Directors of subsidiary companies take heart - not only is the Corporations Law on your side but the judges are as well.
The proposition that directors of wholly-owned subsidiaries can take into account the interests of their holding company without running the risk of breaching their duties has now been accepted as part of our general law. This important decision by the South Australian Full Supreme Court comes at a time when the Corporations Law has been amended to include section 187 which has a similar effect. In Pascoe Ltd (in liquidation) v Lucas ((1999) 33 ACSR 357) the earlier decision of Debelle J ((1998) 16 ACLC 1247) has been confirmed by the South Australian Full Court. In this judgment a number of important things are discussed by Justice Lander who gave a judgment on behalf of the Full Court. Because the facts are slightly unusual, issues which are not unlike those that may arise in other similar company set-ups, we set them out in some detail from the headnote of the case published in Butterworths Law Reports. The appellant, Pascoe Ltd (P), was incorporated in the Cook Islands on 15 November 1988. The respondent, Lucas (L), was a director of P (indeed the main director) from 18 November 1988 to 11 December 1989.
The transactions which were the subject of the proceedings involved companies within the Bond Group. In particular, they concerned finance and the movement of capital within the Bond Group in respect of the Bond Group's takeover of the Bell Group Ltd, completed in August 1988. The Bell Group Ltd's subsidiaries included various companies in the J N Taylor Holdings Ltd Group, including D. D was a wholly owned-subsidiary of the holding company in J N Taylor Holdings Ltd and was also P's sole shareholder at all material times. As a result of the transactions which were the subject of the proceedings, the holding company in the Bond Group, BCH, controlled the ultimate holding company of J N Taylor Holdings Ltd, which, in turn, was the ultimate holding company of D and P. Prior to 15 November 1988, the treasury company within the J N Taylor Holdings Group, JNTF, indirectly lent the sum of $126.8 million to the treasury company of the Bond Group, BCF. At trial (and later on appeal) it was found that the sole purpose for P's incorporation was to unwind the effect of this indirect loan. The contemplated scheme for unwinding the loan involved P obtaining funds from JNTF and, through intermediaries, lending those funds to C, a wholly-owned subsidiary of BCF, which would then on lend the same funds to BCF. As it happened, by 23 November 1988, JNTF lent $100 million to D, which, in turn, took up $100 million of redeemable preference shares in a wholly-owned subsidiary which, further in turn, took up $100 million RPS in P.
On appeal, it was found that D acquired the redeemable preference shares and capitalised P for the sole purpose of having P on lend those moneys, through subsidiaries to companies within the Bond Group and on a limited recourse basis. It was also found, at trial and on appeal, that the transactions involving P were orchestrated by two directors of P, Co and N, neither of whom were called to give evidence. P was incorporated for the sole purpose of the transactions, obtaining its capital from D and acted at the behest of D. In May 1989, P resolved to extend the loan from P to D to 24 November 1989, reserving the right to recall the loan on one month's notice. In August 1989, P's board resolved to require payment of the loan to D, On 14 September 1989, BCF drew two promissory notes, drawn in favour of C, and endorsed by C, in favour of D and P. On the same day, P wrote to D, advising that it accepted the notes in full and final satisfaction of the amount owed by D to P. BCF later replaced the two promissory notes, at P's request, so that the promissory notes were from BCF to P directly. Consequently, BCF became indebted to P.
By August and September 1989, the Bond Group's financial position was precarious, a fact known by L. P now in liquidation brought proceedings against L for breach of his statutory duty pursuant to the equivalent of section 181 of the Corporations Law and the common law fiduciary duty to P, and for negligence, in respect to the transactions. P contended that L's conduct and breaches of his duties were not authorised, or ratified, by P's members in general meeting. P further alleged that by reason of those breaches, it suffered loss or damage in the sum of $50 million, together with a sum of interest of $2.8 million, a separate claim for the loss of use of money and declaratory relief. P's case against L was that he breached his statutory and fiduciary duties to P: first, by authorising the loan by P to D in November 1988, where moneys were repayable only on a limited recourse basis; second, by causing P to extend the date for repayment of the loan in May 1989; third, by allowing P to accept promissory notes from BCF in full and final settlement of D's obligation to repay the loan.
The trial judge found, inter alia, that P was incorporated for the sole purpose of the series of transactions, that P acted at the behest of its sole shareholder, D, at times when P was solvent, and the acts of P and L were intra vires and not performed in bad faith. The trial judge also rejected allegations that L acted dishonestly and that P had suffered any loss. The basis for the latter finding was that the true nature of the series of transactions was restructuring of JNTF's lending arrangements with BCF, and P was incorporated and capitalised for that purpose alone. After reviewing the facts in some detail, including the way in which the company had been established, and evaluating some of the intricate loan and other arrangements that had taken place, Lander J felt that it was inappropriate to find that L had been acting dishonestly or for an improper purpose. As far as the trial judge was concerned, a view that the Full Court upheld, the situation was one where there was one shareholder company which had provided approval, in advance, for the transactions that had been entered into by the company. That amounted to giving the company (and its directors) authority to enter into the transaction even though that transaction in certain circumstances may have given rise to a breach of duty on the part of the relevant director. In those circumstances there would be no breach of duty in his view. However, he added the following qualification:
"That proposition [i.e. that no breach of duty was involved] is subject to qualification. First the company must be solvent. In my opinion, for the reasons I have already given, the company was solvent. Second the transaction itself must be [within power]. Third the directors must make full disclosure to the shareholders. Fourth the directors must be acting in good faith." (See para 266 of the judgment.) Having looked at the relevant authorities (but without referring to the fact that the Corporations Law was to be amended to deal with this type of situation) Lander J concluded: "It follows from [all of the matters I have considered], applying the principles to which I have referred that [L] is not liable to [the liquidator]. [Liability does not arise] because the company has been incorporated for the sole purpose of the transaction which it entered into; and at all material times it was solvent; the sole shareholder authorised the directors to enter into the transaction and indeed subscribed capital for that very purpose which meant full disclosure had been made to the directors; the transaction was [within the power of the company]; and there was no suggestion that the directors were acting in bad faith [in so far as the company was concerned]." (See para 273.)
Having dealt with the issue of liability Lander J also addressed the question of whether he would have excused L from liability had a different conclusion been reached. He noted that section 214 of the International Companies Act (which applied to the Cook Islands) was identical to section 1318 of the Corporations Law. In his view, the court would have granted relief if there had been a breach of duty. Further, there was no suggestion that L has used his position to benefit himself. There was no suggestion that he had acted otherwise than what he thought was in the best interests of the company. It was certainly reasonable for him to cause the company to carry out the transaction because it had been incorporated for that purpose. However, there was no need for the court to exercise its discretion in this case because there had been no breach of duty. The fact that the court indicated that it would have exercised that discretion and relieved the director is certainly comforting for directors at a time when there is still some doubt as to how far the business judgment rule extends in these circumstances (it does not extend beyond the duties of care and diligence) and in the light of the proposed amendments to make directors liable for "uncommercial transactions" (see last month's Early Warner).
The decision may well indicate that there is no need for section 187 of the Corporations Law especially if judges display the approach adopted by both Debelle J and the Full Court in this case. This writer would argue that we need a statutory provision that goes beyond the wholly-owned subsidiary scenario – it needs to be extended to partly-owned subsidiaries (in appropriate circumstances) and even to joint venture companies as is the position in New Zealand. That, however, will have to wait the further consideration of the Companies and Securities Advisory Committee (CASAC) report into Corporate Groups which will gain the attention of our lawmakers later this year. In the meantime, however, the decision in Pascoe is one that will give heart to company directors.
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