A directors duty: whose interests come first?

Directors always owe a duty to act in the interests of the company.

 A recent case in Western Australia was highlighted where directors may have to consider the interests of creditors

Ever since the High Court of Australia in the case of Spies v R ((2000) 18 ACLC 77) said that Australian law did not impose a duty on directors to act in the interests of creditors, in contrast to some views that have been expressed in the late 1970s, 1980s and 1990s, there has been some concern that perhaps that statement may have gone too far. Views have been expressed that in certain circumstances directors did need to take into account the interests of creditors, particularly so because the Corporations Act contains a remedy, S.1324, for creditors, and others whose interest are affected, against directors in the event that the directors breach their duty. The question of whether directors should take into account the interests of creditors was considered in the Supreme Court of Western Australia by Justice Heenan in Geneva Finance Ltd (Receiver and Manager Appointed) v Resource and Industry Ltd & Anor ((2002) 20 ACLC 1427.

Briefly, Geneva Finance Limited (Geneva), a financial institution, borrowed money from the public on deposit and loaned it to various builders. Geneva got into financial difficulties and a receiver/manager was appointed. The financial difficulties were quite severe and it became clear that there would be no money available to pay unsecured creditors whilst the secured creditors could not be paid in full. The critical issue that led to the insolvency was the large exposure to bad and doubtful loans to companies related to Geneva.

It was alleged that there were serious inadequacies in the reporting function of some of the directors about the extent of those loans and the conduct of certain board meetings. The receiver/manager began proceedings in the name of the company to recover damages and/or compensation for breaches of duty by a non-executive director of Geneva, a Mr Hawkins and certain other companies which were related to Geneva. There were questions about the securities advanced in support of the various loans made by Geneva to various companies and directors involved with Hawkins' companies. The receiver/manager alleged that there were a number of breaches of the Corporations Act, that Hawkins, a director of Geneva, had breached his duty, and that alternatively preferences had been given to Hawkins' companies in the payment of certain debts. The court dismissed the application made for the recovery of damages from Hawkins and for the setting aside of certain preferences. Justice Heenan said the company had received value for the various loans that had been made and no preferences had been given.

In the course of the matter the court was asked to consider what was the nature of the duty owed by directors. Apart from the fact that the steps that he had taken were shown to be in the context of what was appropriate, the court had to examine whether Hawkins, and indeed other directors, owed duties to creditors of Geneva because the company might have been in financial difficulties. The court dealt with the arguments of the receiver/manager as follows: "The high water mark of the plaintiff's case is the submission that Hawkins was in breach of his duty to the creditors of Geneva Finance because of the pending insolvency of the company which he knew or should have known. It is an inescapable corollary of that submission that the alleged duty to the creditors, not only included an obligation to safeguard their interest generally, but an obligation to see that creditors of the same degree were treated equally – in other words to avoid any transactions which would disturb the ... entitlements of the creditors [to receive payment equally]."

The receiver/manager relied on a number of cases, beginning with Justice Mason's dicta in Walker v Wimbourne ((1976 137 CLR at 6-7). Justice Heenan, after examining the relevant cases and the arguments culminating in the decision in Spies v R, said that the orthodox way to treat the duties of directors was as follows: "The duty [of a director] is that ... especially if the director is approaching insolvency, [the director] is obliged to consider the interests of creditors as part of the discharge of his duty to the company itself, but that he does not have any direct duty to the creditors and certainly not one enforceable by the creditors themselves in 'special responsibility' cases or under statutory provisions now prevailing in a liquidation ... The issue of an alleged duty by directors to creditors resembles a similar controversy over the question of whether or not the directors owe a fiduciary obligation to the shareholders."

He then discussed a number of cases culminating with Brunninghausen v Glavanics ((1999 17 ACLC 1247) (Law Reporter, August 2000). Having set the basis of how the issue should be addressed, Justice Heenan reached these important conclusions: "This is a case where a company is suing the director on its own behalf and no question of the enforceability of an alleged duty to a creditor arises. Rather, the true question is the scope of the obligation of a director to take into account the interests of creditors when discharging his duty to the company, especially if it is approaching insolvency. Clearly, a director has an obligation to the company ... and this is a duty of a fiduciary nature ... It is also the case that there can be concurrent equitable and contractual fiduciary obligations resting upon the one person ... It is also the case that, even in inherently fiduciary relationships such as the relationship between a director and the company, there may be some obligations which are not fiduciary in their character ... But none of this, in my opinion, will lead to any other conclusion in the present case but that, at all material times, Hawkins had a fiduciary duty to Geneva Finance to exercise his powers in the best interests of the company as a while and that the scope of this duty involved giving due attention to the company's creditors."

His Honour made it clear that to succeed in the case the receiver/manager had to show that the relevant decision taken in relation to the various loans and payments were in fact not "made in the best interests of the company as a whole, or ... the dominant purpose of those undertaking those transactions was to secure a benefit for [one creditor] at the expense of other creditors of the [same class]." Justice Heenan was clearly of the view that there had been no breach of duty. Further he said: "There may well be instances where the lack of reasonable diligence by a director in performing the duties of his office is so gross that the director cannot be heard to say that no improper intent or purpose should be attributed to him for a transaction which advantaged a third person because he simply did not know or understand the true position. However, for that to occur, I consider that the neglect by the director of his duties would need to be gross before it was sufficient to attribute to him an improper purpose for a transaction in which he was involved and in which he had believed himself to be acting honestly."

This decision is important because it makes it clear that directors could, in certain circumstances, have to take into account the interests of creditors, but also reflects on the nature of the duty of care that has to be exercised by directors in complex situations where debts are outstanding. While there was no discussion of S.180 of the Corporations Act, the case is a welcome statement that for directors to be made liable they must be engaged in what is described as unconscientious behaviour or behaviour that lacks the necessary standards that a director should attain in the appropriate cases. In particular His Honour referred to Richard Brady Franks Ltd v Price ((1937) 58 CLR 112) where the High Court had to consider the propriety of the actions of directors of a company in financial difficulties who issued certain debentures to try to save the company. The court held that the directors had been acting in what they believed to be the best interests of the company at the time, and that by preferring one creditor to another did not necessarily amount to a breach of duty owed to the company.

Chief Justice Latham, in comments that will no doubt still be relevant in cases in the future, said: "It is not for a court to determine whether or not the action of the directors was wise. The question is whether it is shown that they did not honestly act for what they regarded as the benefit of the company." The judgment has confirmed that directors must, in certain circumstances, take into account the interests of creditors but only in the context of acting in the interests of the company. What is disappointing from this decision, and of course if an issue was not argued then it is not fair to criticise the judge, is that S.1324 was not considered. However, perhaps there was insufficient evidence to suggest that there was any issue of statutory duties.

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The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.