Director's Counsel - Long after we’ve parted

A recent judgment shows that fiduciary obligations continue even after business relations come to an end. Professor Bob Baxt reports.

In many business situations involving non-public companies, where a partnership or a joint venture converts its arrangements into a company, some very interesting questions arise about the obligations each of the partners/joint venturers/shareholders (directors) may have to each other (and their organisations) at the end of, or the breaking up of their relationship.

The law recognises that partners, joint venturers and directors of companies owe what are known as fiduciary duties to their joint venturers, partners and in the case of a company, to the directors of the company (and in some cases to the shareholders of the company as well). When the partners/joint venturers/shareholders (directors) dissolve the former arrangements and go off on their own way, often without making full and proper account to their former partners/joint venturers/shareholders (directors) of the assets/business/profits they have collected, run and obtained in their previous arrangements, some difficult questions may arise. This is what the NSW Supreme Court dealt with in the recent decision of Lawfund Australia Pty Ltd v Lawfund Leasing Pty Ltd and ors [2008] NSWSC 144.

The facts of the case were briefly these: The plaintiff, Lawfund Australia (Lawfund) had, prior to 2002, operated mainly as a mortgage aggregator. The second and third defendant, Ms Ward and her company A-Ward, had conducted their business as lease finance brokers. In 2002, Lawfund wanted to expand its lease finance business and entered into an agreement with Ward. The lease finance business was conducted through a new joint venture company called Lawfund Leasing, in which Lawfund and Ward each had a holding of 50 per cent.

By 2004, the relationship between Lawfund and Ward had become strained. On 28 September, 2004, Lawfund proposed to terminate the relationship. The terms included the winding up of Lawfund Leasing and that Ward would vacate the Lawfund premises by 31 October. When Ward left, she allegedly took all the hardware and software associated with the business with her. She sub-leased another building to Lawfund Leasing from her own company, A-Ward. She allegedly continued to carry on the business of Lawfund Leasing until August 2005.

Ward later sought to enforce various aspects of the joint venture agreement she had with Lawfund which, in turn, sought to wind up Lawfund Leasing. Ward alleged that Lawfund had repudiated the contract between them and that she had accepted the repudiation and had treated the contract as terminated. She then transferred the Lawfund Leasing business to her own company A-Ward. Meanwhile, Lawfund established its own lease finance division under the name of Probitas Leasing.

In its capacity as a shareholder of Lawfund Leasing, Lawfund brought a statutory derivative action under Part 2F 1A of the Corporations Act against Ward and her companies, arguing that Ward breached her statutory duties as a director of Lawfund Leasing as well as certain other common law fiduciary duties. It also sought to restrain Ward and her company from using the name Lawfund. A winding up order was also sought.

Counter claims were brought by Ward and her company against Lawfund, arguing that the joint venture agreement had been repudiated and seeking damages both for misleading and deceptive conduct under the Trade Practices Act. She also claimed that Lawfund had acted oppressively pursuant to section 232 of the Corporations Act and sought an order from a court that Lawfund purchase all of her shares in Lawfund Leasing.

It is unnecessary in this note to consider the claims in relation to misleading and deceptive conduct and some of the other interesting issues that arose. We concentrate on the findings by the court about the obligations of the parties to each other on the basis that they owed fiduciary duties to each other.

Justice Brereton relied on the principles set out in the House of Lords decision of Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 (at p 379) where Lord Wilberforce noted that there was “room in company law for recognition of the fact that behind [the company] or amongst it, there are individuals, with rights, expectations and obligations inter se which are not necessarily submerged in the company’s structure”.

In these circumstances, Justice Brereton agreed that there were certain equitable obligations that were imposed between the shareholders of a corporation, including the shareholders in this case, namely:

• An association had been formed and continued on the basis of a personal relationship between the parties that involved mutual confidences in each other;
• An understanding that all or some of the shareholders would participate in the conduct of the business; and/or
• There had been certain restrictions imposed on the ability of the parties to transfer their shares, so they could not take out their stake and go elsewhere.

Justice Brereton concluded that both Lawfund and Ward owed fiduciary obligations to each other and in particular, they owed the following fiduciary obligations:

‘…to act with respect to the joint venture in good faith, and not to use their position or entitlement acquired by them in the course of and for the purpose of the joint venture to their own separate advantage or in a manner inconsistent with the interests of Lawfund Leasing as the joint venture vehicle, without the fully informed consent of the other and of Lawfund leasing’ (at [28]).

Having established this principle, the judge noted that the existence of fiduciary obligations did not preclude the joint ventures from terminating their arrangements.

Notwithstanding that right, the law also recognised that certain fiduciary obligations continued to apply after the termination of an arrangement. Lawfund alleged that Ward had breached her duties as a director by failing to comply with the terms of section 181 and 182 of the Corporations Act – that is, the duty to act honestly and the duty not to misuse one’s position as a director of a company. On the other hand, Ward counter claimed that Lawfund had breached its obligation by carrying on a separate leasing business after the termination of the joint venture and that this business competed illegally with the Lawfund Leasing business.

Justice Brereton noted that it was a well established equitable principle that partners are in breach of their fiduciary obligations if the partner carries on a business in competition with that of a joint venture in which the partner was involved. Yet, on the basis of these facts, the new business Probitas Leasing only begun to operate after the joint venture had been terminated. The critical question for the judge was whether with the joint venture having come to an end, Lawfund was precluded from operating the business Probitas by virtue of any surviving joint venture obligation.

He concluded that the termination of the partnership (or a joint venture), while it does alter the relationship between the relevant persons, “does not bring to an end all the fiduciary obligations which attend the relationship of partnership – and in particular those relating to partnership property, including commercial opportunities” (at para 68). While the joint venture remained afoot, certain obligations continued.

Having stated these principles, Justice Brereton then clarified some further points which are of interest in the context of the continued existence of relationships between parties such as joint venturers and others where no clear agreement is reached on the division of property that belongs to the business between the parties. At para 70-71 of the case, Justice Brereton noted that:

• If, after termination, one partner carries on the business using the capital of the other, that partner is liable to account to the partnership, and any commercial opportunities that arise must be exploited for the benefit of the partnership.
• A partner could, however, set up a new business in competition with the business of the former partnership, by pursuing new clients and contracts, rather than renewing those of the former partnership.
• Generally speaking one partner would not be entitled to take for itself the assets of the joint venture, such as the name, the business and the goodwill.
• However, in the absence of an agreement, undivided assets of a partnership that were not sold after dissolution would belong to the partners in common. Neither would be entitled to prevent the other from using them. This would include use of the firm’s name, so long as its use was not misleading (that a partner did not hold out to clients that the other members of the firm were still acting in partnership).

In all of the circumstances, Justice Brereton held that while the parties were at liberty to carry on the business of the joint venture, to establish new businesses and to service new and existing clients, it was important that the joint venture property should not be misused. To the extent that joint venture property was used for the individual purposes of the former joint venturers, they had to account to each other for the profits made from the use of this property. On the facts, it appeared that Ward carried on the existing business of Lawfund Leasing without accounting to Lawfund as the former company. This was problematic because not only did she continue to owe fiduciary duties to Lawfund Leasing as a director, she also owed equitable obligations as a former shareholder in a quasi partnership.

In conclusion, Justice Brereton restated the principle that equitable obligations arising in an incorporated joint venture are additional to the duties that are imposed by the principles of company law. They did not supplant the duties of directors although they may in fact be co-existent with these. While persons at the conclusion of a partnership may be at liberty to set up a new business and even exploit existing clients of the joint venture company “this does not relieve a partner/director from his or her obligations as a director to act honestly in the interests of the company as a whole”.

Justice Brereton decided that Ward had contravened both sections 181 and 182 of the Corporations Act. An order was made to determine what profits were generated by her and what should be divided between the two parties.

The outcome of this case turns on the fact that although the joint venture had been terminated, the parties had not made an agreement as to the division of the business assets, nor as to whether the business would be sold. The judgment suggests that in circumstances such as these, parties will not necessarily breach their ongoing fiduciary obligations to each other simply by establishing a new business in competition with the business of the former joint venture.

However, while the company established through the former joint venture is still in existence, the relevant directors’ duties to that company remain even though the joint venture agreement may have ended. In this context, former joint venturers who are also directors must continue to discharge their statutory duties. Conduct which may not constitute a breach of surviving equitable obligations may, nonetheless, contravene their legal duties under the Corporations Act and the common law.

Professor Bob Baxt is a partner at Freehills and chairman of the AICD Law Committee