Coal & Gypsum Co [1894] 27 NSR 305; Chatham National Bank v McKeen (1895) 24 SCR 348; Holmstead v Annable (1914) 18 DLR 3. 15 See Austral (1990) 21 NSWLR 389, 391 (Young J). 16( 1991) 22 NSWLR 532 ( Green ). 4
As such, a director who during the court-ordered liquidation of the company gained a profit for himself through the re-sale of part of the company s assets and used information and advantages gained in the course of his directorship for his personal benefit was held not to breach his fiduciary obligations because such obligations were non-existent. However, his honour then immediately went on to say: This is not to say that persons who were directors at the time of the winding up can take advantage, at the expense of the company, of knowledge or information obtained as a director before that liquidation. They would be in much the same position as a director who, after acquiring knowledge in that capacity, resigns as a director and makes a profit from a transaction by using that knowledge at the expense of the company. 19 These two statements are difficult to reconcile. Although his honour holds that the directors no longer owe fiduciary obligations to the company, they cannot engage in any conduct of the sort which would normally breach those fiduciary obligations. Moreover, Cohen J does seem to acknowledge that his finding may not be correct, remarking several times Even if there is some fiduciary duty retained by directors.. 20 What does this mean for directors and their advisors? Statutory duties While the duties not to misappropriate their position or information in ss 182-83 are worded broadly (must not improperly use their position... or information... ), the directors duty of care in s 180 and good faith in 181 are worded so as to only be enlivened upon the exercise of a power by the directors ( A director or other officer of a corporation must exercise their powers and discharge their duties... ). This means that while ss 182-83 are likely to remain relevant after a liquidator is appointed, the effect of the continuation of the duties with respect ss 180 and 181 may be minimal since, having had their powers suspended, the directors need the consent of the liquidator or the court or creditors or committee of inspection to engage in relevant conduct which ss 180 and 181 attempt to regulate. Such consent would be unlikely to be given where it may constitute a breach of these duties. Fiduciary duties If directors do continue to owe fiduciary obligations to the company in liquidation, in addition to consent from the liquidator or court or creditors or committee of inspection to act, directors will need to consider any additional steps that are required to avoid a breach of their fiduciary duties. 17 Effect on directors, Ford s Principles of Corporations Law [27.121]. 18 Green (1991) 22 NSWLR 532, 543 (Cohen J). 19 Green (1991) 22 NSWLR 532, 543-4 (Cohen J). 20 See Green (1991) 22 NSWLR 544, 545 (Cohen J). 5
What does this mean for insolvency practitioners and their advisors? Compulsory winding up On the balance of the authorities we can be confident that a liquidator in a compulsory winding up is in a position to give informed consent on behalf of the company in relation to transactions as between the company and its directors that would otherwise result in a director breaching their continuing duties. This is subject to particular provisions in the Act which specifically requires the approval of creditors or the court e.g. S477(2A) Compromises in excess of the statutory amount. Voluntary Winding Up The position in relation to the power of a liquidator in respect of voluntary winding up to give informed consent on behalf of the company is less clear. Although the respective provisions in the Act are structured differently, there is nothing to suggest insolvency practitioners should treat a members and creditors voluntary winding up differently. Arguably the existence of S 495(2) and 499 (4) of the Act tend to the view that directors can have an ongoing role and if that were the case, then how can informed consent be given in respect of dealings between the company in liquidation and those directors. In general terms such consent can only be obtained by all parties being fully advised of the particular circumstances and then giving consent. This would require approval of the transaction at a properly informed and constituted meeting of the creditors and members. Arguably this would be the case irrespective of the size of the transaction. It will be a challenge for the liquidator to put before a meeting of creditors and members in respect of a request for informed consent to a transaction that involves a director s use of position and knowledge (S182-183) in sufficient detail to exactly describe what the position / knowledge that is the property of the company as distinct from the inherent knowledge of the director. A further aspect is whether a former director or a director at the date of liquidation can be restrained by the company in liquidation from engaging in the same line of business as the company prior to its liquidation. Is the mere step of setting up of a new business by the director where there is no evidence of phoenix activity such that the mere use of corporate memory is a breach of S182-183 of the Act. Whilst it may be possible to establish the position and knowledge of the director, experience dictates that it will be difficult for the company in liquidation to establish a loss in circumstances where it has ceased to trade and the corporate memory would be boxed up with the company records. Going Forward We do not think there is a need of legislative reform as much as the need for a better understanding by practitioners and perhaps a consistent approach by the Courts. Perhaps if the position can be summarised in this way: 6
In respect of compulsory winding up: The legislature and the case law is clear that director s powers cease at the commencement of the winding up but their obligations and duties to the company continue. The liquidator in a compulsory winding up can give informed consent, subject to any specific provisions in the Act requiring the consent of creditors, committee or the Court. In respect of voluntary winding up: The position is that the director s powers cease but are subject to being enlivened by the liquidator, creditor or committee. The language used by the legislature is different. S495(2) is directed only to directors but reserves to the company in general meeting, with the consent of the liquidator, to give such powers as they may deem fit back to the directors. S499(4) is worded slightly differently in that the consent of the liquidator is not required to the granting of powers by a committee or creditors. That being said, in practice, it is difficult to see a liquidator not taking steps to prevent a delegation of power to a director that the liquidator deems not to be in the interests of creditors and/or members. Note: This Newsletter/Article has been written by Barrett Walker Lawyers with the research assistance of Bryden Dalitz, Law Student. Important: Clients should not act solely on the basis of the material contained in Client Alert. Items herein are general comments only and do not constitute or convey advice per se. Also changes in legislation may occur quickly. We therefore recommend that our formal advice be sought before acting in any of the areas. Client Alert is issued as a helpful guide to clients and for their private information. Therefore it should be regarded as confidential and not be made available to any person without our prior approval. 7