Duties of loyalty and good faith

Wednesday, 01 May 2002


    Punishment for breaching confidences – a warning to directors and all officers of companies

    It is trite law that directors and officers of companies stand in a fiduciary relationship to the company, to which they owe duties of loyalty and good faith. So, the rules make it clear that directors should not use company information for their own advantage. They should not establish a new company that competes with their company without clear permission to do so. When directors and employees break these laws and commit a breach of duty, what are the consequences? Usually the company can seek an injunction to stop the activity continuing and can also seek damages. But, will the court award what are known as punitive damages in the cases of officers or directors misappropriating property that belongs to a company? What is the law on this? In Digital Pulse Pty Ltd v Harris & Ors ((2002) 40 ACSR 487), the first case for some time dealing with this issue, Justice Palmer in the Supreme Court of New South Wales sent a very clear signal to directors and officers that if they breach their obligations they may face very significant damages claims. Of course, there is also the prospect that a regulator, in this case the Australian Securities and Investments Commission may seek penalties under the relevant legislation.

    Justice Palmer had to consider the following facts as taken from the Butterworths Corporations and Securities Reports. The plaintiff company (Digital) provided computer-based multimedia services to clients. The first and second defendants (Harris and Eden) were its employees. A company controlled by Harris (known as Juice) was the third defendant in the case. Harris and Eden signed employment contracts with Digital containing terms preventing them from competing with it during the term of their employment. While still employees of Digital, Harris and Eden established a competing business. Digital claimed that they had diverted work from it in a number of projects without its knowledge or consent, and that they had misused confidential information. Digital sued the employees for damages, equitable compensation or an account of profits, compensation for breach of statutory duties which arose under the Corporations Act 2001 and sought exemplary damages for the alleged breaches of fiduciary duty. Justice Palmer held that the defendants were liable because they had breached their duties. His Honour held that where there was a breach of contract (and in this case there was such a breach) and also a breach of fiduciary duties (which was found or conceded) the plaintiff could normally elect which remedy it sought either equitable compensation or an account of profits. Justice Palmer considered that the best way of giving equitable compensation to a plaintiff in such circumstances was to assess the value of the lost opportunities by looking at the margins that might have been realised had the company carried out the work that the defendant company carried out. The court would in such a case make an allowance for tax. In addition, the court might also order equitable compensation for the misuse of confidential information, which carries with it of course the notion that a breach of fiduciary duty had occurred.

    After considering the detailed facts and the corresponding legal rules, Justice Palmer concluded (at paragraph 128): "All of these circumstances, taken together, demonstrate deliberate wrongdoing for profit, in contumelious disregard of [the rights of the plaintiff] deserving of special condemnation and punishment. To call a spade a spade, what [the first and second defendants] did was to defraud their employer of its valuable business opportunities and its confidential information. ... By concealing facts which they had a duty to disclose, namely, the business opportunities which should have been [those of the company], and by engaging in conduct in which they had no right to engage, namely, taking those opportunities for [the defendants' company] in breach of their fiduciary and contractual duties of loyalty, [the first and second defendants] deprived [the plaintiff] of its lawful rights, opportunities or advantages to derive business from the diverted projects. Both in the criminal court and in an equity court, [the relevant conduct] bears the stigma of fraud."

    Justice Palmer then considered whether punitive or exemplary damages should be awarded. In his view there had been a variety of positions taken in relation to this matter in Australian courts. He noted the distinction between compensatory damages and exemplary or punitive damages: "Compensatory damages are given to place the plaintiff in as good a position, so far as money can do it, as if the wrong had not occurred. Exemplary damages are in quite a different category and serve quite different purposes:

    - to punish the wrongdoer for reprehensible conduct;

    - to deter not only the wrongdoer but others of like mind in the community from similar conduct; [and]

    - to ameliorate the victim's sense of grievance and thereby to abate the urge for self help or violent retribution, to the danger of the public peace." (at para 113)

    There had been some disagreement in Australian and English courts as to when exemplary or punitive damages should be awarded. Justice Palmer took the view that: "Consistency in the law required that the availability of exemplary damages should be coextensive with its rationale. Where wrongful and reprehensible conduct calls for the manifest disapprobation of the community, where a punishment is called for to deter the wrongdoer and others of like mind from similar conduct and where something more than compensation is felt necessary to ameliorate the plaintiff's sense of outrage, then it should make no difference in the availability of exemplary damages that the court to which the plaintiff comes is a court of equity rather than a court of common law." (at para 170) Justice Palmer ordered that Digital was entitled to equitable compensation or an account of profits in respect of the projects which had been diverted to the defendant company. He also ruled that Digital was entitled to equitable compensation from Harris in the sum of $11,000 in respect of misappropriated confidential information. Finally, Justice Palmer ordered that an award of exemplary damages of $10,000 be made against both Harris and Eden.

    The decision may be appealed. Its consideration of section 182 and other provisions of the Corporations Act may prompt ASIC to pursue separate civil penalty remedies. Whatever happens, the decision is a powerful reminder of the need for company officers (directors and others) to ensure that they do not breach the confidences of the company nor misuse or appropriate for themselves information or property of the company.


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