Professor Bob Baxt reviews a recent case that exposes the difficulties of superimposing personal obligations in the context of a company structure.

    The doctrine of equitable contribution

    It is a trite observation that under Australian law, when a company is created, even though the company is comprised of people who might otherwise have been in a partnership or joint venture, that entity, the company, is a separate legal entity. Furthermore, the people who form the company – whether there are only two or a very small number of members – have obligations to the company and, to a certain extent, to each other while running the company. Where directors of the company decide to carry on separate businesses in addition to that which is carried on by the company – provided they do not act against the interests of the company (for example, by utilising its name, assets, and opportunities for their own benefit) – there is no good reason why those separate enterprises and their assets and liabilities should be treated as belonging to the company. There is also no compelling reason why any personal debts incurred by a director should be shared by the other director.

    The High Court of Australia in Friend v Brooker [2009] HCA 21 has recently emphasised this point in an interesting and important decision. In this case, it reversed a majority decision of the New South Wales Court of Appeal and in doing so, restored the decision of Justice Nicholas in the New South Wales Supreme Court.

    While the case is not a true company law case, it deals with certain principles of equity – the equitable doctrine of contribution and whether a fiduciary relationship existed between the directors of the company to contribute to the debts of the other director. It is a very important decision for company directors.

    The facts arose in this way. Brooker and Friend were employees of John Holland Construction but had formed a joint venture or partnership to carry on a building and construction business. In 1977, this was converted into a company called Friend and Brooker. It was argued by Brooker that, throughout their relationship, the corporate vehicle’s aim was to conduct the business of the joint venture, which had wide-ranging interests. He further argued that debts incurred by him in pursuing his own business activities were, in effect, joint debts with Friend by virtue of the equitable doctrine of contribution, fiduciary relationships and other factors.

    At first instance, Justice Nicholas made what the High Court of Australia stated was a critical and important finding: “What happened was that from the time of incorporation the partnership ceased, just as the parties intended. The effect of incorporation changed the basis upon which the business had been conducted since May 1977, not only with regard to third parties, but also as between themselves. Thereafter, their relationship was as co-directors of the company and the assets and liabilities associated with the business were the company’s.” (Quoted by Justices French, Gummow, Hayne and Bell at para 12 of the High Court decision.)

    The two directors were equal shareholders in the company and in effect, created loan accounts between themselves and the company for much of the business’s activities. After some years of successful trading, they experienced difficulties in the company and in their separate businesses. Brooker and his wife sought funds to develop property owned by Brooker’s wife and mother. It was alleged by Brooker that Friend knew about the loan and had agreed that it should be obtained on their joint behalf. However, on the basis of the evidence, Justice Nicholas ruled: “There is no evidence that Friend agreed to be jointly liable for, or to contribute to, the repayment of the [relevant loan]. It is difficult to accept that, if in truth [Brooker] held the belief that [Friend] was equally liable for this loan, [Brooker] proceeded with the borrowing, and procured the securities from his wife and his mother without first obtaining [Friend’s] acceptance of such liability.” (Quoted by the majority judges in the High Court at para 18.)

    Justice Nicholas further ruled that there was no evidence to support a conclusion that Friend had intended to be bound by the obligations incurred by Brooker, his wife and his mother. As a result of the dispute surrounding the loan, and as the parties fell out, Brooker sued Friend for money outstanding in relation to the loans on the basis that Friend had to contribute an equal proportion of the money to be repaid. He relied on a number of grounds, including the fact of their equitable relationship to each other.

    Justice Nicholas, at first instance, had ruled that the doctrine of equitable contribution did not apply and that Friend was not liable by virtue of any other equitable arrangements between them. Brooker appealed to the New South Wales Court of Appeal. By a majority, it overturned Justice Nicholas’s judgment. The court further held that the equitable doctrine of contribution did apply and that Friend had fiduciary obligations to Brooker to account for the amounts outstanding.

    In both the New South Wales Court of Appeal and in the High Court, there was considerable discussion of a number of cases dealing with the doctrine of equitable contribution, whether there was a fiduciary relationship between the parties (Brooker and Friend) and certain related matters. It was suggested by Brooker, and inferred by majority of the New South Wales Court of Appeal, that where directors are involved in a common enterprise and the enterprise is pursued by the company and it suffers loss, by virtue of their relationship to each other, each director must contribute to the debts of the other.

    In addition to relying on the doctrine of equitable contribution, Justice McColl ruled that Brooker and Friend were subject to a fiduciary relationship “to be equally and personally liable for each other for losses flowing from personal borrowings”.

    On appeal to the High Court, Friend argued that the doctrine of equity did not impose any fiduciary duties between the parties in this particular context; there were duties owed to the company and not to each other as individuals. He also argued that the doctrine of equitable contribution did not apply in this case.

    The High Court was assisted in reaching its decision to reverse the Court of Appeal’s decision by the fact that over many years Friend and Brooker had each utilised their connections with family and friends to obtain loans that were then advanced to the company. However, this did not mean they owed an obligation to each other in relation to their separate borrowings.

    In all of the circumstances, the High Court (Justices French, Gummow, Hayne and Bell in one judgment and Heydon in a separate concurring judgment) ruled that there was no obligation on the part of Friend to contribute to Brooker’s debt and the trial judge’s findings were reinstated. There was no common design between the parties to ensure they would equally share in the profits and losses of respective family dealings. The evidence at first instance suggested that was not the case.

    In support of its conclusion that the interaction of the two parties should not be seen as creating any fiduciary obligations, Friend also emphasised that the parties by selecting a corporate structure as the vehicle of their business enterprise had by implication determined that the equitable doctrine of contribution should not be extended to “outflank the consequences of the selection by the parties of the corporate structure”. (High Court of Australia at para 88.)

    In the joint judgment of the High Court, the judges added that this selection of a corporate structure brought with it “the attendant legal doctrines of corporate personality and limited personal liability. Moreover, at the time of the incorporation of [the relevant company], the Companies Act 1961 (NSW) was in force and this (and the successor legislation) provided for the breakdown of relations between the controllers of closely held companies by such provisions as those for winding up on the just and equitable ground … and for oppression suits …” (at para 88 of the High Court decision).

    The joint judgment of the High Court emphasised that it was inappropriate to enlist doctrines of remedies relating to contribution and fiduciary relationships to disturb the findings of fact by the trial judge. The Court of Appeal was also in error.

    In a separate judgment, Justice Heydon reached similar conclusions, but did so on other grounds as well. These included questions of pleading (the way in which the case was argued before the court) and the nature of the trial in which evidence was led and relied upon by the trial judge, who will always have the best opportunity to assess the evidence and evaluate the facts.

    While the case turns very much on its own facts, the High Court clearly rejected the attempt to extend doctrines of equity and fiduciary relationships beyond the bounds that were relevant in the current circumstances. The choice of the corporate form was critical in the view of the joint judgment and this provides a clear message that the courts will not look behind the corporate form to find other relationships in existence unless the facts are so blatant as to require them to do so. Furthermore, the decision shows a willingness on the part of the High Court to “wind back” the reliance of doctrines of equity in earlier judgments of the High Court to expand the elements of liability in certain circumstances. It is an important decision for company directors, and more generally in relation to joint ventures and other similar organisational structures.

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