Do directors owe duties to creditors?

Professor Bob Baxt believes the question of whether a court can order damages against a director in favour of creditors or others needs to be clarified following a recent decision.

It is useful to set out the actual terms of section 1324(10) of the Corporations Act 2001 to help readers appreciate the thrust of this article. The language of this section is critical in evaluating what a court might do in relevant circumstances.

The section states: "Where the court has power … to grant an injunction restraining a person [in particular a director] from engaging in particular conduct [that might amount to a breach of the Act], the court may, either in addition to or in substitution for the grant of the injunction, order that person to pay damages to any other person."

In reversing the decision of Justice Cullinane in Phoenix Constructions Pty Ltd v Coastline Properties Pty Ltd [2011] QSC 167, the Queensland Court of Appeal relied on the judgment of Justice Perry in the much earlier South Australia Supreme Court decision in Executor Trustee Australia Limited & ANOR v Deloitte Haskins and Sells ( (1996) 135 FLR 314 decided under the predecessor to the current Corporations Act).

In obiter dicta in the New South Wales Court of Appeal just recently, Justice Bathurst suggested that a remedy in damages under section 1324(10) was available, although he also suggested that damages could only be awarded if the parties were seeking injunctive relief as well (see Dungowan Manly Pty Ltd v McLaughlin [2012] NSWCA 180). Even that interpretation is subject to debate and contrary views in a number of parallel decisions decided over the years.

When section 1324(10) of the Corporations Act (in its earlier form) was introduced into Federal Parliament (it appeared as section 574 of what was in effect the uniform Corporations legislation), the Minister responsible for the legislation, John Moore, made it clear that a court, in considering an application for relief against a director of a company for a breach of statutory duty, would be able to award an injunction (or such other orders) to prevent the company and the director from committing the relevant "misdeed". He also made it clear that where the court felt it appropriate, it could, instead of or in addition to the injunction (or other order), award damages. The language of section 1324(10) is, in my view, absolutely clear on its face.

However, in a critical decision in McCracken v Phoenix Constructions (Qld) Pty Ltd [2012] QCA 129, the Queensland Court of Appeal has unanimously ruled that in fact, at least on the facts in this case, the court could not award damages to Phoenix Construction, a creditor of the company, against McCracken, the sole director of the Coastline Constructions.

Coastline Constructions had gone into liquidation and Phoenix argued that as McCracken had breached his duty under section 182(1) of the Corporations Act (he had arguably used his position to gain an advantage for himself at the expense of the company), such an order was possible. Not only could the court order an injunction or a declaration, but it could also award damages against McCracken.

Justice Cullinane, at first instance in the Queensland Supreme Court, held that Phoenix had established its case that a breach of duty had occurred and that damages of $1,230,614.79 should be awarded against McCracken.

McCracken and his colleagues argued that the trial judge’s decision was wrong on a number of points. In the first place, they argued he was wrong to rule that a breach of duty had occurred and that this was not supported by the facts. More importantly for directors, McCracken argued that the court had no discretion to award damages notwithstanding the language of section 1324(10).

In what was a surprising decision in my view, the Queensland Court of Appeal accepted the argument that damages could not be awarded against McCracken.

It was the court’s view that the way in which the Corporations Act had been structured – with the regulator, the Australian Securities and Investments Commission (ASIC), being given the primary task of ensuring that the Act was complied with – if there were breaches by directors, that organisation should pursue those directors. It was not possible for a court to award damages where there was a breach of a statutory duty – the only remedy was one that could be sought by ASIC.

In essence, the Court of Appeal (without referring to this particular proposition) was confirming a commonly held view by lawyers and judges more generally that directors of a company owed their duty to the company – the shareholders – and not to any other person.

However, with respect to the Queensland Court of Appeal, and in recognition of the growing body of jurisprudence, it is indeed a foolish director (and indeed, one may argue, a court) that does not recognise the development of the law in this context.

To ignore the focus that is being put, not only by our courts, but by our parliaments, in drafting legislation dealing with the duties of directors on the growing range of responsibilities they must observe may lead to a clear case for the High Court of Australia to adjudicate.

Whether this is a good thing or not is another matter. Clearly it would be preferable if the law was clarified once and for all either by a High Court decision of substance on this specific issue, or by specific legislation.

However, policy developments are moving in a different direction. The existence of bodies such as the Australian Securities Exchange’s Corporate Governance Council (which highlights the importance of directors taking into account a range of interests in carrying out their obligations), and the emphasis in legislation point to changing perspectives.
 The Corporations Act indicates that the annual reports of directors must spell out in detail the way in which interests, such as the environment and those of employees, are addressed. Other legislation also highlights the preference to be given to certain interest groups in the context of insolvency or near insolvency. These make it very difficult to ignore the proposition recognised by many judges in recent cases – that in assessing the behaviour and actions of directors, one cannot ignore the facts surrounding other interests, including creditors.

If we did not have in our statute section 1324(10), the words of which are set out at the beginning of this article, the proposition supported by the Queensland Court of Appeal in this case would have been far easier to support.

But in the face of such direct language, and an increasing number of cases in which the courts continue to recognise that where directors breach a statutory duty, and the court considers what remedies are to be made in an application by any person whose interests are affected (and the courts have given that expression the very widest interpretation), one cannot ignore the fact that a remedy in damages might be available at the discretion of the court.

It is a matter for each court and one which will be driven by the facts of the case. There is no reason why any court cannot deny a remedy if in its discretion it believes it is not appropriate to do so. But to deny the fact that such a power exists on the face of the statute in a large number of cases strongly supports clarification from the Parliament or more likely, in an appropriate case, a decision of the High Court of Australia.

The McCracken case is not one that merits, in my view, an appeal to the High Court. The facts and the issues addressed are probably too narrow and the Court of Appeal had all the relevant evidence available to it to decide that the actual claim (alleging a breach of duty) had not been established. That is probably the end of the matter in my view. But the jurisprudential question – could the court award damages once the facts are established – is a matter of great significance affecting company directors throughout Australia.

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