The directors’ balancing act

  • Date:01 Nov 2012
  • Type:Company Director Magazine
Professor Bob Baxt reviews a recent court case that examines whether directors owe duties to creditors when insolvency looms.


The decision of the specially constituted Western Australian Court of Appeal in Westpac Banking Corporation v The Bell Group (in liq) [No. 3] [2012] WASC, delivered in mid- August 2012, regrettably does not provide clear guidance for directors of companies, especially larger ones, on the parameters of their obligations. In particular, it does not shed clear light on whose interests directors must consider, especially when "things get tough".

When it is said they owe a duty to the company, does this mean the company in its traditional sense – the shareholders (or members) – or is there a broader group of people to whom duties may be said to be "owed" or whose interests the directors must consider in the context of the situation they face?

The Western Australian Court of Appeal comprised Acting Justices Lee, Drummond, and Carr, all appointed because of conflicts affecting current members of that court.

They "ruled" by a 2:1 majority that by salvaging its financial position with various institutions and trying to avoid it from going into insolvency, the directors of the Bell Group of companies had (regrettably) not acted with the appropriate set of obligations in mind.

The arrangements gave preferential treatment to the relevant banks over other creditors.

These financial arrangements did not, unfortunately, save the Bell Group from being wound up. The liquidator brought proceedings against the directors of the relevant companies in the Bell Group as well as the banks, seeking a range of orders. These included claims that the restructured financial arrangements gave preferential treatment to the banks to the extent that the directors were knowingly involved in these arrangements. In providing securities to the banks in support of these arrangements, the directors were in breach of their duty to act bona fide in the best interests of the company; and in exercising their powers for proper purposes.

The decision covered a range of other issues, including many technical legal issues, which we do not need to discuss here.

The key question in respect of which the majority of the Court of Appeal upheld the decision of Justice Owen, at first instance, in The Bell Group Limited (in liq) v Westpac Banking Corporation [No. 9] [2008] WAASC 239 was whether the directors had breached their duty in prioritising the claims of the banks over the interests of creditors generally.

The judgments are quite lengthy (and they cover other important legal issues).

Acting Justice Drummond delivered the major judgment on behalf of Acting Justice Lee and himself in evaluating the duties of the directors. Acting Justice Carr disagreed with the approach taken by Acting Justices Drummond and Lee.

Both Acting Justices Drummond and Carr canvassed some of the history of how the common law duties being considered arose – whether the directors were acting in the best interests of the company and/or whether they were exercising their powers in an appropriate fashion.

No claims were made in relation to breaches of the Corporations Act 2001. Had such claims been raised, this could have telescoped the judgment into a further area of controversy – whether the Act provides any answer to the question of whether directors owe duties to creditors in certain scenarios. I will only deal in passing with this additional question at the end of this note.

At the heart of his original decision Justice Owen relied heavily on the warning given by Justice Mason (as he then was) in the 1976 decision of the High Court of Australia in Walker v Wimbourne (1976) (173 CLR1). Justice Mason had "warned" directors that if they did not take into account the interests of creditors when a company whose affairs they were trying to organise was close to insolvency, they did so at their "peril".

That view had been endorsed in a number of later decisions. In the opinion of Justice Owen, endorsed by Acting Justice Drummond, directors, in considering the interests of creditors in a scenario where insolvency was "knocking at the door", were not supplanting the interests of the shareholders. They were in fact properly incorporating a broader range of interests in evaluating those duties.

Acting Justice Drummond held that recent developments in the law in Australia, and the UK in particular, supported his view that there was a broader obligation owed by directors in these circumstances.

He stated that courts would not take at face value what directors said they had to do in the context of carrying out their obligations. Courts would look beyond the bold statement made by directors that they must act in the best interests of the company.

As Acting Justice Drummond noted, other courts were inclined more and more to intervene in company affairs in evaluating the duties of directors. He stated that central to "the development of the principle that directors in discharging their fiduciary duties to their company must, if the company is sufficiently financially distressed, have regard to the proper effects to the interests of creditors".

The deference shown by courts until relatively recently to directors who honestly believed they were acting in the interests of the company allowed directors to ignore such interests.

However, courts will now intervene in an appropriate case, irrespective of the directors’ free beliefs and business judgments, to ensure creditors are properly protected.

Acting Justice Drummond added that developments in recent decades illustrated that directors who ran large public companies in particular needed to "take into account a wide range of interests in addition to that of shareholders in order to better advance the company’s business".

He referred to recent changes to the Companies Act requiring directors of a company, in acting in the way they consider to be most likely to promote the success of the company for the benefit of its members as a whole, to have regard, not only to the interests of creditors, but also to various other interests, including those of the company’s employees, suppliers, customers and the effect of the company’s operations on the community and the environment (see Bell Group at [2049]).

Acting Justice Drummond concluded his analysis by suggesting it was inappropriate to assess whether the directors were acting in the best interests of the company by looking purely at the way directors approached the matter. Rather, they should be looked on objectively.

In contrast to his observations (and those of his brother, Acting Justice Lee), Acting Justice Carr adopted a more traditional approach in evaluating the duties of directors. He noted, and we do need to be reminded of this from time to time, that directors are expected to act with an entrepreneurial "spirit".

Acting Justice Carr differentiated between the position of directors and trustees (both of whom occupy fiduciary positions) with these words: "Directors are not trustees; they are entrepreneurs and the general law gives them considerable leeway in the conduct of a company’s affairs [referring to Mills v Mills, an important judgment of Justice Dixon (1938) 60 CLR 150 at 185-186]. They are thus given encouragement to exercise, rather than stifle, their entrepreneurial skills when they act honestly and not irrationally. Otherwise, company directors might, in circumstances such as the present matter, feel constrained to take a safe and easy option of putting into liquidation companies that had a chance of trading out of their financial difficulties. At the relevant time, alternatives to liquidation were very limited" (Bell Group at [2797]).

Acting Justice Carr also applauded the approach taken by Justice Ipp (as he then was) in Vrisakis v Australian Securities Commission (1989) 9 WAR 395 when he also embraced the need for an entrepreneurial approach to be allowed to directors.

It is important to emphasise that in drawing the distinction between taking into account the interests of creditors and being required actively to protect them, Justice Carr pointed to the clear line of demarcation recognised by the High Court of Australia in Spies v R [2000] HCA 43.

By emphasising that such interest should be taken account of by directors, in the absence of "such a right [being created] by statute, [the law does not confer upon creditors any … general right] against former directors of the company to recover losses suffered by its creditors" (see para 2818).

It was quite clear that the directors were trying to save the very substantial assets of the Bell Group from being frittered away in an insolvency scenario. It was important that they were given an opportunity to try to save the company.

Furthermore, Acting Justice Carr felt there was no breach of duty simply because the directors considered the interests of the individual companies in the group rather than the group as a whole. This is in contrast, of course, to the views taken by Justice Mason in Walker v Wimborne, where he suggested that it would be inappropriate for the group of companies to be put ahead of the interest of the individual companies within the group.

Conclusions

Although the majority of the Court of Appeal ruled that there had been a breach of duty in this particular context, they did so against the framework, which suggested the judges were placing greater emphasis on different sets of facts.

What is not considered in the judgment is the fact that the Corporations Act in section 1324 provides that, in certain circumstances, creditors have a legal right to seek remedies against directors who breach their statutory duties. At some stage, it would be appropriate for this question to be taken to the High Court of Australia so that we can have ruling once and for all as to just how far directors’ obligations go.

One can note, as Acting Justice Drummond did in his judgment and as set out above, that a fine balance needs to be struck between requiring directors to balance the interests of stakeholders generally and to give special attention to others. That balancing act must be within the parameters of their duty to act in the interests of the company which, in my view, means the members as a whole.

The banks and the directors have sought special leave to appeal the decision to the High Court of Australia. A decision from this court is essential to provide some clarification, or we may need it from the Parliament on the issues raised in this case.

Professor Bob Baxt AO FAICDLife is an emeritus partner of Freehills, chairman of the Australian Institute of Company Directors’ Law Committee and author of the 20th edition of Duties and Responsibilities of Directors and Officers