When companies experience an identity crisis Law Reporter

Corporations may be liable to employees for their employee’s own negligence.  When companies experience an identity crisis

Corporations may be liable to employees for their employee's own negligence

With the very detailed discussion taking place in Australia today on the concept of limited liability and the suggestion that the veil of incorporation should be lifted in appropriate cases (see Early Warner) it is interesting to find our High Court adopting a strict analysis of the separateness of the company from those that may either control it or run it.

In the recent case Andar Transport Pty Ltd v Brambles Ltd ((2004) 78 ALJR 907), the issue was complicated by the fact that a director employee of the company who was suing another company for damages as a result of an injury which he had suffered, was treated as quite distinct from the company which he effectively ran, in evaluating a claim for contributory negligence by the defendant.

The facts of the Andar case and a short discussion of the analysis of the High Court will illustrate the line that the High Court is prepared to draw in distinguishing between a company and those who control the company in a case for damages.

The facts, taken from the Law Book Company's Australian Law Journal report of the decision, concerned the provision of laundry delivery services by Brambles to various hospitals. The services were contracted out to various companies such as Andar, which employed drivers to load and deliver the linen as directed by Brambles. An Andar employee (a Mr Wail) was injured while unloading a truck. Wail was also a director of Andar and responsible for the day-to-day running of its business.

Wail had sued Brambles in the County Court in Victoria for damages arising out of the incident and was successful. However, the Court had reduced the damages by 35 percent because it held Wail was partly responsible for the accident.

Brambles, relying on its contract with Andar sought an indemnity from Andar in respect of the amount payable by it to Wail. Alternatively Brambles sought contribution from Andar because it argued that the company's negligence, in its capacity as an employer of Wail, was instrumental in the accident.

The claims brought by Brambles were dismissed by the County Court but the Victorian Court of Appeal overturned that decision. It ruled that Andar was obliged to indemnify Brambles against all sums payable by it to Wail. The Court of Appeal also ruled that sums were payable by way of contribution pursuant to the operation of a piece of legislation in Victorian known as the Wrongs Act 1958 despite the fact that the relevant employee, Wail, was a director of Andar.

Andar in turn appealed the Court of Appeal decision to the High Court of Australia. It argued that Brambles was not entitled to be indemnified under the relevant contract and that because Wail occupied a role both as a director of Andar as well as an employee, Andar submitted that it (Andar) could not be liable to him under the terms of the Wrongs Act.

In essence Andar was arguing that it and the employee were the same person - the company was controlled by Wail, the director/employee. (There were also other technical arguments raised which are not relevant for the purposes of this note).

The High Court by a majority allowed the appeal. However, the High Court also held that Andar could be liable for a breach of duty by it to its own employee (Wail) who was also the most important director and employee of the company. It held that where that breach of duty was brought about by the relevant employee's own action as a director of the company the claim could still be made.

While it is not necessary to deal with this particular issue in any detail we can say in general terms that employers owe a common law duty to their employees to take reasonable care to ensure that the safety of the employee can be provided in the working environment.

It was argued by Andar in this case that as Wail was a director of the company (and in fact responsible for the day-to-day operation of the laundry delivery business which was the subject of the contract between it and Brambles) he could not in essence have legal recourse against his own company for a breach by it of its duty to take reasonable care. Andar also argued that it could not be held liable to Wail by any inference that he Wail had committed a breach of duty in his capacity as a director.

In holding that Andar could be liable to its employee in the context of this case the majority of the High Court relied on an earlier High Court of Australia decision Peate v The Commissioner of Taxation ((1964) 111 CLR 443) where Windeyer J noted (at p 480):

"it is not in legal theory impossible or incompatible for a person to be both governing director and sole controller of a company and servant of that company or its agent to contract on its behalf, always assuming - that the company was not a sham."

After examining a number of other interesting cases and legislation surrounding the employer/employee relationship the High Court in Andar noted that there could be a distinction between the duties that were owed by the company on the one hand and by an employee in his personal capacity as a director in another. At paragraph 49 of the Andar case the High Court majority noted as follows:

"The common law duty to take reasonable care for the safety of employees is imposed directly upon Andar by virtue of its status as an employer. The duty is not imposed upon individual directors of a corporate employer - To seek, as Andar does, to derive some significance from the circumstance that the board of a company is limited to two directors and that one of those directors [the relevant employee] ordinarily manages aspects of the delivery business is therefore to ignore the nature of the obligations imposed upon Andar by the common law."

So, in this particular case, the fact that the employee was responsible for the conduct which led to his own injury was not regarded as a defeating circumstance in allowing liability to be driven home.

In contrast the High Court of Australia in dealing with a criminal law scenario last year made it clear that it was not prepared to treat the company and its governing or main director as separate persons in order to allow the director to escape liability for a breach of the criminal law. In McLeod v The Queen ((2003) 214 CLR 230), a case that we have noted in Law Reporter [September 2003] the issue in question was whether a person who controls a company (which was collecting moneys from members of the public in order to engage in film investment) was guilty of stealing from the company when the company, by a resolution which that particular person was able to ensure was carried by virtue of his position as a shareholder, had authorised the relevant transaction.

In McLeod, in contrast to Andar, the relevant director McLeod was in effect the sole shareholder of the company. He had argued that as the company had consented to the money being used by him he could not be guilty of theft.

The High Court dismissed that argument and held that it was important for it to interpret the law in accordance with current developments and the understanding of the distinct legal identity of a corporation. The majority in McLeod noted (at para 28):

"The scope and operation of the provisions necessarily move with those developments; the construction is informed by the proposition that a company has rights, interests and duties which differ from those of its directors, officers and members. The conduct or state of mind of the latter is not always to be attributed to the former; this is particularly evident upon an insolvent winding up."

They recognised that if company directors tried to be too "cute" in conducting their affairs and argued that the company is separate from themselves when they really controlled what the company could do in a situation such as the use of corporate assets, or where insolvent trading occurs, the court will not differentiate between the company and the relevant director in order to allow a strained and technical interpretation of the law.

All of this suggests that our courts do "move with the times" and can reach decisions in relation to factual scenarios which require a common sense view to be taken. It is the policy of our law that persons employed by companies are owed duties by that company. Unless the law makes it clear that the actions of a company cannot be differentiated from those who control it, then the company should be held liable for injuries sustained by an individual. Any other view would require a very different approach to our laws of negligence and would place even greater strain on the notion of the separateness of a company from its shareholders and/or employees and directors.

The decision in Andar and McLeod show that we do not need to worry too much about the operation of our Corporations Act and

the basic principles underlying it as long as courts are prepared to review relevant facts in a constructive and practical fashion.

Suleman's pyramid implosion

Can you rely on an illegal act in order to recover damages?

A question often asked of lawyers is what happens if parties enter into a contract or engage in conduct which is illegal (that is in breach of a statute although not necessarily criminal) and later one of the parties involved decides to sue on the basis of the illegal contract or conduct? Can that person, or someone standing in that person's shoes, recover in law?

Such a question can be particularly relevant in the context of say actions taken by companies which do not comply with the provisions of the Corporations Act, when a new person gains control of the relevant company, and then wishes to sue other parties in relation to the relevant contract or conduct.

Recently the New South Wales Court of Appeal ruled that, in principle, parties should be able to recover even though their legal action may be based on a breach of relevant legislation.

In Karl Suleman Enterprises Pty Ltd (in liquidation) v Babanaur ((2004) 49 ACSR 612) the relevant facts, as taken from the Lexis Nexis report, are these.

The appellant company Karl Suleman Enterprises (KL) conducted and managed investment schemes. Unfortunately that scheme was at all times unregistered and therefore operating in breach of relevant provisions of the Corporations Act.

Babanaur had been an agent appointed by KL to introduce investors to finance a shopping trolley collection service. Significant sums of money were to be collected from investors by way of a specific loan to the company.

Justice Beazley in the New South Wales Court of Appeal described the scheme as a pyramid scheme under which funds received from new investors were used to pay out existing investors, or to pay interest on money advanced by existing investors. Agents were used to promote the scheme and to introduce investors.

In essence the claim against Babanaur was that he had failed to act in good faith and with loyalty and fidelity, and that moneys he had collected were allegedly used for his own purposes. Certain other pleadings were also set out in the draft pleadings.

The primary judge dismissed the claims in these words:

"The claim of the company, put simply, is that having conducted an illegal and fraudulent operation under which investors - paid money to it, and having passed on some of those moneys to agents engaged to assist in the fraudulent and illegal operation or having allowed those agents to keep some of the moneys collected by them to compensate them for their efforts, it should now recover from those agents the amounts which they received through their agency efforts. In other words the agents having performed in accordance with their contract of agency are to be required to disgorge to the company which institute the fraudulent operations because that company [had had a change of heart]" ...

The judge held that the action on the part of the company was defeated by a lack of clean hands and illegality.

He concluded that it could not succeed on the basis of the relevant pleadings, but that KL (through its liquidator) should have the right to re-plead its case in order for the matter to be reconsidered.

When the case came on appeal the question was whether the trial judge had erred in holding that the original claim was barred by illegality and the doctrine of unclean hands notwithstanding that a right to re-plead the case was given.

The New South Wales Court of Appeal upheld KL's appeal. In essence, as noted in the relevant law report, the legislative framework which required registration of the managed scheme and the way in which the scheme should be conducted (including registration) eventually led the court to the view that the appellant should not be denied its day in court.

Citing a number of cases including the High Court case of Yango Pastoral Co Pty Ltd v First Chicago Australia Ltd ((1978) 139 CLR 410) Beazley JA on behalf of the Court of Appeal noted:

"The registration requirements for the operation of a managed investment scheme is for the protection of investors. The legislation does not expressly make an unregistered scheme unlawful. Rather it impugns the conduct of the entity responsible for registration by imposing a penalty for a contravention of the [relevant provisions]. The members of an unregistered scheme are protected by the provisions whereby the scheme may be compulsorily wound up. There is nothing, therefore, in the scheme of the legislation whereby an implication of an illegality would arise, nor is there anything that points to a legislative intention that contracts entered into as part of an unregistered scheme are illegal." (at para 51)

Were the claims, however, defeated by the argument that the liquidator was coming to the court with unclean hands? After reviewing certain cases dealing with this interesting equitable principle, the Court of Appeal, through Justice Beazley, disagreed with the trial judge. She noted:

"Although his Honour is correct when he says that a change in directorship does not alter the legal identity of a company, I consider that his approach fails to take sufficient regard to the principle ... that the liquidators cannot make legal or non-fraudulent that which was illegal or fraudulent. However, they can take steps to reimburse the investors of sums of money of which they have been defrauded. These proceedings are, we have been informed, an attempt to do that. It seems that that conduct is or is at least of a similar cleansing nature as has been held sufficient to defeat the defence of unclean hands." (at para 57)

The court did indicate that the pleadings would need to be improved if the plaintiffs were to be eventually successful but it also ruled that the mere fact that the scheme had operated on an unregistered basis and was therefore "illegal" in one sense, did not preclude the recovery of the relevant funds for the investors (some of whom may not have been all that innocent) in the relevant situation.

Rich's right of appeal over One.Tel ruling

A recent High Court decision places future administration of the Corporations Act under pressure

When the Corporations Act was amended in the early part of the 1990s to introduce a civil penalty regime for various breaches of the Act, this was in effect the start of a new world for the Australian Securities and Investments Commission (ASIC) in pursuing directors and others who had allegedly breached major provisions of the Act.

The aim was to extricate ASIC (and its predecessor) from the very difficult tasks that often confronted it when it wished to rely on the criminal law by using the Director of Public Prosecutions (DPP) to pursue high profile company executives for breaches of law arising from corporate collapses. When Tony Hartnell was chairman of the predecessor body to ASIC, the Australian Securities Commission, he targeted a number of high profile company directors and companies but regrettably, many of the prosecutions brought failed for one reason or another with some rather unfortunate interaction between the Australian Securities Commission and the DPP.

One of the advantages of proceeding through the civil penalty regime, especially if ASIC was to seek a disqualification order against a director, was that it was assumed that this would be regarded as an indication that the regulator was seeking to "protect" the community against directors who had been accused of breaching major provisions of the legislation.

A string of successful cases run by ASIC, the most notable being those against directors of the HIH and One.Tel organisations confirmed this interpretation of the law.

However, although there have been some concessions by directors of One.Tel in the courts in prosecutions brought by ASIC, one director, Rich has continued to fight hard to avoid ASIC obtaining information from him, arguing that directors were prejudiced in this action by the loss of rules applying the criminal law in cases of this kind.

Rich challenged ASIC's ability to obtain information by way of discovery arguing that this information if provided to ASIC would tend to incriminate them.

Austin J at first instance in the New South Wales Supreme Court dismissed these claims, relying on earlier decisions that the application by ASIC for discovery was being pursued via the civil penalty regime and that these arguments against self-incrimination did not apply.

His decision was upheld by a strong New South Wales Court of Appeal led by Justices Spigelman and Ipp with an equally strong minority judgment being written by McColl J.A. [LawReporter, May, 2004]

Rich sought leave to appeal to the High Court of Australia. In an historic decision in April 2004 the High Court by a majority announced that the leave application was successful at the same time ruled that Rich had been successful in his application to resist the demand by ASIC for the discovery of relevant documents.

At the time of the High Court decision it indicated that it would be delivering reasons for its judgment later but that it was important to announce its view as to the interpretation of the law and this decision was briefly noted in the Company Director May edition

On 9 September the High Court published its reasons in this case. Six members of the court agreed that Rich should be successful in this appeal while Justice Kirby rejected the appeal and in doing so once again warned that dire consequences might flow as a result of the High Court's interpretation of the civil penalty regime in this case.

Set out below is a brief summary of the judgment in the High Court of Australia but in particular I note the judgment of Kirby J which to me raises concerns on the administration of the civil penalty regime which has been so successfully implemented by ASIC and its predecessor over the past 10 to 12 years. This brief summary is based on a note prepared by my firm for its clients.

The majority judges (comprising Chief Justice Gleeson, and Justices Gummow, Hayne, Callinan and Hayden) in their judgment noted that although the Act describes the relevant provisions under which ASIC would pursue directors for breaches of duty as civil penalty provisions, this description was not necessarily conclusive on whether the directors were exposed to penalties of a more draconian nature. In the majority's view it was necessary to focus upon the content of the arguments put forward by the appellants in this case - the claim that they would be exposed to self-incrimination - rather than to the labelling of the penalty regime as either protective or punitive.

The majority rejected the argument that in disqualifying a person from managing a corporation one was in effect protecting shareholders or creditors, rather than punishing the relevant directors. In the court's view this was not a correct assessment of the thrust of the legislation. They held that neither the purpose that the applicant (ie ASIC) may have in seeking the orders, nor the effects of the orders on persons other than the relevant directors, bore on the question of whether the proceedings exposed the directors to penalties. Instead, the court held that one must focus on the nature of the orders that are sought.

Their Honours further noted that:

• If a disqualification order is made, the person against whom the order is made ceases to be a director.
• The order for disqualification therefore causes the person against whom it is made to forfeit any office that person held in a corporation and forbids that person from holding office in a corporation for the duration of the disqualification order.
• Those consequences, whether taken separately or in combination, when "inflicted on account of a defendant's wrongdoing", are penalties.
• The fact that the penalty is not exacted in the form of a money payment does not detract from such conclusions.

In reaching these views the court discussed in some detail certain cases which highlight the differentiation and the classification of penalties in matters of this kind.

After discussing the differences between the classification of the penalty regime as "protective" and "punitive" which had been the basis of earlier cases, the majority indicated that in their view such a differentiation was not helpful. Essentially:

"adopting such a classification diverts attention from the relevant question which is whether the privilege ... applies. That requires consideration of the kinds of relief which are sought in the proceeding. Neither the purpose which the applicant may have in seeking relief of that kind, nor the effects on persons other than the appellants of obtaining that relief, bears upon whether the proceedings expose the appellants to penalties. Yet an attempt to classify the proceedings as 'punitive' or 'protective' appears to require consideration of only those purposes or effects." (at [31])

In essence, what the majority judges indicated was that the forfeiture of an office in a corporation, whether it was in the form of monetary payment or not, was in essence a penalty. Once it was determined that the proceedings exposed a person to a penalty, the proper course was to refuse any order for discovery in these matters.

Justice McHugh, in agreeing with the orders made by the majority, published a much longer judgment in which he examined the issues in some detail. In many ways his judgment replicated some of his arguments.

Justice Kirby in his dissent once again criticised the court for interpreting the relevant legislation in such as way as to critically impact on its administration.

Some readers may recall that Justice Kirby was in the minority and very critical of the majority judgment in the High Court in Re Wakim in 1999 when the then Corporations Act was "almost brought down on its knees" by the decision of the High Court that the relevant legislation at the time was unconstitutional. That resulted in the referral of powers by the various States and Territories to the Commonwealth leading to the current legislative regime that underpins the operation of the Act.

It is interesting to note that the five-year reference will shortly run out and we will need to see a re-negotiation of the reference of powers by the States and Territories to the Commonwealth. It is also understood that this is likely to occur.

In the Rich case Kirby J made these interesting comments about the approach taken by the majority in allowing the appeal. In his view this approach:

"needlessly restricts [ASIC] and the court in trying the claim. The restriction has no foundation in the language of the [Corporations Act]. Judges should not insert it. Doing so seriously impedes the attainment of the [Corporations Act's] important purposes for corporate governance in this country." (para 132)

ASIC will now need to carefully consider how it deals with these issues in administering this area of the law. It may well find that it can no longer pursue the civil penalty regime in the major cases rather limiting itself to criminal sanctions in these cases.

However, the speed and ease at which ASIC can proceed in these matters, if it abandons its reliance on obtaining documents on discovery and other

intrusive implementation of the use of its powers, may well result in a slow down of ASIC's implementation of its current program corporate law administration. This will in turn lead to ASIC seeking alternative measures in pursuing the administration of the Act.

Disclaimer

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.