Directors Counsel: A duty to one or all

Professor Bob Baxt examines a recent appeals case that suggests directors may owe duties to individual shareholders in certain circumstances.

A basic (and some would say trite) rule of company law is that directors owe their duty to the company, the company being the shareholders as a whole. For a number of years, in recent times, there has been debate as to whether directors might be said to owe a duty to creditors, especially where companies may be close to insolvency. The High Court of Australia has ruled that that is not the case. Also, the courts have consistently stated that directors do not owe duties to individual shareholders. But on rare occasions, courts have ruled that in particular circumstances, directors may owe duties to individual shareholders, especially if the company is what is known as a private company (sometimes referred to as a “closely held company”) and the facts are particularly relevant.

Now the New South Wales Court of Appeal (consisting of Justices Allsop, MacFarlan and Young) has ruled that in the circumstances described below, it was appropriate to rule that directors did owe a duty to individual shareholders.

The facts of Crawley & Ors v Short (as executrix of the estate of the late Warwick Gordon Short) & Anor(2010) ACSR 286 are complex but certain key features help to identify the reasons why the court ruled in the relevant way.

The dispute arose as a result of a claim that oppressive conduct had been engaged in two companies – J & J O’Brien (JJO) and Marsico Holdings (Marsico). In particular, the claims related to the acquisition of various shares of members of the two companies by Crawley, a director of the companies.

Marsico and JJO owned and operated hotels in and around Sydney. The shareholding structure of each company was such that each company owned three shares on behalf of three persons, Crawley, Short and Davis. Crawley, who was a director of the relevant companies, had purchased Davis’s interest in each of the companies.

Apparently, Crawley had relied on the pre-emption clauses that existed in the companies’ articles of association to acquire the shares. A central question for the judge, at first instance (Justice White), was whether the price paid and the manner in which the shares were acquired amounted to oppressive conduct pursuant to section 232 of the Corporations Act 2001. Furthermore, some of the shareholders alleged that Crawley, as a director of the relevant companies, had also acted in breach of his duty that was owed to the individual shareholders.

Justice White ruled that a remedy under section 232 of the Corporations Act had been established and ordered that the appellants purchase the shares of the respondents in the two companies in accordance with a formula set out in the judgement. However, he dismissed a claim that Crawley had breached his duty to act in good faith on behalf of individual shareholders.

The appeal was brought by the appellants from parts of the findings of the judge in relation to questions of liability and valuation. The respondents also appealed challenging the primary judge’s rejection of their claim, that their shares should have been assessed as if they constituted one half of the issued capital of each of the companies rather than one third. They also challenged the judge’s ruling that the breaches of duty on the part of Crawley as a director were breaches of duties owed to the companies and not to the shareholders as individuals.

There were a number of separate hearings involving the facts of the case, which are not relevant for our purposes. The New South Wales Court of Appeal overturned aspects of the trial judge’s findings. In particular, we deal with the question of whether the directors (and in particular Crawley) owed a duty to individual shareholders.

The main judgement in this case was written by Justice Young, who noted: “The fact that the result of a very complex case at first instance, with reasons for judgement exceeding 600 pages, is only challenged on appeal [in a limited way] pays tribute to the learned primary judge”.

The judgement of Justice Young sets out in some detail a complex set of facts surrounding the nature of the dispute between the parties in these private companies. There were questions relating to the facts that were central to the arrangements, but also questions relating to the interpretation of the articles of association (the constitution) of the relevant companies.

A critical issue for our purposes is whether there was a duty owed by the relevant director to the relevant shareholders. As noted earlier, and on the basis of the facts before him, Justice White held that there was no duty owed. He reached that conclusion because of the central theme in corporate law that directors do not owe duties to individual shareholders. Justice White cited important cases in this area – Percival v Wright [1982] 2Ch 421, Winthrop Investments Ltd v Winns Ltd [1975] 2 NSWR 666 and Brunninghausen v Glavanics (1999) 46 SWLR 538 and [1999] NSWCA 199. But Justice White did note that certain factual circumstances may give rise to a fiduciary relationship between a director and an individual shareholder being said to exist.

Having considered these background facts and certain other cases, Justice White came down heavily in favour of a proposition put forward by the New South Wales Court of Appeal in the Brunninghausen case at [1999] NSWCA [para 58]: “Where a director’s fiduciary duties are owed to the company this prevents the recognition of concurrent and identical duties to its shareholders covering the same subject matter. However, this should not preclude the recognition of a fiduciary duty to shareholders in relation to dealings in their shares where this would not compete with any duty to the company.”

Justice Young, after analysing the complex set of facts, made these relevant comments:

1. It is not proper to read the Brunninghausen dicta quoted above as being an exhaustive statement of the way in which the court should examine such issues.
   
2. There will be a variety of situations where a shareholder or a director/shareholder holds a special position where he or she may owe duties to another shareholder.
   
3. Without suggesting this was an exhaustive list, he ruled that a duty could occur where one shareholder undertakes to act on behalf of another shareholder, where one shareholder is in a position to have special knowledge and knows that another shareholder is relying on him or her to use that knowledge for the advantage of another shareholder as well as himself or herself; and where the company is in reality a partnership in corporate guise, nowadays termed a quasi-partnership.
   
4. In a pure partnership, a partner has a clear fiduciary duty not to take a personal advantage when dealing with the share of another partner.
   
5. There may be closely held corporations where the interests of the shareholders are so diverse that no such duty can be implied (Justice Young referred to a home unit company as a prime example where each shareholder is only interested in his or her own home unit).
   

In all the circumstances, and taking into account the detailed facts we have briefly outlined in this note, but which the Court of Appeal recognised had been dealt with effectively and fully by Justice White, the court ruled that on the question of fiduciary duty, Justice White was incorrect. The primary judge ought to have found that a fiduciary duty had been breached by the behaviour of Crawley in the relevant circumstances.

The decision is one that will clearly trouble many corporate lawyers. To break away from the tradition that directors owe their companies (that is to shareholders as a whole) will inevitably create various exceptions to the way in which companies should be governed and continue to be governed. One exception leads to the possibility of that exception being widened and escalated into a broader set of circumstances.

Even today, there are still debates as to whether directors do owe a duty to creditors in particular cases.

Certainly, the application of section 1324 of the Corporations Act (which allows persons whose interests are affected to challenge a statutory breach of duty on the part of the directors) will give an opening to creditors and others to sue directors in certain circumstances. This decision may well provide them with even further opportunities to do so.

Professor Bob Baxt AO FAICDLife is a partner at Freehills and chairman of the Australian Institute of Company Directors’ Law Committee