When family affairs fall foul Law Reporter

Paying yourself too much as a director - a sure recipe for complaint

When a company is a closely held one (a family company) with few outside investors, it is usual for the directors and the members to work out things in order to avoid complaints - such as one that the directors are getting paid too much or that certain things are being done in a way that might favour one group over another. However, when things do not work out well in such family companies, complaints will be made about overpayment of directors, discrimination in other factors and related matters. These complaints usually finish up in a court. An interesting recent example of such a case is Shamsallah Holdings Pty Ltd v CBD Refrigeration and Airconditioning Services Pty Ltd ((2001) 19 ACLC 517). We have taken the facts from the CCH Law Report. Shamsallah Holdings Pty Ltd and De Chelor Holdings Pty Ltd, who together owned one third of the shares in CBD Refrigeration and Airconditioning Services Pty Ltd, applied to the court under the oppression remedy, section 246AA of the Corporations Law, for an order that the other shareholder, Darian Holdings Pty Ltd, purchase their shares.

Darian Holdings was controlled by Ian and Darryl Wooten, who were the directors of CBD and who were responsible for its management and control. CBD had grown substantially since being incorporated in 1990, but by 1997 there had been a falling out between the two groups of shareholders when the Wootens claimed that Shamsallah and De Chelor were involved in a business that was competing with CBD. Section 246AA(1) of the Law provides that a member who believed that the affairs of the company were being conducted in a manner that was unfairly prejudicial to, or unfairly discriminatory against, a member or members, may apply to the court for relief. The basis of Shamsallah/De Chelor's claim was that the directors of CBD had paid themselves excessive remuneration, that they had restricted the payment of dividends and retained cash resources that were surplus to the operating needs of the company, and that they had prevented the applicants from having access to information to which they were entitled. Justice Owen of the Western Australian Supreme Court eventually accepted the applicant's arguments that the payments were too high, but only after he had examined the dividend policy and practice of the company. One of the interesting questions was whether, in the context of the directors' remuneration, the level of salaries paid was justifiable. In the judge's view as no independent investigation had been carried out before the directors voted themselves the increases from which they benefited then they ran the risk that the increases might be challenged. Owen J noted that the company had in fact increased its profits very significantly (five-fold over the relevant period), but the question was still were the salary increases justified on the basis of those increases and the work that they had done. He made some interesting observations which may well be followed in later cases. "If the [level of salaries are not justifiable then that may constitute] what might in the vernacular be regarded as 'ripping off' the company ... It is true that directors should make a bona fide attempt to estimate proper remuneration and that there is no evidence that the [directors] did so before voting themselves the several increases from which they have benefited. ... The mere fact that no independent investigation was carried out at the time when the increases were made is a factor to be taken into account. But the ultimate question remains: are the salary levels so high as to amount to oppressive conduct?"

(at para 30) The judge accepted that the directors had been responsible for the significant improvement in the company's profitability over a number of years and deserved to be rewarded. But he raised an interesting note of caution in these comments. "It is a notorious fact that executives of large companies in Australia, indeed in the Western economies generally, are paid astonishing salaries to create shareholder wealth. The irony is that the salaries are payable whether or not the envisaged increment to shareholder wealth is actually attained. I am not suggesting that salary levels of a large conglomerate should translate to the situation in which [this company] finds itself. However, it is another notorious fact that small business is difficult and so often the success of an enterprise is dependent on the experience and willingness to work of the proprietors. All of this suggests to me that salary levels ought not to be divorced from the actual circumstances of the individual business. I do not think that, taken alone and in the circumstances of this case, for the managers of the company, who have been materially responsible for the development of the business, to take salaries that are high but not excessively so, is oppressive. I am not suggesting that 'hands on' directors can take, as salaries, whatever they like or whatever they think the company can bear and thus ignore the interests of persons whose interests are represented solely by invested capital." (at para 35)

So, on the question of the salaries the judge felt that on the surface the payment was not unreasonable. But, that was not the only issue that had to be assessed. He had to also look at the dividend policy of the company and see how this measured up to the salaries paid. Owen J noted that there had been cases in which a failure to pay a sensible rate of dividend would be a cause for challenging the actions of the directors. The dividend policy in this company had not been reviewed since 1992. This was so even though the company had substantial cash reserves. He was critical of the directors in failing to review dividend policy especially when this decision was taken in light of the significant salaries that they had paid themselves. Having dealt with the question of dividends he then returned to the question of salaries. "It seems apparent that the [directors] have reviewed their salary packages from time to time and have voted themselves increases that are not insignificant. I have already said that I do not regard the salary increases as amounting to oppressive conduct and I do not resile from that conclusion. However, it can be assumed that in deciding whether or not to increase their remuneration [the directors] took into account the profitability and changing financial circumstances of the business. In this respect the question can be asked: why did they not also review the dividend policy? The applicants represent a sizeable minority within the corporate structure. It is the only set of interests within that corporate structure other than the interests of the [directors] themselves. It should have been apparent to the [directors] that any decision they took in relation to salaries would have a negative impact on the applicants. If the dividend policy were to be followed there would be less money in the after-tax profit pool. They should also have been aware that the payment of dividends was the only mechanism by which the applicants could benefit from the activities of the company.

In my view the [directors] should have reviewed the dividend policy in the light of changing, and improving circumstances to see it remained as relevant as it was seen to have been in 1992. Not to do so when, at the same time, they were taking steps to ensure that their own interests were properly recognised and that they were adequately remunerated for their business activities on behalf of the company is, it seems to me, oppressive." (at paras 55-56) In the circumstances the court was prepared to make the relevant orders being sought, namely that the shares of the applicant shareholders were to be bought at a reasonable price to include a component of goodwill. This was so even though the applicants had not been responsible for the development of the goodwill of the company. The result in this case is a quite expensive one in the context of the work done by the directors. The court is suggesting that had the directors looked more closely at the question of dividend policy, and made allowances for dividends being adjusted to reflect the company's financial success, the oppression remedy may not have succeeded at all.

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