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LIABILITY OF A HOLDING COMPANY FOR THE DEBTS OF ITS INSOLVENT SUBSIDIARY
By
Johanna Barbara Cilliers
B A LLB H Dip Co Law L L M
Submitted in fulfilment of the requirements for the degree of
Doctor of Philosophy
from the University of Western Australia
Law School
University of Western Australia
Year of submission: 2002
PREFACE
I gratefully acknowledge a grant received from the University of Western
Australia, which was applied towards the research for this thesis.
My supervisor, Professor Jim O'Donovan, has offered invaluable guidance and
assistance which I sincerely appreciate and for which I would like to thank him.
I would also like to thank m y family, especially m y husband, both for acting as
a sounding-board and for his encouragement and motivation.
I declare that the thesis is my own composition, substantially completed during
the course of enrolment in this degree at the University of Western Australia
and has not previously been accepted for a degree at this or another institution.
INDEX
1 INTRODUCTION
1.1 Separate entity principle and limited liability 1
1.2 Extension of limited liability to corporate groups 6
1.2.1 Automatic extension inappropriate 6
1.2.2 Risk of creditor prejudice 8
1.2.3 Creditors are less efficient risk-bearers 14
1.3 Scope of investigation 16
1.3.1 Comparison with other jurisdictions 16
1.3.2 Limitation of topic 18
1.3.3 Roadmap 23
2 THE MEANING OF CONTROL AND THE REGULATION OF CORPORATE GROUPS
2.1 Background 25
2.2 Various applications of the control concept 28
2.2.1 Subsidiary/holding company relationship 29
2.2.1.1 Test of controlling the composition of the board 30
2.2.1.2 Voting control test 31
2.2.2 Consolidated accounts 35
2.2.3 Related party transactions 38
2.2.4 Cross share-holdings 41
2.3 Evaluation of position of group creditors 44
2.3.1 CASAC recommendations 45
45 2.3.1.1 Regulation by general control test
2.3.1.2 Wholly-owned groups to choose whether enterprise principles 46
apply
2.3.2 Critique of CAS AC recommendations 49
2.3.2.1 Regulation by general control test 49
(a) Replacement of 'holding/subsidiary' with 'control' 50 (b) Preferred definition of 'control' 52
2.3.2.2 Wholly-owned groups to choose whether enterprise principles 57
apply
60
61
3 PIERCING THE CORPORATE VEIL
3.1 Background
3.2 Fraud
3.2.1 Limited to exceptional cases 61
3.3.2 Further restriction on lifting the veil 66
3.3 Agency
3.3.1 Extent of control 70
3.3.2 Authorisation to contract 72
3.4 Single economic unit 74
3.5 Evaluation of position of group creditors 95
4 DIRECTORS' DUTIES: GENERAL PRINCIPLES
4.1 Background 98
4.2 Fiduciary duty to act in interests of company 99
4.2.1 Objective test laid down in Charterbridge 100
4.2.2 Subjective test laid down in Walker v Wimborne 102
4.2.3 Implied recognition of Charterbridge test after Walker v 105 Wimborne
4.2.4 Express recognition of Charterbridge test after Walker v 109 Wimborne
4.3
4.3.1
4.3.2
4.3.3
4.4
4.4.1
4.4.2
4.4.3
4.4.4
4.5
4.5.1
4.5.2
4.5.3
Nominee directors: notion of 'dual loyalty'
Traditional approach
Pragmatic approach
Notion of 'dual loyalty' similar to Charterbridge test
Duty of care, skill and diligence
Scope of duty
Statutory formulation of duty
Overlap with fiduciary duty
Overlap with insolvent trading provisions
Evaluation of position of group creditors
Fiduciary duty to act in interests of company
Nominee directors
Duty of care, skill and diligence
112
113
114
118
121
121
126
130
133
134
134
136
137
5 DIRECTORS' DUTIES: CAPITA SELECTA
5.1 Background 139
5.2 Particular difficulties in intra-group transactions 139
5.2.1 Downstream, lateral and upstream transactions 139
5.2.2 Restructuring a group 142
5.2.3 Uncommercial transactions 146
5.3 Duty to take into account interests of creditors 153
5.3.1 Extension of duty 153
5.3.2 Insolvency as condition established 155
5.3.3 Concept of'insolvency'delineated 157
5.3.4 Duty to future creditors 159
5.3.5 No direct duty to creditors 162
5.4 Statutory duty to act in interests of company 164
5.4.1 Interests of the company and proper purpose 164
5.4.2 Specific provision for corporate groups 167
5.5 Evaluation of position of group creditors 173
6 INSOLVENT TRADING: HOLDING COMPANY AS SHADOW DIRECTOR
6.1 Background 182
6.2 Addressing the problem 188
6.2.1 Position in the United Kingdom 188
6.2.2 Position in Australia 192
6.2.3 Position in New Zealand 196
.3 Liability of holding company 199
6.4 Evaluation of position of group creditors 218
6.4.1 Meaning of 'directors of the body' 218
6.4.2 Meaning of 'accustomed to act' 221
6.4.3 Meaning of directions or instructions' 222
7 INSOLVENT TRADING: HOLDING COMPANY AS SHAREHOLDER
7.1 Background 225
7.2 Addressing the problem 226
7.3 Liability of holding company 230
7.3.1 Criteria to be satisfied for contravention 230
7.3.1.1 'Incurs a debt' 233 (a) General 233 (b) Narrow approach - directors may easily escape liability 235 (c) Flexible approach - more difficult for directors to 238
escape liability (d) Voluntary and involuntary debts 240
7.3.1.2 'Insolvent' 243
7.3.1.3 'Reasonable grounds for suspecting' 247
7.3.2 Defences 250
7.3.2.1 Reasonable grounds to expect insolvency 251
7.3.2.2 Reliance on another 256
7.3.2.3 Illness or some other good reason 257
7.3.2.4 Reasonable steps to prevent incurring a debt 264
7.4 Evaluation of position of group creditors 265
7.4.1 Disadvantages as a result of intermingling 265
7.4.2 Other disadvantages 266
8 CONTRIBUTION AND POOLING: THE CURRENT POSITION
8.1 Background 272
8.2 Indirect pooling by the regulator 274
8.2.1 Shortcomings of Deeds of Cross Guarantee vis-a-vis creditors 276
8.2.1.1 Multiple insolvencies 276
8.2.1.2 Release from obligations 280 (a) Revocation 280 (b) Sale 281
8.2.2 Shortcomings of Deeds of Cross Guarantee vis-a-vis directors 282
8.2.2.1 Breach of fiduciary duty 282 (a) Committal 283 (b) Revocation 285
8.2.2.2 Breach of insolvent trading provisions of the Corporations Act 286
8.3 Indirect pooling by the courts 287
8.3.1 Schemes of arrangement and compromises/arrangements with 287 creditors
8.3.2 Other avenues 292
8.3.2.1 Rights of contribution and subrogation under inter-company 292 guarantees
8.3.2.2 Section 447A of the Corporations Act 296
8.3.2.3 Section 510 of the Corporations Act 303
8.4 Evaluation of position of group creditors 312
8.4.1 Indirect pooling by the regulator 312
8.4.2 Indirect pooling by the courts 315
9 CONTRIBUTION AND POOLING: THE CASAC RECOMMENDATIONS FOR A MODIFIED NEW ZEALAND MODEL
9.1 Background 318
9.2 Harmer Report recommendations 320
9.2.1 Contribution 320
9.2.2 Pooling 323
9.3 Legislative provisions relating to contribution and 325 pooling in New Zealand
9.4 Case law on contribution in New Zealand 328
9.4.1 'Such other matters as the Court thinks fit' 328
9.4.2 'Just and equitable' 330
9.5 Case law on pooling in New Zealand 334
9.5.1 'As if they were one company' 334
9.5.2 'Just and equitable' 337
9.6 Evaluation of position of group creditors 341
9.6.1 CASAC recommendations 341
9.6.1.1 Contribution orders 341
9.6.1.2 Pooling orders 343
9.6.2 Critique of CASAC recommendations 346
9.6.2.1 Uncertainty exists also in respect of pooling orders 346
9.6.2.2 Uncertainty exacerbated by confusing contribution and pooling 348
9.6.2.3 Summary 351
10 PROPOSALS
10.1 Inadequacy of existing law 352
10.1.1 Piercing the corporate veil 353
10.1.2 Directors'duties 354
10.1.3 Insolvent trading 355
10.1.4 Contribution and pooling 356
10.2 Proposed model 358
10.2.1 Pooling: To be used as a last resort 358
10.2.2 Contribution: Presumption of abuse based on control 361
10.2.2.1 Liability based on status versus liability based on fault 361
10.2.2.2 Substantive aspects 364
10.2.2.3 Procedural aspects 368
10.2.2.4 Contribution with a difference 374
10.2.2.5 Advantages of proposed model 378
10.3 Conclusion 381
SUMMARY 383
TABLE OF CASES 384
BIBLIOGRAPHY 395
ABBREVIATIONS 416
1
1.1
1.2
1.2.1
1.2.2
1.2.3
1.3
1.3.1
1.3.2
1.3.3
INTRODUCTION
Separate entity principle and limited liability
Extension of limited liability to corporate groups
Automatic extension inappropriate
Risk of creditor prejudice
Creditors are less efficient risk-bearers
Scope of investigation
Comparison with other jurisdictions
Limitation of topic
Roadmap
1
6
6
8
14
16
16
18
23
1 INTRODUCTION
1.1 Separate entity principle and limited liability
Anthropomorphism, prevalent in religion and politics since the Middle
Ages, also found its way into law.1 In the eighteenth century the
anthropomorphic idea inspired lawyers to regard every company as an
'artificial body' or legal persona, which was in turn the impetus for the
development of the principle of separate legal personality of a company.2
This principle and the other principles of our company and insolvency law
were developed in England in the nineteenth century, culminating fin de
siecle in the doctrine of limited liability in respect of companies. The
twentieth century evidenced the phenomenon of group activity in the sense
of the conduct of various businesses by a holding company through a
number of subsidiaries. Thus, as the Cork Report pointed out: 'It is not
surprising, therefore, that some of the basic principles of company and
insolvency law fit uneasily with the modern commercial realities of group
enterprise.'3
Consider the following scenario. Company A is the holding company of the
A B C Group.4 Company A and company B, a wholly owned subsidiary of
company A, have the same directors. Creditors of company B suffer losses
as a result of company B 's actions. They institute action not only against
company B, but also against company A. W h e n the creditors settle the
particular dispute with company B, the latter has no assets left and is
virtually insolvent. However, it becomes clear that a few similar actions lie
ahead. Company A decides to restructure the A B C Group. As part of the
restructuring company B is liquidated and company C is incorporated with
1 CT Carr, The General Principles of the Law of Corporations (1905) 150-155. 2 JB Cilliers 'Similar Company Names: A Comparative Analysis and Suggested Approach - Part I' (1998) 61 THRHR 132; JB Cilliers, The Prohibition of and Protection Against the Use of Identical and Similar Company Names in Company Law: A Comparative Study (1996), 1. 3 United Kingdom: Report of the UK Review Committee on Insolvency Law and Practice chaired by Sir Kenneth Cork, Cmnd 8558 (1982) (Cork Report), para 1922. 41 n Australia t he t erms ' holding c ompany' a nd ' parent' (or ' parent c ompany') a re used interchangeably. For the sake of consistency the term 'holding company' is used throughout this thesis, unless a quotation is used or reference is made to authority which itself makes use of the term 'parent'.
2
the financial assistance of company A to continue company B's activities.
As anticipated, company B's creditors institute a second series of actions
against company A.
Startling though it may be, as the law currently stands there is generally no
basis on which to hold company A or its directors (who acted on its behalf)
liable in this hypothetical scenario, whether by piercing the corporate veil
between the different group companies or otherwise. Company A is allowed
to continue trading without the risk of being held liable for the claims by
company B's creditors. Company A is legally entitled to use the corporate
structure to ensure that the liability of particular activities falls on another
group member. Since company B is in insolvent liquidation and company C
did not exist at the time it is claimed the losses were suffered, there is no
remedy available for the creditors.
The rule that shareholders and directors are not generally liable for the debts
of their company has become almost synonymous with the principle of
separate legal personality.5 However, incorporated companies existed and
operated long before the general introduction of limited liability. The
limitation of its members' liability was not a consistent feature of a
company incorporated as a separate legal person - it was only generally
introduced when the change of law was considered a matter of social and
economic necessity.6 But the separate legal entity principle, which was
reaffirmed in Salomon v Salomon & Co Ltd,1 was taken to have been
Limited liability is not an inevitable, but rather a natural, consequence of separate legal personality. It is possible to register an unlimited company: s 112 and s 113 of the Corporations Act 2001 (Cth) (Corporations Act). The Corporations Law was replaced by the Corporations Act on 15 July 2001. Reference is made to the Corporations Law where applicable in this thesis, for example, where previous case law is discussed. Unless otherwise indicated, however, the provisions of the Corporations Law and the Corporations Act discussed in this thesis may for all practical purposes be regarded as similar. 6 See D K Avgitides, Groups of Companies - The Liability of the Parent Company for the Debts of its Subsidiary, (1996), 43. 7 [1897] A C 22 (Salomon v Salomon), reversing sub nom Broderip v Salomon [1895] 2 Ch 323. For a discussion oi Salomon v Salomon, see L Sealy, 'Modern insolvency law and Mr Salomon' (1998) 16 C&SU 176 at 176-77; Avgitides, above n 6, 147-150. For a more extended discussion of corporate personality, see the various contributions in R Grantham and C Rickett (eds), Corporate Personality in the 2(fh Century, (1998) and the Federal Law Review, 'Special issue on corporate law: a century of Salomon'' (1999) 27 Fed L Rev 173-
3
extended so that the liability of shareholders and directors would be limited
as a general rule. From this it follows that ordinarily a holding company is
not liable for the debts of its subsidiary.8
Arguably, in Salomon v Salomon9 a radical proposition by Lord Macnaghten
extended the separate legal entity principle unnecessarily to include limited
liability. First his Lordship laid down clearly the concept of separate
corporate personality when he stated:10
The company is at law a different person altogether from the subscribers to the memorandum; and though it may be that after incorporation the business is precisely the same as it w as before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them.
However, Lord Macnaghten then continued by saying that '[n]or are the
subscribers as members liable, in any shape or form, except to the extent
and in the manner provided by the Act'.11 Since then the separate legal
entity and limited liability principles have been 'fused' and viewed as the 1*)
same. Thus, although it developed as a sort of 'afterthought', the rule of
limited liability became generally entrenched as part of the principle that a
company is a separate legal entity and has since become one of the linchpins
of modern company law.
Lord Denning pointed out that the doctrine laid down in Salomon v 1 "\
Salomon 'has often been supposed to cast a veil over the personality of a
limited company through which the courts cannot see'.14 This doctrine will
be adhered to unless the existence of special circumstances justify the lifting
321. As Avgitides, above n 6, points out at 13-44, English law had accepted long before this case that a non-human entity could in law be the subject of rights and duties. This was borne out by the legislative reforms five decades earlier, culminating in the Companies Act 1844 (UK). 8 But see, eg, s 588V of the Corporations Act. 9 [1897] A C 22. 10 Ibid 5\. uIbid. 12 H G Henn and JR Alexander, Laws of Corporations and Other Business Enterprises (1983), 19. 13 [1897] A C 22. 14 Littlewoods Mail Order Stores Ltd v Mc Gregor (Inspector of Taxes) [1969] 3 All ER 855 at 860.
4
of the veil of incorporation b y the court or specific 1 egislative previsions
enable the corporate veil to be pierced.15 The principle that a company is a
separate legal entity is also firmly entrenched in Australia, where it has been
extended to companies carrying on business in corporate groups.
Moreover, in this country the extension of the separate legal entity principle
was also adopted so that, among other things, creditors of a particular
subsidiary m a y only look to that subsidiary for payment of monies owed,
and not to any of the other companies in the group.
The fact that holding companies also enjoy limited liability is largely
responsible for claims that creditors of group companies are inadequately
protected. Under general law limited liability allows holding companies,
which by definition control their subsidiary companies, to undertake risky
projects through their subsidiaries with finance from external creditors. If
the subsidiary becomes insolvent, the creditors are not repaid, while the
holding company may c ontinue to flourish because it is not liable for the
debts of its subsidiary. It would therefore appear that creditors are not
adequately protected against possible abuse of control in a group situation,
especially where insolvency intervenes.
1 7
In Re Southard & Co Ltd a holding company placed its wholly-owned
subsidiary in a creditors' voluntary liquidation through an extraordinary
general meeting of shareholders. The holding company subsequently sought
an order for the compulsory winding up of the subsidiary. The question that
arose was whether the order should be refused on the ground that a minority
of unsecured creditors opposed the petition. The court refused the winding-
Technically speaking there is a difference between piercing the corporate veil and lifting the corporate veil. See further the discussion in I Ramsay and D Noakes, 'Piercing the corporate veil in Australia' (2001) 19 C&SLf 250 at 251-252. The distinction between the meaning of the two terms is not widely recognised in Australia, with the courts sometimes using them as alternatives. The terms are used interchangeably in this thesis. 16 Walker v Wimborne (1976) 137 C L R 1; Industrial Equity Ltd v Blackburn (1977) 137 C L R 567. This thesis applies to both formal and informal groups. A n example of an informal group may be found in Walker v Wimborne, where the companies were only associated and did not formally fall within the definition of holding and subsidiary company of the Corporations Act. 17 [1979] 1 WLR1198.
5
up order since the holding company had not proved that the assets of its
subsidiary would be realised more expeditiously and more economically if
the company were wound up compulsorily.18 However, the right of the
holding company to place its subsidiary in voluntary liquidation was not
challenged. In this regard Templeman LJ in an oft-quoted passage restated:19
English company law possesses some curious features, which may generate some curious results. A parent company may spawn a number of subsidiary companies, all controlled directly or indirectly by shareholders of the parent company. If one of the subsidiary companies, to change the metaphor, turns out to be the runt of the litter and declines into insolvency to the dismay of its creditors, the parent company and the other subsidiary companies may prosper to the joy of the shareholders, without any liability for the debts of the insolvent subsidiary.
Although Roman law had traces of limited liability and group trading, the
modern limited liability company in the common law developed in the mid-
nineteenth century in England from where it spread to other j urisdictions
such as the United States of America (United States).21 Generally, the object
of using the corporate form was to facilitate the raising of capital, but it is
arguable that from the earliest times the predominant motive was to obtain
the advantage of limited liability.22 In the United States Anderson v Abbott22
confirmed that the main purpose of incorporation was insulation from
creditors.24 This was reiterated by the Master of the Rolls in Commissioners
of Inland Revenue v Sansom25 where he stated:26
[T]he great reason why so many people form their businesses into limited companies and others invest their money in them is in order that they may be under no personal liability in respect of the transactions of those companies, and that is a perfectly legitimate object..,
18 Ibid 1206 (Buckley LJ). 19 Ibid 120$. 20 See W Buckland, Roman Law and Common Law (1965) 54; S Williston, 'History of the Law of Business Corporations Before 1800 (pt 2)' (1888) 2 HarvLRev 149 at 164. 21 P W Ireland, 'The Rise of the Limited Liability Company' (1984) 12 Int J Soc Law 239; Avgitides, above n 6, 13-44. 22 Ireland, above n 21, 248; A Freiberg, 'Abuse of the Corporate Form: Reflections from the Bottom of the Harbour' (1987) 10 UNSWLJ 67 at 90. Cf A Hicks, 'Corporate form: Questioning the unsung hero' (1997) JBL 306 at 315-6. 23 321 U S 349 (1944), 361 (Douglas J). 24 On the history of limited liability in the United States, see E M Dodd, 'The evolution of limited liability in American industry: Massachusetts' (1948) 61 Harv LRev 1351. 25 [1921] 3 K B 492. 26 Ibid 500 (Lord Sterndale M R ) .
6
1.2 Extension of limited liability to corporate groups
1.2.1 Automatic extension inappropriate
Limited liability has been described as 'the greatest single discovery of
modern times' and 'by far the most effective legal invention ...made in the
nineteenth century'.27 It has also been said that '[ejven steam and electricity
are far less important than the limited liability corporation, and they would 98
be reduced to comparative impotence without it.' But it does not
necessarily mean that a blanket extension of this principle to corporate
groups is justified.29 The main problem is that, in the nineteenth century
when the principle of separate legal personality was laid down, the practice
of companies trading as a group had not been e stablished. The separate
legal entity principle only regulated the affairs of a single company and
made no provision for companies carrying on business as part of a group.
The holding company/subsidiary relationship came into existence some time
after the notion of limited liability had become popular and the latter was
' President Eliot of Harvard, quoted in W W Cook, 'Watered stock - Commissions - Blue sky laws - Stock without par value' (1921) 19 Mich L Rev 583. Cf however, W P Hackney and T G Benson, 'Shareholder liability for inadequate capital' (1982) 43 Uof Pitt L Rev 837 at 841 and S M Bainbridge, 'Abolishing veil piercing' (2001) 26 Iowa J Corp L 479 who quote President Nicholas Murray of Columbia University as having said in 1911: 'I weigh m y words when I say that in m y judgment the limited liability corporation is the greatest single discovery of modern times ... Even steam and electricity are far less important than the limited liability corporation, and they would be reduced to comparative impotence without it'. See further A Muscat, The Liability of the Holding Company for the Debts of its Insolvent Subsidiaries (1996) 153 and the authorities referred to there. 28 N M Butler, 'Why should we change our form of Government', quoted in JC Bonbright and G C Means, The Holding Company- Its Public Significance and its Regulation (1932) at 3. 29 See, eg, R Nathan, 'Controlling the puppeteers: reform of parent-subsidiary laws in N e w Zealand' (1986) 3 Canterbury L Rev 1 at 25, who is of the view that 'the extension of limited liability to corporate shareholders has the undesirable consequence of fostering inefficient investment in rather marginal and questionable undertakings.' 30 JE Antunes, 'The liability of poly-corporate enterprises' (1999) 13 Conn J Int'l L 197 at 208. For a discussion of reasons for corporate groups, see I Ramsay and G Stapledon, Corporate Groups in Australia (1998) 14-16. 31 F Wooldridge, Groups of Companies - The Law and Practice in Britain, France and Germany (1981) 1.
7
automatically extended to corporate groups without taking into account the
different considerations involved.32
Professor Blumberg, a leading authority on corporate groups in the United
States, argues that, while in a single corporation the shareholder has to be
insulated from liability by way of limited liability, this is not necessary in a
group situation. The shareholders of the holding company already have the
privilege of limited liability. In this regard he states:34
The courts, dazzled by the concept of the corporation as a separate entity, the same rule was applied apparently unthinkingly and automatically to the parent corporation, achieving a different unanticipated end ...[L]imited liability for corporate groups, one of the most important legal rules in economic society appears to have emerged as an historical accident.
The majority of commentators agree with the view that one should not
extend the concepts of legal personality and limited liability uncritically to
holding companies.35 It is submitted that there is ample justification for this
view. W h e n a company becomes part of a corporate group a double layer of
protection is called into use. Individual shareholders will still enjoy limited
liability if the holding company is held liable for the debts of another
company in the group. Also, by incorporating again - by making use of a
subsidiary - individuals w h o invested in the company originally and enjoyed
limited liability are n o w not even liable for their original investment.
Liability is therefore being limited twice (or many times) over.
A n extension of the concept of limited liability would ignore the fact that
completely different considerations apply, depending on whether one is
32 In England, the Limited Liability Act 1855 (18 & 19 Vict, c 133) introduced general limited liability. For the historical background, see H A Shannon, 'The coming of general limited liability' (1931-1932) 11 Economic History 267; Avgitides, above n 6, 13-44. 33 Hereinafter referred to as 'Blumberg'. 34 See PI Blumberg, The Law of Corporate Groups: Problems in the Bankruptcy or Reorganization of Parent and Subsidiary Corporations Including the Law of Corporate Guarantees (1985) (Corporate Groups: Bankruptcy) 3 99-452. Cf Berkey v Third Ave Ry 244 NY 84, 155 NE 58 (1926). 35 Antunes, 'The liability of poly-corporate enterprises', above n 30, at 213-214. Muscat, above n 27, 158 and 161. 36 Muscat, above n 27, 195. See further J Farrar, 'Legal issues involving corporate groups' (1998) 16C<ft£L/184atl89.
8
dealing with the liabilities of sole independent corporations or with mere
parts of a corporate group whose activities fall squarely under the control of
the holding company. W h e n one attempts to apply the principle of a
company's separate legal existence to conglomerates, a legal minefield
fraught with problems is exposed, so that the strict application of this
principle requires re-evaluation in an environment where group trading is
commonplace.37 The indiscriminate application of limited liability to
corporate groups has led to 'untenable distortions' and 'grossly unfair
results'.38 The best proof that the automatic extension of the principle in
Salomon v Salomon39 is not appropriate where corporate groups are
involved is the growing number of cases in which it is alleged that the result
of the application of this rule is inequitable. These cases range across the
whole spectrum of the law and will probably increase, since enterprises
operating in industrial sectors usually expand by making use of subsidiaries
to limit their exposure for torts.40
1.2.2 Risk of creditor prejudice
Limited 1 iability is generally j ustified o n the b asis that i t i s e conomically
efficient.41 A number of reasons are given in support of the argument that
C Schmitthoff, 'Introduction' in C M Schmitthoff and F Wooldridge (eds) Groups of Companies (1991) ix; JE Antunes, Liability of Corporate Groups - Autonomy and Control in Parent-Subsidiary Relationships in US, German and EU Law: An International and Comparative Perspective (1994) (Liability of Corporate Groups) 4. 38 Antunes 'The liability of poly-corporate enterprises', above n 30, 213-214. 39 [1897] A C 22.
Illustrations of catastrophes involving large multinational corporate groups are the Bhopal disaster in India, the A m o c o Cadiz channel oil spill in France, and the chemical accidents involving Sandoz in Switzerland and Hoffmann-La Roche in Italy. Recent examples of corporate collapses in Australia include Ansett Holdings Ltd, HIH Insurance Ltd, One.Tel Ltd and Harris Scarfe Holdings Ltd. See further C C H , Collapse Incorporated - Tales, Safeguards & Responsibilities of Corporate Australia (2001). See also F Varess, 'The buck will stop at the board? A n examination of directors' (and other) duties in light of the HIH collapse' (2002) 16 Comm LQ 12.
If the principle that a company is a separate legal entity is strictly adhered to in a group context, a risk for creditors exists in that assets and liabilities can be moved around in the group. One of the most important justifications of limited liability for corporate groups - ie that risk can be allocated efficiently as creditors can determine what risk is involved and act accordingly - is thereby negated: See H Hansmann and R Kraakman, 'Toward Unlimited Shareholder Liability for Corporate Torts' (1991) 100 Yale LJ 1879; R E Meiners, JS Mofsky and R D Tollison, 'Piercing the Veil of Limited Liability' (1979) 4 Delaware J Corp L 351 at 361; Freiberg, 'Abuse of the Corporate Form: Reflections from the Bottom
9
limited liability is more efficient as a general rule than unlimited liability.
First, it is argued that it reduces the agency costs involved in supervising
management and the wealth of other shareholders.43 Secondly, it is argued
that it contributes to the efficient operation of securities markets by
providing an incentive to managers to act in shareholders' interests by
promoting the free transfer of shares. Limited liability is also justified on the
basis that it fosters effective diversification by shareholders, lowering their
individual risk and reducing the cost of capital. Furthermore, it is argued
that limited liability benefits society in general by facilitating ideal
investment decisions by management.44
Blumberg points out that many of the justifications for limited liability have
limited or no application as far as holding companies and their wholly
owned subsidiaries are concerned.45 The argument that agency costs are
lower does not apply to holding companies with wholly owned subsidiaries,
as a holding company has strong incentives to monitor the managers of its
wholly owned subsidiaries and there are no other shareholders involved
whose wealth must be monitored. The argument that limited liability
provides an incentive to managers to act in shareholders' interests by
promoting the free transfer of shares does not apply where the holding
company is the only shareholder. The justification that limited liability
allows shareholders to diversify in an efficient manner, enabling them to
minimise their individual risk, is to a lesser extent applicable to holding
companies. This is because holding companies are generally less risk-averse
than individual shareholders, as they have a double layer of protection.46
of the Harbour', above n 20, 77-78; Companies and Securities Advisory Committee (CASAC), Report on Reform of the Law Governing Corporate Financial Transactions, (Burrows Committee Report) (1991) 1. 42 F Easterbrook and D Fischel, The Economic Structure of Corporate Law (1991), 41-44. 43 Agency costs are the costs of monitoring and assessing management. 44 For a comprehensive explanation, see F Easterbrook and D Fishel, 'Limited liability and the corporation' (1985) 52 Univ Chicago Law Rev 90; P Halpern, M Trebilcock and S Turnbull, 'An economic analysis of limited liability in corporation law' (1980) 30 UT Faculty LR 299. 45 P Blumberg, 'Limited liability and corporate groups' (1986) 11 J Corp Law 573 at 623-626. See also Bainbridge, above n 27, 529fF. 46 K Hofstetter, 'Multinational enterprise parent liability: efficient legal regimes in a world market environment' (1990) 15 North Car J Int'l L & Comm 299 at 307. See further IM
10
Blumberg admits, however, that some of the justifications for limited
liability are applicable to partly owned subsidiaries.47 Although his analysis
demonstrates that the case for limited liability is diminished as far as
wholly-owned subsidiaries are concerned, it does not prove that it would be
more efficient to remove limited liability from holding companies. Indeed,
this is a question that has been troubling lawyers for a very long time. In this
regard the n o w famous debate between Professors Landers and Posner as
to whether limited liability should apply to so-called 'multi-tiered'
corporations in bankruptcy that took place in the United States in the 1970's
is relevant.50 This debate is revisited in Chapter 10.
Landers opposed limited liability of group companies, arguing that creditors
of a single corporation were not exposed to the same dangers as creditors of
group companies.52 In a group there was a great incentive for group
controllers to move assets between different companies, so that profits to the
group, rather than to individual companies in the group, were maximised.
Due to the likelihood of intra-group movement of assets, it may be too
expensive for creditors to obtain information regarding the financial position
of the relevant company.53 Creditors could thus easily be misled as to which
company in the group owned what assets. Complex group structures may be
Ramsay, 'Allocating liability in corporate groups: an Australian perspective' (1999) 13 Conn J Int'lL 329 at 341-343; I Ramsay and D Noakes, 'Piercing the corporate veil in Australia' (2001) 19 C&SLJ 250 at 263. 47 Blumberg, 'Limited liability and corporate groups', above n 45, 573. 48 K Yeung, 'Corporate groups: legal aspects of the management dilemma' [1997] LMCLQ 208 at 256-263. 49 Hereinafter referred to as 'Landers' and 'Posner' respectively. ,0 This debate was started by JM Landers, 'A unified approach to parent, subsidiary, and affiliate questions in bankruptcy' (1975) 42 Univ Chicago Law Rev 589. R A Posner challenged this in 'The right of creditors of affiliated corporations' (1976) 43 Univ Chicago Law Rev 499. Landers had an opportunity to reply to Posner in 'Another word on parent, subsidiaries and affiliates in bankruptcy' (1976) 43 Univ Chicago Law Rev 527. 51 See Ch 10 para 10.2.3.
Landers, 'A unified approach to parent, subsidiary, and affiliate questions in bankruptcy', above n 50, 639-40 did, however, state an exception to this principle, namely in cases where a creditor could prove that he relied on the creditworthiness of a particular member of the group.
In other words, the directors would m ake management decisions for the benefit of the group as a whole, rather than looking after the interests of a specific subsidiary company, so that the subsidiary may never become profitable.
11
used to conceal the true financial position of individual group companies
from creditors. Furthermore, the directors could make management
decisions for the benefit of the group as a whole, rather than look after the
interests of a specific subsidiary company, so that the subsidiary might
never become profitable. Basically, Landers argued that the abuses of
limited liability in corporate groups were so rife that creditors should be
excused from having to prove that an abuse occurred. Landers contended
that, because limited liability shifted the risk of business failure to creditors,
for which they were under-compensated, limited liability was inefficient in
corporate groups.54
In stark contrast to Landers, Posner supported limited liability for group
companies. H e claimed that creditors were fully compensated for the risk
they had to bear, which was reflected in their profit margin. Posner argued
that creditors should contract to protect themselves against subsequent
action by a corporation that adversely affected their prospects of being
repaid. H e denied the claim that a holding company had the incentive to
maximise the profits of the group rather than individual companies. Instead
he claimed that, when the profits of each individual company were
maximised, the profits of the group would likewise be maximised.56 Posner
argued that abuses were not as prevalent as portrayed by Landers, who only
considered reported case law on bankruptcy. This, according to Posner, was
not a true reflection of everyday business transactions involving creditors.
Posner said that it was d eceptive to look only a t these cases, because the
incorrect impression could be created that invariably the purpose of carrying
54 Landers, 'Another word on parent, subsidiaries and affiliates in bankruptcy', above n 50, 529. 55 Landers was primarily concerned with the increase in misappropriation risk: Landers, 'A unified approach to parent, subsidiary, and affiliate questions in bankruptcy', above n 50, 595-596. 'Misappropriation risk'provides increased opportunities for asset shifting from shareholders to creditors. It should be distinguished from 'enterprise risk', which is the irreducible variability in the earnings of the business. Although Posner did consider misappropriation risk, he appeared to be more concerned with the allocation of enterprise risk: Posner, 'The right of creditors of affiliated corporations', above n 5 0,5 07-509 and 515-516. Their approaches conflict, because the desirability of enterprise risk allocation by making use of limited liability m a y substantially increase misappropriation risk in corporate groups. 56 Posner did not supply any reasons in support of his claim.
12
on business in a group was to mislead creditors. H e also claimed that
liability of a holding company for its subsidiaries' debts would increase the
cost of credit, as creditors of one company would have to examine the
creditworthiness of all the other group companies.57
Although this controversy is still unresolved,58 it may be argued that
Posner's claim that creditors are fully compensated for the risk that they
have to bear can only be true in an ideal market where all information is
available to creditors and where there are no transaction costs.59 The reality
is that high transaction costs m a y prevent the proper re-allocation of risks.
The costs involved for creditors in obtaining sufficient information about
their credit risk m a y be out of proportion to the amount involved. There is
also empirical evidence, at least in the United States, to the effect that it is
very rare for trade creditors to extract negative pledges. ' Furthermore, it is
very difficult for individual creditors to co-operate in a collective action.
They m a y therefore lack the necessary incentive to act jointly to prevent
opportunistic behaviour by the company to their detriment.62
From the exposition above it appears that the removal of limited liability
may be justified in certain circumstances to ensure that holding companies
do not transfer the risk of business failure to the creditors of their subsidiary
companies without compensation.63 The transfer of assets between different
57 Posner, 'The right of creditors of affiliated corporations', above n 50, 513-514. See C W Frost, 'Organizational form, misappropriation risk, and the substantive
consolidation of corporate groups' (1993) 44 Hastings LJ 449 at 467ff. Blumberg, Corporate Groups: Bankruptcy, above n 34, 448-52 sided with Landers, while Hansmann and Kraakman, above n 41, at 1919-1921 sided with Posner. See further D W Leebron, 'Limited liability, tort victims, and creditors' (1991) 91 Columb L Rev 1565 and R A Posner, Economic Analysis of Law (1992) at 406-09 (revisiting the debate). 59 Yeung, above n 48, 256-263.
K Hofstetter, 'Parent responsibility for subsidiary corporations: evaluating European trends' (1990) 39 ICLQ 576. J C Coffee,' Shareholders versus managers: the strain in the corporate web' (1986) 85
Mich LRev\. See also Bond Brewing Holdings Ltd v National Australia Bank Ltd (1990) 1 A C S R 445; R Grantham, 'The judicial extension of directors' duties to creditors' [1991] JBL 1 at 3 and the authorities cited there.
I Ramsay, 'Holding company liability for the debts of an insolvent subsidiary: a law and economics perspective' (1994) 17 UNSWLJ 520 at 523.
D D Prentice, 'Groups of companies: the English experience' in KJ Hopt (ed) Groups of Companies in European Law - Legal and Economic Analyses on Multinational Enterprises
63
13
group companies m a y enhance the efficiency of the group and should
therefore not as a matter of course be prohibited. Such transfers may,
however, prejudice creditors' interests where there are insufficient assets to
satisfy their claims. The legal protection of creditor interests m a y therefore
be justified where the transaction costs are prohibitive, so as to preclude
them from protecting themselves by contract against actions that m a y reduce
the assets of the particular company.64 The theory that creditors can protect
themselves by charging higher interest rates for higher levels of risk does
not ring true where the costs involved for the creditor to obtain the
necessary information regarding the level of risk are disproportionate to the
amount involved in the transaction.65 The removal of limited liability in the
context of corporate groups across the board may, however, not be justified,
as creditors will then need to assess the credit risk of all group companies.
This will increase the cost of credit66 and may serve to discourage
entrepreneurial activity.
It is relevant that creditors of an insolvent company are faced with what is fZQ
known as a 'moral hazard'. This may be explained as follows. Excessive
risk-taking by shareholders is exacerbated at the onset of insolvency. The
existence of limited liability means that a holding company is only liable to
the amount of its shareholding in its subsidiary if the latter becomes
insolvent. The holding company as shareholder (via its directors) is
therefore prepared to engage in risky investments as it has nothing to lose.
Most of its funds have already been dissipated and there is a remote chance
that, if it continues the business of the company, insolvency m a y even be
prevented so that the holding company does not lose its original investment
(1982) 102 at 106. See further Ramsay, 'Allocating liability in corporate groups: an Australian perspective', above n 46, 366-367. 54 Yeung, above n 48, 256-263. 65 Ramsay, 'Allocating liability in corporate groups: an Australian perspective', above n 46, 363-364. 66 Posner, 'The right of creditors of affiliated corporations', above n 50, 516-517; Cork Report, above n 3, para 1946. 67 Cork Report, above n 3, para 1940. 68 Yeung, above n 48, 256-263; Coffee, above n 61, 61-62. 69 L Lin, 'Shift of fiduciary duty upon corporate insolvency: proper scope of directors' duty to creditors' (1993) 46 Vand L Rev 1485 at 1489-93.
14
in the subsidiary.70 It is thus in the interests of the holding company that the
subsidiary should continue trading when it is insolvent, even though it is
obviously more risky for the subsidiary's creditors.71 It is therefore often
said that, because of the principle of limited liability, a holding company has
a perverse incentive to allow the subsidiary to continue trading while it is
insolvent.
1.2.3 Creditors are less efficient risk bearers
Leaving aside the question of the risk of creditor prejudice, a related
question is whether, on policy grounds, limited liability should in any event
be extended to corporate groups. It is sometimes argued that the application
of limited liability to corporate groups, irrespective of the control of the
holding company over the subsidiary, is inefficient on the ground that the
holding company is a more efficient bearer of risk of business failure than
the creditors of the subsidiary.72 This argument is even more controversial
than the argument relating to the risk of creditor prejudice that formed the
subject of the debate between Landers and Posner. It entails that the power
of the holding company to control the affairs of its subsidiaries should lead
to a positive duty to act on the part of the holding company, in order to
prevent detriment to the creditors of its subsidiaries.74
The Australian legislature has, however, embraced the notion that holding
companies are superior risk bearers by enacting ss 588V-588X of the
Corporations Act.15 This thesis therefore proceeds upon the assumption that
holding companies are the most efficient risk-bearers in the context of
corporate groups. Section 588V shifts the risk of loss that results from
insolvent trading by an insolvent subsidiary from its creditors or its directors
Coffee, above n 61, 61. 71 Ibid 61-62.
Ramsay, 'Holding company liability for the debts of an insolvent subsidiary: a law and economics perspective', above n 62, 540-541. See the discussion in para 1.2.2 above.
74 Yeung, above n 48, 256-263.
See also I Ramsay, Transcript of Symposium held at Connecticut in 1998, published in (1999) 13 Conn JInt'l L 397 at 471-4. For a detailed discussion of s 588V, see Ch 7.
15
to the holding company. Sections 588V-588X provide that a holding
company m a y be held liable for debts incurred by a subsidiary under certain
circumstances. This will be the case when the holding company (or one or
more of its directors) was aware of, or could reasonably be expected to be
aware of, grounds for suspecting that the subsidiary was insolvent and failed
to take all reasonable steps to prevent the subsidiary from incurring the debt.
It is not necessary to prove that the holding company was actively involved
in the affairs of the subsidiary.76 In its defence the holding company may,
however, prove that it expected or that it had reasonable grounds to expect
that the subsidiary was solvent and would remain solvent at the relevant 77
time.
It is submitted that Ramsay is correct, at least theoretically, when he states
that these provisions are advantageous to ensure that the most efficient risk
bearers,78 namely the holding companies, as opposed to the subsidiary's
creditors or directors, bear the risk of business failure.79 It is conceded that
sophisticated creditors m a y be better placed than individual shareholders to
monitor management, because they have specialised knowledge and do not
suffer from what has become known as the 'free rider' problem. This
entails that shareholders are often reluctant to incur expenses in instituting
proceedings against management because they are unable to exclude other
shareholders w h o have not contributed to the legal costs from participating
in the benefits obtained. At the same time it must be acknowledged that a
holding c ompany i s in a b etter position than b oth individual shareholders
and creditors to monitor the affairs of its subsidiaries. The fact is, however,
that in practice holding companies emerge unscathed.
76 J Hill, 'Corporate groups, creditor protection and cross guarantees: Australian perspectives' (1995) 24 Can BusUl2\ at 237. 77 Section 588X of the Corporations Act. 78 This statement was made in the context of public companies. 791 Ramsay, 'Holding company liability for the debts of an insolvent subsidiary: a law and economics perspective', above n 62, 523. 80 See further on the 'free riding' problem Bainbridge, above n 27, 491.
16
1.3 Scope of investigation
1.3.1 Comparison with other jurisdictions
Countries other than Australia have employed different techniques in an
attempt to overcome the separate legal entity principle in corporate group
insolvencies. To effect this the corporate entity is not necessarily
disregarded, but priorities are adjusted by taking into account principles of
equity. In N e w Zealand, for example, the courts have a wide discretion to
deal with group companies in liquidation. The N e w Zealand courts are
allowed to make 'contribution orders' on broad grounds where a related
company is liquidated and there is also provision for so-called 'pooling o i m
orders' in respect of related companies in liquidation. Apart from ordering
that a related company should contribute to the assets available for winding
up, the court can - where there is more than one related company in
liquidation - wind up the companies as if they were one on the basis that it is
just and equitable to do so.
The basic legal principle in New Zealand, like in Australia, is that each
company in a group is a separate legal entity. This entails that the directors
of a particular company in the group have to take into account the interests
of their own company before the interests of the group as a whole. In
practice, however, this is not always the case. The concept of requiring a
company to contribute to the assets of a related company which is in the
process of being wound up, and the idea of winding up different companies
as if they were one company, is out of line with the separate legal entity
principle. Instead, it acknowledges the concept of so-called 'enterprise'
liability, discussed in Chapter 2.82
The United States has a concept similar to the pooling of assets in New
Zealand, but goes a bit further. In the United States there is a bankruptcy
See Ch 9 para 9.3 for a discussion of the concept of a 'related' company under the N e w Zealand law.
17
principle of substantive consolidation that allows the assets and liabilities of
various corporations to be consolidated in one entity against which all
claims are instituted.83 Another principle of the United States bankruptcy
law, equitable subordination, confers jurisdiction on a court to defer certain
inter-corporate claims84 if it is just and equitable to do so.85 In applying this
principle, the courts scrutinise the conduct of the parties and the financial
arrangements giving rise to the debt. A n inter-corporate claim will not easily
be deferred - something like fraud or mismanagement has to be established
before deferral of the inter-corporate claim will be ordered. If it is deferred,
the external creditors are given priority.
In May 2000 CASAC released its Corporate Groups Final Report, making
radical recommendations for reform of the law of insolvency in the context
of corporate groups.86 C A S A C paid particular attention to the position in
N e w Zealand and the United States, recommending, inter alia, that the N e w
Zealand law on pooling orders in liquidations should be adopted. This
necessitates an investigation of the current position and most recent
developments across the Tasman in this country. In addition, where
appropriate, the position in the United States is also periodically referred to,
being one of the countries at the forefront of legal responses to the problems
encountered with corporate groups. In the search for an equitable solution to
the problem of winding up a group of companies, the position in the United
Kingdom, from which the Australian corporate law system originates, is
also taken into account. Although reference is occasionally made to other
jurisdictions as authority or by way of illustration, it should be pointed out
82 See Ch 2 para 2.1. 83 See, in general, Blumberg, Corporate Groups: Bankruptcy, above n 34, chapter 10. 84 Typically, an inter-corporate claim is a debt owed to the holding company by its subsidiary. 85 For a further discussion on equitable subordination under United States law, see, eg, JD Cox, TL Hazen and F H O'Neal, Corporations (1997) para 7.10 (pp 123-126). 86 (Final Report). See also the C A S A C Discussion Paper on Corporate Groups (December 1998) and the C A S A C Corporate Groups Draft Proposals (October 1999). On 11 March 2002 C A S A C became known as the Corporations and Markets Advisory Committee ( C A M A C ) as a result of the Financial Services Reform Act 2001.
18
that this work is not an exhaustive comparative analysis - the focus is on the
Australian law.
1.3.2 Limitation of topic
The main area to be investigated in this thesis is how creditors may enjoy
sufficient protection when they are dealing with companies forming part of
a group where one or more of the companies are faced with insolvency. It
should be noted that this study has been undertaken from a law and
economics perspective, although a number of analytical frameworks do exist
within which the question of the liability of a holding company for the debts
of its insolvent subsidiary has been examined, notably a sociological
89
viewpoint.
W h e n observing the corporation through an economics lens, as has been
done in this thesis, the corporation may be seen simply as a "nexus of
contracts ... a financing device ... [that] is not otherwise distinctive".90
W h e n viewing the corporation from a sociological vantage point, however,
the corporation may be seen as "a central institution ... [and as] an
institution it is a particular historical pattern of rights and duties, of powers
and responsibilities".91 In other words, adopting a sociological perspective
on law entails treating it as an aspect of social life in an attempt to
This thesis does not deal with issues of extra-territoriality and international law related to regulating cross-border corporate groups.
A corporate group would comprise a holding company and its subsidiaries, including any intermediate subsidiaries in a corporate chain.
See also L Johnson, 'Individual and collective sovereignty in the corporate enterprise' (1992) 92 Colum L Rev 2215. For further alternative analytical frameworks in which the liability of a holding company for the debts of its insolvent subsidiary have been examined, see, eg, the contributions utilising Teubner's autopoetic theory in D Sugarman and G Teubner (eds), Regulating Corporate Groups in Europe (1990). '° FH Easterbrook & D R Fischel, The Economic Structure of Corporate Law (1991) at 10, 12. S ee further on a s ociological a pproach t owards c ompany 1 aw, S W heeler ' Company Law' in PA Thomas, Socio-Legal Studies (1997) at 279ff. 91 R N Bellah et al, The Good Society (1991) 97.
19
understand the larger social environment and the place of the law within it
systematically and empirically.92
Indications are that, if the institution of groups of companies were viewed
from a sociological perspective, the solution of where liability should fall in
corporate groups would probably entail some form of group liability, as
opposed to liability only of the particular company or companies involved.
This is because, when the institution of the modern company rose to
prominence in the 1800s, it fitted into society on the basis of a natural
person or individual holding shares in this legal entity - the company - to
shield it from liability. However, in the twentieth century, the emphasis has
shifted to the group where one company holds shares in another company
and the dominant purpose is the raising and management of capital on a
wider, often trans-national, scale, such capital representing the whole
enterprise or business. Before one could reach a conclusion on the liability
in corporate groups from a sociological perspective, however, further
empirical studies would have to be conducted. Embarking on a discussion of
the problem of the liability of a holding company for the debts of its
subsidiary and the related question of how such liability should be regulated
from a sociological perspective falls outside the scope of this thesis.
It should be noted that this thesis focuses on trade creditors, lessors and
banks that have lent on an unsecured basis, and does not deal with the
position of involuntary creditors, such as tort creditors or employees, to
which different considerations apply.95 A number of reasons exist for
92 R Cotterrell (ed), Sociological Perspectives on Law, Vol I: Classical Foundations (2001) xi; R Cotterrell (ed), Sociological Perspectives on Law, Vol II: Contemporary Debates (2001) xi-xiii. 93 See R Cotterrell, The Sociology of Law: An Introduction (1992) 130. 94 For examples of related empirical studies, see I Ramsay and M Blair, 'Ownership concentration, institutional investment and corporate governance: an empirical investigation of 100 Australian companies' (1993) 19 MULR 153; and IM Ramsay and G P Stapledon, Corporate Groups in Australia (1998). 95 O n the position of involuntary creditors, see, eg, H Hansmann and R Kraakman, above n 41; D Wishart, he personal liability of directors in tort' (1992) C&SLI 363; R Carroll, Corporate parents and tort liability' in M Gillooly (ed), The Law Relating to Corporate Groups (1993) 91; R B Thompson, 'Unpacking limited liability: direct and vicarious liability of corporate participants for torts of the enterprise' (1994) 47 VandL Rev I; R
20
distinguishing between tort creditors and contract creditors. The main
distinguishing feature between tort creditors and contract creditors is the
involuntary nature of the relationship between the tort victim and the
96 tortfeasor. This is important for a number of reasons.
First, disclosure requirements and other procedures that protect shareholder
and contract creditors' interests are rendered ineffective to a large extent.
This is because in the typical scenario a tort victim will not have knowledge
of or access to information to assess the risk of harm or the ability of a
subsidiary to pay compensation.97 Secondly, there is often no continuing
relationship between the parties. While, in the case of contract creditors,
there m a y be long-term interests to be served by a holding company
agreeing to meet its subsidiary's obligations, in the case of tort creditors no
such interest is likely to exist.98 The third reason for distinguishing between
tort and contract creditors provides an even stronger argument in favour of
differential treatment of them by the law. This is that tort victims are
frequently less able to predict the likelihood or the nature of the loss or
injury that m a y be inflicted upon them and to implement appropriate steps to
protect their position, for example, by insurance.99
The emphasis in this thesis is on the problems that may arise because a
subsidiary is subject to the control of its holding company, with certain
consequences for the subsidiary as a separate legal entity, its directors and
creditors. Although the significance of factors such as economic integration
and financial interdependence in the context of control is recognised, the
focus of this thesis is on legal control which, in a sense, m a y be said to
Carroll, 'Shadow director and other third party liability for corporate activity' in I Ramsay, Corporate Governance and the Duties of Company Directors (1997) 162; P Edmundson and P Stewart 'Liability of a holding company for negligent injuries to an employee of a subsidiary: C S R v Wren' (1998) 6 Torts U 123; R Grantham, R and C Rickett, 'Directors' 'tortious' liability: contract, tort or company law?' (1999) 62 MLR 133; K Wnepper, 'Piercing the corporate veil: a comparison of contract versus tort claimants under Oregon law' (1999) 78 Or LR 347.
R Carroll, Corporate parents and tort liability' in M Gillooly (ed), The Law Relating to Corporate Groups (1993) 91 at 93-95. 97 Ibid 94. 9*Ibid. "Ibid.
21
incorporate these factors. The focus of the thesis is on cases in which control
is in a holding company, rather than in an individual, a trust or another non
corporate association or entity.
As the thesis does not consider the position of minority shareholders, partly-
owned subsidiaries are only dealt with for the purposes of considering
creditors' entitlements.100 The thesis is furthermore confined to corporations
that are affiliated in a way that depends significantly on share ownership,
namely vertical corporate groups, consisting of a holding company and one
or more subsidiaries.101 Apart from the fact that vertical groups are more
prevalent, the question of liability in any event does not generally arise in
horizontal groups, because of their non-hierarchical linkage. Group
accounting and taxation matters also fall outside the scope of this thesis.
In search of an answer to the question how to balance entrepreneurial
investment, on the one hand, with creditor protection, on the other, the Cork
Report in the United Kingdom highlighted two principal issues in the 1 (WX
possible reforms of insolvency law for corporate groups in 1982. The first
issue highlighted by the Cork Report is how the claims of the other
companies in the group should be treated in the insolvent liquidation of one
company in the group. This is inextricably linked with the principle of pari
passu, according to which like claims are to be treated alike, or creditors of
the same standing should receive equal treatment. The general
recommendation made in the Cork Report regarding the principle oi pari
passu, namely that 'any inter-company indebtedness which appears to
100 For more on shareholder protection, see the contributions of M Gillooly, 'Outside shareholders in corporate groups' at 159 and P Redmond, 'Problems for insiders' at 208 in M Gillooly (ed), The Law Relating to Corporate Groups (1993). 101 This is as opposed to so-called 'horizontal' groups, where corporations are affiliated purely by contracts or interlocking directorates. For a discussion of the distinction between vertical and horizontal groups, see, eg, M A Eisenberg, 'Corporate groups' in M Gillooly (ed), The Law Relating to Corporate Groups, (1993) at 1. 102 See Antunes, Liability of Corporate Groups, above n 37, 235. 103 Above n 3.
22
represent the long-term capital structure of a subsidiary should be
subordinated to the claims of external creditors', was not implemented.
In its Final Report, CASAC recommended that the Corporations Law (now
Corporations Act) should not be amended to allow courts to subordinate
intra-group claims in the insolvency of a group company. ' Although
equitable subordination along these lines is not negated outright as a
possible solution, it is excluded by the scheme of the Corporations Act
and would warrant a thorough investigation before the viability of
implementing it in Australia could be properly considered. In this light,
coupled with the fact that numerous general doctrines and statutory
provisions already exist in Australian law which could be invoked to
produce similar results to equitable subordination, it m a y be argued that 108
there is scarcely any need for such a doctrine in this country. Equitable
subordination is therefore not discussed further in this thesis.
The other issue highlighted by the Cork Report is whether any of the other
companies in the group should be held liable for the debts of an insolvent
group company. This involves liability to external creditors and is also
known as 'the corporate liability rule'. The Cork Report was of the view that
the corporate liability rule was so important that it warranted a full-scale
review. It considered that the matter of groups raised issues that were
outside its terms of reference, which were confined to insolvency law. A s a
result no specific recommendations were made as far as the liability of
For a further discussion on equitable subordination under English law, see, eg, R Schulte, 'Corporate groups and the equitable subordination of claims on insolvency' (1997) 18 Co Law 2.
C A S A C Final Report, above n 86, Recommendation 24. In this regard s 555 of the Corporations Act provides: 'Except as otherwise provided by
this Act, all debts and claims proved in a winding up rank equally and, if the property of the company is insufficient to meet them in full, they must be paid proportionately'. Although this pari passu principle is subject to specific statutory exceptions, s 555 does not admit any general law exceptions.
It is conceded that equitable subordination could be introduced by an express provision in the Corporations Act. Section 563C recognises debt subordination by means of an agreement or declaration by a creditor of a company. However, there is at present no capacity for a court to order equitable subordination of a lender's claim. See further J O'Donovan, Lender Liability (2000) para 11.80.
23
holding companies was concerned. It is the purpose of this thesis to
examine the corporate liability rule, while only referring to the principle of
pari passu to the extent that is necessary.
1.3.3 Roadmap
Since the concept 'control' plays such a crucial role in the relationship
between holding companies and their subsidiaries, its meaning is considered
at the outset in Chapter 2, before considering the safeguards available for
group creditors under the current regime.110 In Chapter 3 the protection for
creditors under the doctrine of piercing the corporate veil is analysed, while
Chapters 4 and 5 consider the scope of directors' duties in corporate groups.
In particular, the issue of whether directors may disregard their duties to
their individual companies in favour of acting for the benefit of the group
and what implications this has for creditors, is considered.
Especially significant in the context of the protection o f creditors are the
provisions of the Corporations Act under which a holding company may be
held liable for insolvent trading by its subsidiary. Chapters 6 and 7 deal with
the liability of the holding company for insolvent trading in its capacity as
shadow director and in its capacity as shareholder respectively. Although
108 D B Robertson, 'The lender-borrower relationship and the subordination of lender's claims - Part III' (1991) JBFLP 219 at 230. 109 As far as liability to external creditors in corporate groups is concerned, five principal policy options were suggested to the Committee in charge of the Cork Report, above n 3. The five options outlined in the Cork Report, above n 3, are: (1) that each group company should be jointly and severally liable for the external debts of all the other companies in the group; (2) that group responsibility should arise only by way of a voluntary contracting-in procedure; (3) that group responsibility should be qualified by a contracting-out procedure; that liability should be imposed on one or more of the other companies in the group in the event of a proven departure from a predetermined code of conduct; and (5) that 1 iability should be imposed on one or more group members by a decision of the court in the course of the insolvency of another group member, where the court has a wide discretion but is required to have regard to certain guidelines. For further comment on these five options, see C A S A C Final Report, above n 86, para 6.30. 110 In this thesis the historical setting of the problem posed has not been reviewed since it has on previous occasions been done extensively. See, eg, Antunes, Liability of Corporate Groups, above n 37, 13-111; Avgitides, above n 6, 13-44. For a critical account of the role of limited liability to commercial expansion historically see, eg, B C Hunt, The Development of the Business Corporation in England, J800-1867, (1936). For a different, morally grounded, perspective of Salomon v Salomon see, eg, G R Rubin, 'Aron Salomon and his circle' in J Adams, Essays for Clive Schmitthoff, (1983) at 99ff.
24
contribution and pooling as such have not formally been recognised in
Australia, both the regulator and the courts have done so indirectly, as
discussed in Chapter 8. The recent C A S A C recommendations relating to
contribution and pooling are dealt with in Chapter 9, before an exposition of
m y proposals follows in Chapter 10.
2 THE MEANING OF CONTROL AND THE REGULATION OF CORPORATE GROUPS
2.1 Background 25
2.2 Various applications of the control concept 28
2.2.1 Subsidiary/holding company relationship 29
2.2.1.1 Test of controlling the composition of the board 30
2.2.1.2 Voting control test 31
2.2.2 Consolidated accounts 35
2.2.3 Related party transactions 38
2.2.4 Cross share-holdings 41
2.3 Evaluation of position of group creditors 44
2.3.1 CASAC recommendations 45
2.3.1.1 Regulation by general control test 45
2.3.1.2 Wholly-owned groups to choose whether enterprise principles 46
apply
2.3.2 Critique of CAS AC recommendations 49
2.3.2.1 Regulation by general control test 49 (a) Replacement of 'holding/subsidiary' with 'control' 50 (b) Preferred definition of 'control' 52
2.3.2.2 Wholly-owned groups to choose whether enterprise principles 57
apply
2 THE MEANING OF CONTROL AND THE
REGULATION OF CORPORATE GROUPS
2.1 Background
There are two major types of regulatory strategies posed as a solution to what
has been described as 'one of the great unsolved problems of modern company
law',1 namely, in what circumstances a holding company m a y be held liable for
the debts of its subsidiary. The two regulatory strategies are the traditional
entity law approach and the revolutionary enterprise approach. In addition, and
falling between the entity approach and the enterprise approach, lies an
intermediate approach, also known as the dualist approach.
According to the entity approach a holding company should not be held liable
for the debts of its subsidiary, because they are separate legal entities. Only in
exceptional circumstances will this rule be set aside and the corporate veil
lifted.4 Underlying this approach is the idea of corporate autonomy. By
contrast, in terms of the enterprise approach, the holding company should be
held liable for all the debts of its subsidiary, because it controls the latter.5
Enterprise liability entails an automatic application of the opposite rule to
limited liability that applies in the entity approach, namely, that there is
1 C M Schmitthoff, 'Introduction' in C M Schmitthoff and F Wooldridge (eds), Groups of
Companies (1991) ix. 2 The enterprise approach is followed in the European Union. The entity law approach is followed in many countries, including Australia, the U K , N e w Zealand and the United States. In the United States, however, the legislature, assisted by the courts, increasingly make use of single enterprise principles in the context of corporate groups: PI Blumberg, 'The increasing recognition of enterprise principles in determining parent and subsidiary corporation liabilities' (1996) 28 Conn L Rev 295. See also PI Blumberg, The Multinational Challenge to Corporation Law, Oxford University Press, 1993, at 100-107. The selective introduction of single enterprise principles into United States corporate law has been made possible mainly because the courts have held that controlling shareholders owe duties of fairness to minority shareholders: see, eg, JD Cox, T L Hazen and F H O'Neal, Corporations (1997) para 11.10 (pp 250-258). 3 The best example of this strategy is the German model. This is blown in Germany as the
'Konzernrecht'. 4 See C h 3 for a discussion of the lifting of the corporate veil. 5 Under the enterprise approach the group of related companies is treated as one economic enterprise. See further A A Berle, 'The theory of enterprise entity' (1947) 47 Columb L Rev 343.
26
unlimited liability of the holding company. Underlying this approach is the
notion of corporate control.6 The dualist approach distinguishes between
preserving the subsidiary's autonomy and legitimising the holding company's
control. In a contractual group7 the holding company's control is legitimised,
while in a factual group8 the subsidiary's autonomy is preserved.
In contractual groups the de jure (legal) control of the holding company is
embodied in a special contract known as a 'contract of domination'. The law
expressly recognises that holding companies control their subsidiaries. In
exchange for this control the holding company is obliged to make good all the
annual losses of the subsidiary or is held jointly liable for the debts of the
subsidiary. B y comparison, in the factual groups, the control by the holding
company of the subsidiary is only de facto (effective). This entails that the
entity approach basically applies so that, in exercising its control over the
subsidiary, the holding company has to act in the best interests of the
subsidiary. The holding company is only obliged to compensate for losses that
occurred as a result of its controlling influence over the subsidiary.
As in other common law countries, the whole system of Australian corporate
law is based on the classical legal model of the individual autonomous
company, where an entity law approach is followed. This model proceeds upon
the assumption that the company is an independent economic and legal entity
where individual widely dispersed shareholders are interested in the best return
on their investment and where those managing the company are interested in
acting in the best interests of the company. The fact that each individual
shareholder has only very small voting power ensures harmony between
individual interests. This, in turn, ensures that the interests of other groups of
persons such as creditors are at the same time protected, though indirectly.9
See also JE Antunes, 'The liability of polycorporate enterprises' (1999) 13 ConnJInt'l L 197 at 217-218.
Under German law this is known as 'Vertragskonzerne'. Under German law this is known as 'Faktische Konzerne'.
9 H Wiedemann, "The German experience with the law of affiliated enterprises' in Klaus J Hopt (ed) Groups of Companies in European Law - Legal and Economic Analyses on Multinational Enterprises, Volume II, (1982) 21-22.
27
However, as soon as one shareholder, or a group of shareholders acting in
concert, acquires a majority of shares so that it can control the company, this
harmony is endangered. The reason for this is that these shareholders may
abuse their influence in furtherance of their own interests and to the detriment
of other relevant groups of persons. The dangers are exacerbated in two
instances. The first instance is where the number of shares held by a
shareholder is increased, culminating in the case of a single shareholder
company or a wholly owned subsidiary. The second instance is where the
controlling shareholder becomes active in an economic activity external to the
company, that is, where the shareholder is an entrepreneur such as another
company. The chances for abuse are therefore the greatest in the case of a
holding/subsidiary company relationship, particularly in the case of a wholly
owned subsidiary.10
Contrary t o w hat u sually happens i n t he c ase o f a n i ndividual s hareholder, a
corporate shareholder will most likely make use of its controlling power to
continue to seek its o w n economic interests within the controlled company and
at the expense of the controlled company.11 In other words, because the
controlled company m a y easily become subservient, the shareholders of the
controlling company are likely to act in their own interests rather than in the
interests of the controlled company with which they now compete. W h e n the
autonomy of the controlled corporation is destroyed in this way, not only the
corporation as an economic entity, but also other interested parties, such as
creditors, m a y be jeopardised to a serious extent. It is therefore imperative that
w e look more closely at what is meant by control in this context. As will be
10 A n empirical study undertaken in 1997 involving Australia's top 500 listed companies revealed that the vast majority, that is 90%, of controlled entities were wholly-owned: I Ramsay and G Stapledon, Corporate Groups in Australia (1998) at 3. 1' T he f act t hat t he c ontrolling s hareholder h as e xternal b usiness o perations may lead t o t he
controlled company not being managed in its own interests. 12 Wiedemann, above n 9, 21-22. 13 JE Antunes, 'The law of affiliated companies in Portugal', paper delivered at the Convegno Internazionale Di Studi, Sui Gruppi Di Societa, 16-18 November 1995, (Fondazione Giorgio
Cini - Venezia) (Rivista Delle Societa) at 4.
28
seen in Chapter 10, the notion of 'control' plays a significant part in the model
proposed as a solution to the problem of liability in corporate groups.1
2.2 Various applications of the control concept
Because of the pivotal role that the concept of 'subsidiary' plays in the control
relationship, one should start with a discussion of its definition in the
Corporations Act 2001 (Cth)15 and the case 1 aw interpreting it. W e can then
turn to a discussion of the concept of 'control' as used in various other contexts
relating to groups in the Corporations Act, namely, in the context of the
consolidation of group accounts, related party transactions and cross-
shareholdings. These provisions, together with the insolvent trading provisions
of the Corporations Act discussed in Chapters 6 and 7, override the strict
application of the separate entity approach in the context of corporate groups.
As will be seen, a different, broader, definition of control is used to regulate
aspects of corporate groups in the context of consolidation of group accounts,
related party transactions and cross-shareholdings than in the definition of
'subsidiary'.
The term 'holding company', used inter alia in s 588V, is defined in relation to
'subsidiary' in s 9 of the Corporations Act}6 The narrow interpretation of
'subsidiary' in s 46 was therefore automatically transposed into s 588V of the
Corporations Act. This has resulted in a serious deficiency in s 588V, which
provides for a holding company to be held liable for the debts of its insolvent
subsidiary in certain circumstances.17 The current position is that, if a company
does not fall under the definition of a subsidiary, s 588V of the Corporations
14 See Ch 10 para 10.2. (Corporations Act).
Section 9 of the Corporations Act defines 'holding company', in relation to a body corporate, to mean 'a body corporate of which the first body corporate is a subsidiary'. In turn, a 'body corporate' is defined in s 9 as follows: '(a) includes a body corporate that is being wound up or has been dissolved; and (b) in this Chapter (except s 66A) and section 206E includes an unincorporated registrable body'. While 'corporate' is not defined in the Corporations Act,
'body' is defined in s 9 to mean 'a body corporate or an unincorporated body and includes, for example, a society or association'.
29
Act simply does not apply.18 In other words, despite the existence of control,
one company m a y fairly easily avoid falling within the technical definition of
'subsidiary' and so escape the provisions of s 588V of the Corporations Act
altogether. Since s 588V of the Corporations Act relies totally on the existence
of a holding/subsidiary relationship, its operation is significantly limited by this
possibility. The liability of the holding company (in its capacity as
shareholder) for the insolvent trading of its subsidiary is discussed in detail in
Chapter 7.
2.2.1 Subsidiary/holding company relationship
The Corporations Act does not specifically define the expression 'corporate
group'. The Corporations Act does, however, define 'related body corporate',
which is generally regarded as the legal definition of a group company.21 T w o
companies are 'related' where one company is the holding company of the
other (the subsidiary), or where each of the two companies is a subsidiary of the
same holding company. In other words, to establish whether two companies
are related, it is of paramount importance to establish when one company may
be regarded as the 'subsidiary' of the other or whether they have a common
holding company.
The Corporations Act makes use of the term 'control' in defining the term
'subsidiary'. Section 46(a) provides that a body corporate (the first body) is a
subsidiary of another body corporate in one of three instances only, namely, if:
It is relatively simple to restructure the operations of group companies so that they fall
outside the ambit of this section. 18 Section 588V of the Corporations Act also does not apply to joint ventures. 19 I Ramsay, Transcript of Symposium held at Connecticut in 1998, published in (1999) 13 ConnJInt'lL 397 at 471-4. 20 Section 9 of the Corporations Act. 21 IM Ramsay, 'Allocating liability in corporate groups: A n Australian perspective' (1999) 13 Conn JInt'lL 329 at 334-337. 22 Section 50 of the Corporations Act.
30
(a) the other body (i) controls the composition of the first body's board; (ii) is in a position to cast, or control the casting of, more than one-half of the maximum n umber o f v otes t hat might b e c ast a t a g eneral meeting o f t he first
body; or (iii) holds more than one-half of the issued share capital of the first body (excluding any part of that issued share capital that carries no right to participate
beyond a specified amount in a distribution of either profits or capital); or
(b) the first body is a subsidiary of a subsidiary of the other body.
2.2.1.1 Test of controlling the composition of the board
Australian case law provides a narrow definition of the term 'control' for
purposes of determining whether a company is a subsidiary of another company
in the context of controlling the composition of its board. This is illustrated by
the decision in Mount Edon Gold Mines Ltd v Burmine Ltd.24 Burmine Ltd
(Burmine) had two major shareholders, namely Europa Minerals Group Pic
(Europa Minerals), which indirectly held 38,5% of its shares, and Mount Edon
Gold Mines Ltd, which held 19,6% of its shares. Most of the other shares in
Burmine were widely held. In an effort to establish whether Burmine was a
subsidiary of Europa Minerals, White J acknowledged that Europa Minerals
effectively controlled the board of directors of Burmine, as it was impossible to
appoint a director to the board of Burmine without the approval of Europa Oft
Minerals. Indeed, both companies regarded their relationship as one of
holding company/subsidiary and prepared their financial accounts accordingly.
In addition, Burmine stated in its annual reports and returns lodged with the
Australian Securities and Investments Commission (ASIC) that Europa
Minerals was its ultimate holding company.
However, his Honour found that that was not sufficient to make Burmine a
subsidiary o f E uropa M inerals for p urposes o f s 4 6 o f t h e Corporations A ct.
White J was of the view that some form of legally enforceable power to control
the board of directors was necessary - effective (de facto) control on its own
3 O n the holding of more than half the issued share capital, see, eg, NCSC v Brierley Investments Ltd (1988) 14 A C L R 177 at 184. 24 (1994) 12 A C S R 727 (Mount Edon). 5 It was necessary to establish whether Burmine was a subsidiary of Europa Minerals for purposes of the takeover provisions of the then Corporations Law.
31
was insufficient. A n example of legally enforceable power would be a
provision contained in the constitution of the company, or in a shareholders'
agreement, pursuant to which the holding company had the power to appoint
the majority of directors. His Honour said that, if a legally enforceable power
were not a requirement in this context, the relationship of holding
company/subsidiary would be entirely uncertain and unascertainable.
White J explained his view by stating that, only when a general meeting is held
at which it can be ascertained whether a certain company has in fact controlled
the composition of the board, will the existence of a holding
company/subsidiary relationship be certain. Even then the fact that a company
has control over the composition of the board m ay only be true for that
particular meeting. Where the majority shareholder with the power to control
the composition of the board has not attended the meeting in question, a
minority shareholder m a y then be said to control the composition of the board.
This is so because the directors put forward by it are voted into office while the
directors against w h o m it votes are not. At the next meeting attended by the
majority shareholder, the directors appointed by the minority shareholder may
be removed and directors of the majority shareholder m a y be voted into office.
The company is then no longer the subsidiary of the minority shareholder. In
his view this could not be what Parliament had intended, as it would create too
much uncertainty.27
2.2.1.2 Voting control test
The notion of control and question as to when one company will be regarded as
the subsidiary of another again came before the court in Bluebird Investments
Pty Ltd v Graf28 Santow J had to determine this question in the context of
controlling the composition of the board as well as in the context of voting
control. Bluebird Investments Pty Ltd (Bluebird) held 501 shares, or 21.6% of
Mount Edon (1994) 12 ACSR 727 at 741.
Ibid747-8. (1994) 13 ACSR 271 (Bluebird Investments).
32
the issued share capital of Graf Holdings Pty Ltd (Graf). It was undisputed that
Parer Pty Ltd (Parer) was a subsidiary of Graf.29 The defendants challenged the
validity of the transfer of 4001 shares in Bluebird to Parer. This transfer was
challenged on four different grounds. The only relevant ground for present
purposes is the contention by the defendants that Graf was a subsidiary of
Bluebird.
As b ackground, i t should b e p ointed o ut that s 36(1) o f t he t hen Companies
Ordinance 1981 (ACT) precluded a subsidiary from holding shares in its
holding company. Section 7(1) of the Companies Ordinance 1981 (ACT)
contained a definition of subsidiary almost identical with the definition of
subsidiary in the current s 46 of the Corporations Act set out at the beginning of
paragraph 2.2.1. Section 7(1) of the Companies Ordinance 1981 (ACT)
provided:
[Deemed subsidiary] For the purposes of this Code, a corporation shall, subject to sub-s (3), be deemed to be the subsidiary of another corporation if: (a) that other corporation-
(i) controls the composition of the board of directors of the first-mentioned corporation;
(ii) is in a position to cast, or control the casting of, more than one-half of the m a x i m u m number of votes that might be cast at a general meeting of the first-mentioned corporation; or
(iii) holds more than one-half of the issued share capital of the first-mentioned corporation (excluding any part of that issued share capital that caries no right to participate beyond a specified amount in a distribution of either profits or capital); or
(b) the first-mentioned corporation is a subsidiary of any corporation that is that other corporation's subsidiary (including a corporation that is that other corporation's subsidiary by another application or other applications of this paragraph).
Thus, if Graf were a subsidiary of Bluebird in terms of s 7(1) of the Companies
Ordinance 1981 (ACT) at the time of the transfer, Parer would also be a
subsidiary of Bluebird.31 This, in turn, would make the transfer invalid as a
result of the prohibition in s 36(1) of the Companies Ordinance 1981 (ACT).32
29 Ibid 274. 0 The slight differences in the wording of s 36(1) of the Companies Ordinance 1981 (ACT) and the current s 46 of the Corporations Act are negligible and have no bearing on the present discussion.
^ Parer would then be a member of a company that is its holding company, namely, Bluebird The successor section was s 185 of the Corporations Law, which has since been repealed.
33
The court found that the 'control' referred to in the first test in s 7(l)(a)(i) of the
Companies Ordinance 1981 (ACT), namely, controlling the composition of the
board, meant control flowing from a legally enforceable power. In this regard
the decision in Bluebird Investments22, followed the decision in Mount Edon24
confirming that de facto control is not sufficient to satisfy the test of controlling
the composition of the board.35 Where a company thus holds less than 5 1 % of
the shares in another company, a holding company/subsidiary relationship will
not arise by virtue of s 7(l)(a)(i) of the Companies Ordinance 1981 (ACT).
This is the case even if there is effective control as a result of the fact that the
other shareholdings are widely dispersed.
The court also found that Bluebird did not hold more than one-half of the issued
share capital of Graf pursuant to s 7(l)(a)(iii) of the Companies Ordinance
1981 (ACT). It held that the remaining 88.4% of the share capital not held by
Bluebird should not be excluded under the terms of s 7(l)(a)(iii) of the
Companies Ordinance 1981 (ACT) as carrying no right to participate beyond a
specified amount in distribution of profits or capital. Although these shares
were subject to a discriminatory dividend article, there was no 'specified
amount' of profits in relation to which their right to participate was limited.36 A
de facto limitation resulting from an exercise of the discretion to exclude from
dividends does not give rise to a limitation that 'specifies' any amount of
profits.37
Most significant in Bluebird Investments for present purposes, however, is the
consideration of the voting control test contained in s 7(l)(a)(ii) of the
Companies Ordinance 1981 (ACT), currently contained in s 46(a)(ii) of the
"(1994) 13 ACSR 271. 34 (1994) 12 ACSR 727. 35 In Mount Edon (1994) 12 ACSR 727 the current equivalent of s 7(l)(a)(i) of the Companies Ordinance 1981 (ACT) is s 46(a)(i) of the Corporations Act. On Bluebird Investments (1994)
13 ACSR 271, see also P Edmundson, 'Indirect self-acquisition: The search for appropriate concepts of control' (1997) 15 C&SU 264 at 271-2. 36 Bluebird Investments (1994) 13 ACSR 271 at 279.
"Ibid. nIbid.
34
Corporations Act.29 The question of law that arose in respect of the voting
control test was similar to that arising in relation to the composition of the
board test discussed in paragraph 2.2.1.1 above.40 The question was whether
Bluebird, for purposes of the 'voting control test', had to be in the position to
cast more than half the votes, or have control of their casting, by virtue of a
legally enforceable power vested in it, or whether it was sufficient for this to be
achieved de facto and, in a practical sense, in the absence of such legally
enforceable power.41
Santow J pointed out that the 'composition of the board' test discussed above,
for which a legally enforceable power is a requirement, refers only to control.
The 'voting control' test, however, is different from the 'composition of the
board test'. The 'voting control' test refers to alternatives, namely, control as
well as present ability.42 Present ability is indicated by the words 'is in a
position to cast'. B y reason of the alternative of present ability the 'voting
control' test m a y be satisfied in the absence of a legally enforceable power.
This may be explained as follows. Since the alternative of present ability exists,
it may be sufficient under s 7(l)(a)(ii) of the Companies Ordinance 1981
(ACT) to have arrangements that fall short of actual control to create the
holding company/subsidiary relationship. This m a y be the case where the
putative holding company is actually in a position (or has the power) to vote
more than 5 0 % of the total votes capable of being cast.43
An example of the above-mentioned arrangements is where the putative
holding company is given a general proxy to vote the required number of shares
Santow J in Bluebird Investments (1994) 13 A C S R 271 at 281 pointed out that White J in Mount Edon (1994) 12 A C S R 727 proceeded on the basis that the same conclusion reached in respect of the control of the board's composition applied in the voting control test. 40 See the discussion of Mount Edon (1994) 12 A C S R 727 in para 2.2.1.1 above. The question to be determined in this case was limited to the context of control of the composition of the board. There was no need to consider the question of voting control in s 46(a)(ii) of the then Corporations Law, the equivalent of s 7(l)(a)(ii) of the Companies Ordinance 1981 (ACT) in
that case. In Bluebird Investments (1994) 13 A C S R 271, however, Santow J dealt with this issue expressly. 41 Bluebird Investments (1994) 13 A C S R 271 at 280 *2 Ibid 2%2.
"Ibid.
35
to constitute that majority at future meetings, without any control as to how
votes are to be cast.44 Even if the proxy is revocable, in the absence of
revocation, the putative holding company is in a position to cast more than 5 0 %
of the votes. Thus, such an underlying arrangement, though not legally
enforceable, m a y satisfy the voting control test. In summarising this point,
Santow J concluded:45
[A]n actual power, revocable or not, legally enforceable or not, to cast more than 5 0 % of the votes does suffice to satisfy the 'present ability' alternative, so long as it does not depend on further action of support and is not under the control of another person.
In other words, an actual power, revocable or not, or legally enforceable or not,
to cast more than 5 0 % of the votes at a general meeting would be sufficient to
create 'a position to cast' more than 5 0 % of the total votes capable of being cast
at a general meeting.46 O n the facts of Bluebird Investments41 this test was not
satisfied. As a result Graf, and thus Parer, was not a subsidiary of Bluebird. The
court found that the transfer from Bluebird to Parer was valid or, if not, that an
order validating the transfer should be made.
2.2.2 Consolidated accounts
Another area in which the concept of 'control' plays an important role relates to
the disclosure of financial statements or accounts. For many years, in exchange
for the enjoyment of the privilege of separate legal existence, a company has
had to comply with certain disclosure requirements relating to its business and
affairs. Even as far back as the middle of the nineteenth century, in the Joint
Stock Companies Act 1844 (UK), a disclosure quid pro quo was present in
that information about the incorporated entity's affairs had to be reported. The
disclosure requirement became even more important after limited liability was
45 Ibid 282-283. 46 Section 7( 1 )(a)(ii) of the Companies Ordinance 1981 (ACT). This section is equivalent to current s 46(a)(ii) of the Corporations Act. 47 (1994) 13 A C S R 271. 48 7 & 8 Victoria, c 110.
36
granted to shareholders in 1855 pursuant to the Limited Liability Act 1855
(UK).49
Strictly speaking, in line with the disclosure requirement, each of the companies
in a corporate group, as a separate legal entity, has to prepare and properly
disclose its o w n separate financial statements. However, where a group of
companies acts as a single economic unit, it could be misleading to display
separate financial statements for each company without presenting the whole
picture. The law therefore introduced the requirement that the individual
financial statements of each separate group company need to be consolidated
into one to provide information to the public in respect of the profitability and
solvency of the group as a whole.50 Previously, the consolidation of financial
statements (also known as the group reporting requirements) applied only to
bodies that fell within the definition of holding companies and their
subsidiaries. This meant that formal control concepts applied, as provided for in
the definition of 'subsidiary' in s 46 of the then Corporations Law, and had the
effect, for example, that non-corporate bodies such as trusts were not included.
In 1991 the Australian Accounting Standards Board (AASB) moved away from
the legal definition of 'subsidiary' contained in s 46, which proved to be too
inflexible for determining when financial statements should be consolidated.
For accounting purposes a control test replaced the traditional holding
company/subsidiary definition and that of related bodies corporate in defining
group requirements. For reporting purposes unincorporated entities such as
trusts are now included, and a substantive rather than a formal approach is
followed to determine the existence of control.51 The accounting standards use
w 19 & 20 Vict, c 47. 0 The effect of consolidation is to reduce the significance of the separate entity doctrine not to remove it altogether: Industrial Equity v Blackburn (1977) 137 C L R 567- R P Austin
'Corporate groups' in Grantham, R and Rickett C (eds), Corporate Personality in the 2(fh
Century (1998) 7lat 71-72. ^ 11 See R Austin, 'Problems for directors within corporate groups' in Gillooly M (ed) The Law Relating to Corporate Groups, (1993) 133 at 151-157.
37
a much broader approach towards the meaning of 'control' than that adopted by
the courts in the definition of 'subsidiary', and define 'control' as follows:52
the c apacity o f a n e ntity to d ominate d ecision-making d irectly o r i ndirectly, i n relation to the financial and operating policies of another entity so as to enable that other entity to operate with it in pursuing the objectives of the controlling entity.
Since 1998 the obligation to consolidate has been incorporated in the
accounting standards and not in the body of the Corporations Act. This
obligation has, however, the force of law pursuant to s 296 and s 304 of the
Corporations Act, which require entities to comply with the accounting
standards.
As will be seen in Chapter 8, ASIC was of the view that consolidated accounts
would more accurately reflect the commercial realities of statements of holding
companies and their wholly-owned subsidiaries as they had many interests in
common.54 A wholly-owned entity whose holding entity is a company or a
registered foreign company m a y obtain relief from the financial reporting
requirements by relying on Class Orders issued by ASIC. Obtaining the relief
would mean that the wholly-owned entity would not be required to lodge
financial statements in respect of itself separately in addition to the consolidated
accounts. One of the conditions for such relief stipulated by ASIC in their Class
Orders is that the wholly owned-entities to which it applies must have entered
into a so-called Deed of Cross Guarantee with their holding entity.55
In terms of the Deed of Cross Guarantee every wholly-owned subsidiary in the
group as well as the holding company guarantee the debts of every other
52 A A S B 1024 (para 9) and A A S B 1017 (para 9). 53 Pt 3.6, Div 4 A of the Corporations Act (ss 294A, 294B, 295A, 295B) previously contained the consolidated financial statement requirements. The Company Law Review Act 1998 (Cth),
Sched 1, has repealed these provisions and replaced them with Pt 2M.3. See H A J Ford, R P Austin and IM Ramsay, Ford's Principles of Corporations Law, loose-leaf para 10.201 for a
discussion of the history of consolidation. 54 A S C Media Release 91/64, Public Hearing: Accounting relief for wholly-owned subsidiaries,
para 3. 55 See ASIC Class Order 98/1418 'Wholly-owned entities', Condition (l)(i).
38
company forming part of the group. The corporate regulator assumed that
creditors would be adequately protected by virtue of such guarantee, as
creditors had access to the assets of all the other companies in the group in the
event of the insolvency of one of the group companies. T h e Deeds o f Cross
Guarantee pursuant to the ASIC Class Order and the serious prejudice to
creditors (as well as directors) that m a y result from their use in practice is en
discussed in more detail in Chapter 8.
2.2.3 Related party transactions
The concept of 'control' also plays an important role as far as the related party
provisions are concerned. Over the years directors have often abused their
fiduciary positions in particular circumstances, for example, by diverting
money belonging to the company to themselves in the form of loans or by
diverting corporate assets improperly in the context of inter-company CO
transactions. Directors' misuse of their position of trust to benefit themselves
or parties related to them has been particularly rife in companies operating in
corporate groups, where it is more difficult to detect. To counter this abuse, the
corporations legislation has introduced certain provisions that regulate the
financial benefits between public companies and their related parties.
Currently Part 2E.1 prohibits a public company, or an entity that controls a
public company, from giving a financial benefit to a related party. This
prohibition applies unless the financial benefit is approved by shareholders or it
falls under one of the exceptions contained in ss 210-216 of the Corporations
Act. Section 228 of the Corporations Act defines 'related party' to include
companies or other entities controlled by directors of the public company in
question. The underlying principle of these so-called 'related party provisions'
is that financial benefits given to persons w h o are in a position to exert a
ASIC Pro Forma 24 'Deed of cross guarantee', cl 3. 57 See Ch 8 para 8.2. CO
I Ramsay, 'Corporate disclosure of loans to directors: report of an empirical study' (1991) 9 C&SU 8 0 for a n e mpirical study o f 1 oans t o d irectors. F or e xamples where e xcessive 1 oans
39
significant influence on the decision to give such benefits should be subject to
the approval of shareholders, unless the benefits are on commercial terms.
Previously, the related party provisions made use of the wide Australian
Accounting Standards definition of 'control', set out in paragraph 2.2.2 above.59
Since the commencement of the Corporate Law Economic Reform Program
Act 1999, however, the related party provisions have used the s 50AA
definition of 'control'.60 Although this definition is not identical with the
definition of 'control' in the Australian Accounting Standards, it is as wide.
Section 50AA of the Corporations Act provides as follows:61
(1) For the purposes of this Act, an entity controls a second entity if the first entity has the capacity to determine the outcome of decisions about the second entity's financial and operating policies. (2) In determining whether the first entity has this capacity: (a) the practical influence the first entity can exert (rather than the rights it can enforce) is the issue to be considered; and (b) any practice or pattern of behaviour affecting the second entity's financial or operating policies is to be taken into account (even if it involves a breach of an agreement or a breach of trust). (3) T h e first entity does not control the second entity merely because the first entity and a third entity j ointly have the capacity to determine the outcome of decisions about the second entity's financial and operating policies. (4) If the first entity: (a) has the capacity to influence decisions about the second entity's financial and
operating policies; and (b) is under a legal obligation to exercise that capacity for the benefit of
someone other than the first entity's members; th^ first entity is taken not to control the second entity.
The related party provisions do not play as significant a role in the context of
the protection of creditors of corporate group companies as one might have
hoped.62 They are stated to apply only to public companies. However, even
have been made to insiders and associated companies in Australia, see generally T Sykes, Two Centuries of Panic: A History of Corporate Collapses in Australia (1988). 59 Repealed s 243D(1) of the Corporations Law. 60 Note to s 208(1) of the Corporations Act. See further I Ramsay and G Stapledon, above n 10,
17ff. 61 The control test in s 5 0 A A of the Corporations Act does not require that control be exercised
actively. What is relevant is the practical influence that the controlling company can assert. Therefore the test in s 5 0 A A m a y include de facto forms of control that would not fall within the ambit of the holding company/subsidiary and related company tests: C A S A C Corporate
Groups - Final Report (May 2000) (Final Report) para 1.22. 62 The interests of shareholders are not discussed in this thesis. For a discussion on the effectiveness of the related party provisions in the context of the protection of shareholders, see
40
leaving aside this restriction for the moment, it is significant that, while the
object o f the r elated p arty p rovisions was s tated p reviously a s p rotecting t he
resources of a public company, 'in particular, those available to pay the
company's creditors', this is n o longer the case.63 T h e object o f Chapter 2 E,
currently expressed in s 207 of the Corporations Act, is stated simply as
follows: 'The rules in this Chapter are designed to protect the interests of a
public company's members as a whole, by requiring member approval for
giving financial benefits to related parties that could endanger those interests.'
Closely aligned with this is the fact that the related party provisions do not
contain any restriction on the members of a public company to approve
transactions t hat a dversely affect t he i nterests o f i ts c reditors, e ven w hen t he
company is insolvent or on the brink of insolvency.64 The situation m a y be
compared with the position of creditors under the maintenance of share capital
provisions, where creditors enjoy specific protection.65 Furthermore, the giving
of a financial benefit to or by a wholly owned subsidiary of a public company
falls under one of the exceptions to the prohibition in Part 2E.1 of the
Corporations Act.66 In this regard the Attorney General commented in 1992
that' the 1 aw d oes n ot n eed toe oncern i tself w ith t ransactions w ithin w holly
owned company groups'.67 A benefit m a y thus be given to a wholly owned
subsidiary despite the fact that in that particular case the transaction m a y not be
J Baker, 'Are the objects stated in section 243A of the Corporations L aw achieved by Part 3.2A?' (1997) 15 C&SU411 at 487-8. 63 Previously s 243A provided as follows: 'The object of this Part is to protect: (a) a public company's resources (in particular, those available to pay the company's creditors); and (b) the interests of its members as members; by requiring that, in general, financial benefits to related parties that could diminish or endanger those resources, or that could adversely affect those interests, be disclosed, and approved by a general meeting, before they are given.'
See further P Hanrahan, 'Transactions with related parties by public companies and their 'child entities' under Part 3.2A of the Corporations Law' (1994) 12 C&SLJ 138 at 154. 65 See, eg, Baker, above n 62, 491. Cfalso Ch 5 para 5.3.
Some of the other exceptions include reasonable remuneration for company officers and financial benefits given on arms' length terms. 67 M Duffy, 'Address by The Hon Michael Duffy, Attorney-General, to the Victorian Division of the Australian Institute of Company Directors', 18 June 1992, Melbourne, at 5. The Companies and Securities Law Review Committee was also of the view that financial
transactions to and from wholly owned subsidiaries should be exempt from the prohibition: Report on Directors' Statutory Duty to Disclose Interest (Companies Act s 228) and Loans to Directors (Companies Act s 230) (CSLRC Report), N o 9, 22 November 1989. For further discussion, see Baker, above n 62, 487-8.
41
in the interests of the company that confers the benefit.68 This assumes that the
interests of holding companies and their wholly-owned subsidiaries are
identical. However, this is not necessarily the case.69 A benefit conferred on a
wholly-owned subsidiary could greatly prejudice creditors of a solvent holding
company that becomes insolvent as a result of the transaction .70
2.2.4 Cross shareholdings
The final area in which the concept of 'control' features in the context of
corporate groups relates to cross shareholdings. Probably as a flow-on effect
from the maintenance of share capital doctrine, the Corporations Act has
traditionally prohibited a subsidiary from acquiring shares in its holding 71
company. The provisions restricting cross shareholdings within groups
initially relied on the definition of subsidiary contained in s 46 of the
Corporations Act to ascertain whether there was a breach of this prohibition.
This meant that one company, the first company, could legally hold shares in a
second company, where the first company in reality controlled the second
company, as long as the first company was not technically a subsidiary of the
second company pursuant to s 46 of the Corporations Act. It could in certain
instances be fairly easy to escape falling within the definition of subsidiary
since the concept of 'control' in s 46 of the Corporations Act, at least in the
context of the test of controlling the composition of the board, was defined in a
narrow manner by the courts.72
On 1 July 1998 sections 185 and 205(1 )(b)(ii) of the Corporations Law, which
prohibited a subsidiary from acquiring shares in its holding company, were
repealed and replaced by Part 2J.2 as part of the changes to the then
Corporations Law made by the Company Law Review Act 1998. The changes
contained in Part 2J.2 of the Corporations Act stemmed from the
68 See further Baker, above n 62, 493-494. 69 Cf ASIC's view stated in para 2.2.2 above and in Ch 8 para 8.2. 70 See further Ch 5. 71 See the former ss 185 and 205(1 )(b)(ii) of the Corporations Law. See further Ramsay, above
n 19, 349-350.
42
recommendation of the former Corporations L a w Simplification Task Force to
the effect that 'the rules should address the commercial reality of control rather
than legal technicalities'.73 Part 2J.2 of the Corporations Act addresses the
commercial reality of control and does away with the legal technicalities
surrounding the section 46 (subsidiary/holding company) concept of control.
The provisions in Pt 2J.2 of the Corporations Act prohibit an entity from
holding shares in a company that controls it. This is a significant development,
as there is no longer any reliance on the narrow legal definition of control as far
as cross shareholdings are concerned. Pt 2J.2 of the Corporations Act uses a
broad concept of control, similar to the Australian Accounting Standards
concept of control,74 and also very similar to the definition of 'control'
contained in s 5 0 A A of the Corporations Act J5 In this regard s 259E of the
Corporations Act makes provision for the situation when one company controls
an entity (for the purposes of prohibiting a company from acquiring shares in an
entity which controls it) and provides as follows:
(1) For the purposes of this Part, a company controls an entity if the company has the capacity to determine the outcome of decisions about the second entity's financial and operating policies. (2) In determining whether a company has this capacity: (a) the practical influence the company can exert (rather than the rights it can enforce) is the issue to be addressed;76 and (b) any practice or pattern of behaviour affecting the entity's financial or operating policies is to be taken into account (even if it involves a breach of an agreement or a breach of trust).
(3) Merely because the company and an unrelated entity jointly have the capacity to determine the outcome of decisions about another entity's financial and operating policies, the company does not control the other entity.
(4) A company is not to be taken to control an entity merely because of a capacity that it is under a legal obligation to exercise for the benefit of someone other than its shareholders.
It should be pointed out that, pursuant to s 259E(1) of the Corporations Act, the
controlling entity is required to have the capacity to determine decisions
relating to both the controlled entity's financial and operating policies. This
72 See para 2.2.1 above. n Recommendation by the Corporations L a w Simplification Task Force, Share Capital Rules: Proposals for Simplification at 10 (1994). '4 This is discussed in para 2.2.2 above. 75 This is discussed in para 2.2.3 above.
This would be much easier to prove in the case of a wholly-owned subsidiary. 76
43
reflects the Australian Accounting Standards provisions used in the
consolidated accounts discussed in paragraph 2.2.2 above.77 It is also similar to
the provisions of s 5 0 A A of the Corporations Act, which are used in the related
party provisions discussed in paragraph 2.2.3 above. Where, for example, the
financial and operating policies of an entity are determined by different parties,
neither will be regarded as having 'control' for purposes of s 259E of the •JQ
Corporations Act. The provisions of s 259E(3) of the Corporations Act
strengthen the requirement of control of both the financial and operating
policies. Section 259E(3) of the Corporations Act specifically provides that a
company does not control another entity merely because the company and an
unrelated entity jointly are in a position to determine the outcome of decisions
about the other entity's financial and operating policies.79 This is also the
position in the case of the related party transactions.80
Section 259E(2) of the Corporations Act, by requiring the courts to consider the
'practical influence' that the company can exert, deals specifically with the O 1 Q 9
problems that arose in Mount Eden and Bluebird Investments. 'Practical
influence' m a y entail considering some of the factors listed in s 46 of the
Corporations Act, such as controlling the composition of the board or the
number of votes, but s 259E(2) of the Corporations Act does not necessarily
limit it to these two examples. Furthermore, the new test makes provision for
taking into account behavioural patterns over a period of time, thereby
sidestepping the problem of assessing the relationship as a snapshot. Although
77 See A A S B 1024 and A A S B 1017 in para 2.2.2 above. 78 This is different from the previous position where, say, a shareholder with a shareholding of 5 0 % or more was in a position to determine the operating policies of a company. In such a case there would have been a breach if shares were issued to the subsidiary. Currently the same person has to be in a position to control the operating policies and the financial policies. 79 The sentiment that joint control does not give either party control is reflected in A A S B 1024 and old cases on control such as Mendes v Commissioner of Probate Duties (Vic) (1967) 122
C L R 152. 80 Section 50AA(3) of the Corporations Act. 81 (1994) 12 A C S R 727. 82 (1994) 13 A C S R 271. Section 50AA(2) of the Corporations Act, which applies in respect of
related parties, contains a similar provision relating to 'practical influence'. 83 The idea of 'practical influence' may prove to be very useful generally. This is picked up
again in Ch 10.
44
the court found, both in Mount Edon and Bluebird Investments, that the
companies involved persisted in treating each other as related, this did not mean
that they fell within the subsidiary/holding company definition. Under s 259E
of the Corporations Act this behaviour m a y constitute evidence of control.
Moreover, the fact that minority shareholders do not effectively participate in
the control of a widely held public company m a y be taken into account under or
'practice or pattern of behaviour' in s 259E of the Corporations Act.
2.3 Evaluation of position of group creditors
As appears from the above discussion, the concept of a group of companies was
derived from accounting practice and business usage, and not from law.87 Only
when a holding company was required to submit annual group accounts and
report to its shareholders, did the expression of a corporate group acquire a
legal dimension. The definition of a corporate group for the purpose of
consolidated accounts necessarily had to rely on objectively ascertainable
characteristics, such as the percentage of share capital held by one company in
another, and the power of one company to appoint or remove the directors of
the other. It was unnecessary for the definition of 'subsidiary' to be
functional, since it was merely placed on the statute books to establish whether
group accounts were required or not.90
However, as discussed above, the resultant technical definition of subsidiary led
to problems in legal practice, as it did not take into account the business
relationship between companies that could potentially be described as holding
and subsidiary companies. This is so because one company m a y control another
without the latter being a 'subsidiary' as defined in s 46 of the Corporations
84 (1994) 12 A C S R 727 at 735. 85 (1994) 13 A C S R 27 lat 283. 86 See s 259E (2)(b) of the Corporations Act. 7 R Pennington, 'Personal and real security for group lending' in R M Goode (ed) Group Trading and the Lending Banker (1988) 51 at 51-2 88 Ibid. *9Ibid. 90 Ibid.
45
Act. Dejure control will normally be established if the holding company holds,
directly or indirectly, more than 5 0 % of the voting shares of the subsidiary
company. De facto control is possible where the holding company holds
substantially less than 5 0 % of the share capital of the subsidiary. This will be
the case where the subsidiary's shares are widely held and no other shareholder
group holds sufficient voting shares to overcome this so-called minority
control.
As long ago already as the 1930's, the American authors Berle and Means have
assumed that 2 0 % ownership was sufficient to control a large public
corporation.91 Other studies in the United States have assumed that as little as
5 % ownership was sufficient for control because of lack of effective
participation by minority shareholders in widely held corporations. Effective
control based on 5 % ownership is probably unlikely in Australia because listed
shareholdings a re 1 ess d iversified t han i n t he U nited S tates. E ffective c ontrol
based on 2 0 % ownership is, however, possible in Australia, where it is the
largest single holding and the other shares are widely held or held by passive
institutional investors such as A M P or LAG.
2.3.1 CASAC recommendations
2.3.1.1 Regulation by general control test
In response to this problem CASAC recommended in its Final Report in May
2000 that the definition of 'holding company' and 'subsidiary' should no longer
be used in the Corporations Act. Instead, it recommended that these definitions
should be replaced with the concepts of 'controlling' and 'controlled' entities.
In this regard, C A S A C suggested that the definition of 'control' as used in s
91 A A Berle and GC Means, The Modern Corporation and Private Property (1932), especially
Chapter 6 entitled 'The divergence of interest between ownership and control'. 92 M Zeitlin, 'Corporate ownership and control: the large corporation and the capitalist class'
(1973) 79 Am J of Soc 1,073 at 1,087. 93 See I Ramsay and M Blair, 'Ownership concentration, institutional investment and corporate governance: an empirical investigation of 100 Australian companies' (1993) 19 MULR 153; G
46
5 0 A A of the Corporations Act should be used instead of the current definitions
of 'holding/subsidiary' companies.94 C A S A C found the control test to be
preferable to the holding/subsidiary and related company tests,95 and stated that
it should apply in all circumstances.96 The reasons given were that the control
test may better identify all forms of de facto control because it is not limited to
control by way of majority shareholding or by way of the composition of the
board of directors.97 C A S A C stated that:98
[t]he test of control under the Corporations Law [now: Corporations Act] s 50AA should apply throughout the Corporations Law in lieu of the holding/subsidiary and related company tests, which should be repealed.
2.3.1.2 Wholly-owned groups to choose whether enterprise principles
applicable
In respect o f t he r egulation o f c orporate groups, C AS AC i n i ts Final R eport
pointed out that Australia, like other common-law countries, has adopted
corporate law rules that apply differing mixtures of separate entity and single
enterprise principles to corporate groups.99 C A S A C stated that Australian
corporate 1 aw could b e reformed t o a ccommodate m ore e ffectively c orporate
groups and the interests of those involved by allowing wholly-owned corporate
groups to choose whether or not to be consolidated.100 O n this model,
consolidated g roups w ould b e r egulated b y s ingle e nterprise p rinciples. Non-
consolidated wholly-owned and all partly-owned corporate groups would
continue to be regulated by a mixture of separate entity and single enterprise
Stapledon, 'The structure of share ownership and control: the potential for institutional investor activism' (1995) 18 UNSWU 250 at 270. 94 See the discussion in paras 2.2.2 to 2.2.4 above.
'5 In Australia, holding companies and all their subsidiaries are related companies: s 50 of the Corporations Act. C A S A C Final Report, above n 61, para 1 39
97 Ibid.
Ibid, Recommendation 1. 99 .•-<
Germany is the only country that has adopted an integrated single enterprise regime for certain of its corporate groups.
C A S A C Final Report, above n 61, paras 1.81-1.82.
47
principles, but with greater selective use of single enterprise principles, where
appropriate.101
In its Draft Recommendation 2, CASAC proposed that wholly-owned corporate
groups should have the option of operating as a consolidated corporate group
under single enterprise principles. In its response to the submissions received
in relation to consolidation for wholly-owned groups, C A S A C reiterated that it
continued to support its Draft Recommendation 2. It considered that it might
not always be practical for wholly-owned group companies wishing to
consolidate to voluntarily liquidate and operate as divisions of a single
company and that wholly-owned groups should have the election to join to be
consolidated corporate groups. C A S A C also confirmed its view that
consolidated corporate groups should be liable for contractual, as opposed to
tortious, liabilities.
Accordingly, CASAC recommended that the Corporations Act should provide
that a wholly-owned corporate group can 'opt-in' to be a consolidated corporate
group for all or some of the group companies, by resolution of the directors of
each relevant group company. In this regard all the companies in a consolidated
corporate group should be governed by single enterprise principles, as
follows:103
• the Corporations Act would treat the consolidated group as one legal
structure;
• directors of group companies could act in the overall consolidated corporate
group interests without reference to the interests of their particular group
104
companies;
101 This would not only assist the operation of these corporate groups, but would also better protect the interests of any minority shareholders and outsiders who deal with these groups. C A S A C points out at para 1.92 of the Final Report, above n 61, that the remaining chapters of the Final Report (other than Ch 1) examine a range of areas where greater specific use of
enterprise principles may be appropriate for these groups. 102 C A S A C Final Report, above n 61, para 1.105. 103 Ibid, Recommendation 2. 104 Cfs 187 of the Corporations Act, discussed in Ch 5 para 5.4.2.
48
• the holding company and each group company would be collectively liable
for the contractual debts of all group companies, subject to any contrary
agreement;
• group companies could merge merely at the discretion of the directors of
the holding company;105
• ASIC should have the power to provide appropriate relief from accounting
and any other residual separate entity requirements.
CASAC further recommended that all companies that choose to be in a
consolidated corporate group should be required to disclose on all public
documents and on the ASIC database that they are members of that group.107
Finally, CASAC recommended that a consolidated corporate group should not
be collectively liable for the torts of any group company merely by virtue of the 1 flR
consolidation. A consolidated group should be permitted to de-consolidate by
resolution of the directors of all relevant group companies, but may not
otherwise sell any of its group companies.109 Companies in a group that has de-
consolidated should each retain a residual liability for the debts of all the group
companies incurred before the de-consolidation.110
105 Cf C A S A C Final Report, above n 61, Recommendation 15, in the context of corporate group
reconstructions, to the effect that wholly-owned group companies should be able to merge with each other or with their holding company with the approval of the directors of all the merging companies. 106 C/Ch 8 para 8.2.
A modified version of this proposal is adopted in Ch 10 para 10.2.2.4. 18 In its Draft Recommendation 2, C A S A C stated that imposing collective tort liability on all
group companies may serve as a total disincentive to adopting the consolidated group structure: C A S A C Final Report, above n 61, para 1.107. 109 Restricting the sale of group companies within a consolidated corporate group would avoid the difficulties of whether residual group liability should arise upon a sale and h o w to account adequately for the sold company in the event of the consolidated group not keeping separate accounting and other records of that company: C A S A C Final Report, above n 61, para 1.106.
Retaining residual liability for the debts of group companies when de-consolidation occurred would protect creditors who did not secure cross-guarantees, as the ASIC Deeds of Cross Guarantee would not assist these creditors. Furthermore, residual liability would avoid problems that may arise from lack of separate accounts for group companies before their deconsolidation: C A S A C Final Report, above n 61, para 1.107. See further C h 8 para 8.2 on Deeds of Cross Guarantee.
49
2.3.2 Critique of C A S A C recommendations
2.3.2.1 Regulation by general control test
In principle the CASAC recommendation, in effect also extending the reach of
the provisions of s 588V of the Corporations Act, should be welcomed.111 It is
conceded that a control test has certain major advantages over the
holding/subsidiary test, such as being potentially broader and more flexible.112
This would counter the problem that parties m a y easily avoid the narrow
technical definition currently contained in s 46 of the Corporations Act.
Although the suggestion by CASAC regarding regulation by a general control
test is in broad terms acceptable, two points of criticism m a y be raised. First, it
is submitted that C A S A C has gone too far by stating that the definition of
'control' contained in s 5 0 A A of the Corporations Act should be used
throughout and that the current holding/subsidiary test should not even be
retained as part of the general control test. To expand the net, C A S A C
suggested that the definition of 'holding/subsidiary' be discarded and replaced
with the definition of 'control' in set out in s 5 0 A A of the Corporations Act. It
is submitted, however, that the definition of 'holding/subsidiary' has an
important role to play. It should therefore be retained, though in a different
form, as explained in paragraph 2.3.2.1 (a) below.113 Secondly, it is submitted
that a different definition of 'control' than that used in s 5 0 A A of the
Corporations Act and suggested by C A S A C should be used. The reasons for
this second submission are set out in paragraph 2.3.2.1 (b) below.
111 For a more detailed discussion of s 588 V of the Corporations Act, see Ch 7. 112 J Farrar, 'Ownership and control of listed public companies: revising or rejecting the concept of control' in B G Pettet (ed) Company Law in Change - Current Legal Problems (1987) is in
favour of the concept of control but broadening its definition. 113 Cf C A S A C Final Report, above n 61, para 1.40.
50
(a) Replacement of 'holding/subsidiary' with 'control'
m s 46 of the Corporations Act the focus is on the power over the appointment
of directors, the casting of votes and the share capital of a company. These
characteristics are capable of objective measurement, making them certain and
easy to apply.114 B y contrast, the concept of control employed by s 5 0 A A of the
Corporations Act (in the context of related party transactions) and s 259E of the
Corporations Act (in the context of cross shareholdings), respectively, has built
on the concept of control in the Australian Accounting Standards. The
Australian Accounting Standards use a broad definition of control for the
purpose of disclosing controlled entities and the consolidation of accounts.115.
Similar to the position under the Australian Accounting Standards, the focus is
on a more direct measure of power exerted, namely, determining the financial
and operating policies of a company. Although it is broader and more flexible
than the current position, it requires a subjective measurement. This makes the
definition in s 5 0 A A of the Corporations Act uncertain and more difficult to
apply.116
Although on many occasions the wider definition of control in s 50AA of the
Corporations Act may be useful in catching would-be offenders, in many
instances companies will indeed fall under the holding/subsidiary definition in
any event. If, in addition to making use of the definition of control in s 5 0 A A of
the Corporations Act, the definition of 'subsidiary' is retained, it will make it
much easier in these instances at least to establish control, since it is capable of
objective measurement. Having the holding/subsidiary and related party tests
(with the amendments suggested in this paragraph as the minimum
requirement) would not limit the definition of 'control'. Instead of the C A S A C
recommendation, it is therefore submitted that the control test should
14 See also the submissions favouring holding company/subsidiary and related company tests in C A S A C Final Report, above n 61, paras 1.30 and 1.34, 115 The concepts of control in s 50AA and s 259E of the Corporations Act are not identical with the concept of control used in the Australian Accounting Standards or, for that matter, to each
other. Both are, however, very similartothe Australian Accounting S tandards' definitionof control. 116 See further C A S A C Final Report, above n 61, para 1.35.
51
specifically incorporate the existing holding/subsidiary and related company
tests as a minimum guideline existing alongside the suggested broader
definition of control.117
Although it is argued that the concept of 'holding/subsidiary' should in
principle be retained, the current definition of 'subsidiary' should be amended.
It is inherently problematic in that the definition itself contains the term
'control'. The case law has shown that uncertainty could arise if factual control
over the composition of the board, or over the casting of the majority o f the
votes, were sufficient to establish a holding/subsidiary relationship. This is
because the company in control could vary from one meeting to the next. In an
attempt to remove this uncertainty Mount Edonn% required legal control as far
as control over the composition of the board was concerned.119 Bluebird 1 70
Investments confirmed this view and, similarly, required legal control as far
as control of the casting of the majority of votes was concerned. Although more
certainty has been obtained, the effect of Mount Edon and Bluebird
Investments is that the concept of holding company/subsidiary is unduly
narrow. A s a result, it is easy to avoid being caught by the provisions of the
Corporations Act prohibiting certain conduct by related companies.
Also, t he u ncertainty p roblem r eferred t o i n t he p receding p aragraph h as n ot
been e radicated, a s illustrated by the judgment in Bluebird Investments. In
that case it was decided that no legally enforceable power was required as far as
117 Support for this view can be found in C A S A C Final Report, above n 61, para 1.40. According to fh 46 at 15 of the C A S A C Final Report, above n 61, the commentators in favour of this view are the Australian Institute of Company Directors, the Australian Society of Certified Practising Accountants and R Schulte. This does not contradict CASAC's position that the control test focuses on real power and influence instead of the formal criteria contained the holding/subsidiary tests: C A S A C Final Report, above n 61, para 1.41. 118 (1994) 12 ACSR 727. 119 In a situation such as that arising in Bluebird Investments (1994) 13 A C S R 271 this problem would not arise because of the alternative of being 'in a position to cast', as opposed to only 'controlling the casting of in s 46(a)(ii) of the Corporations Act. De facto control could then bring about the existence of a holding company/subsidiary relationship. See further the
discussion in para 2.2.1.2 above. 120 (1994) 13 ACSR 271. 121 (1994) 12 ACSR 727. 122 (1994) 13 ACSR 271. 123 Ibid.
52
present ability in the voting control test was concerned. In other words, a
similar uncertainty that existed in respect of controlling the composition of the
board and in controlling the casting of the majority of the votes n o w exists -
after Bluebird Investments124 - in respect of having the ability to cast such
votes. It is submitted that, by removing the references to 'control' in s 46(a)(i)
and (ii) of the Corporations Act, and by removing the reference to 'in a position
to cast' in s 46(a)(ii) of the Corporations Act, these problems m a y be overcome
without sacrificing the positive elements of the current holding/subsidiary
concept altogether.
Accordingly, it is suggested that the current s 46 of the Corporations Act should
be repealed and replaced with the following provision:
' WHA TISA SUBSIDIAR Y
46 A body corporate (in this section called the 'first body') is a subsidiary of
another body corporate (in this section called the 'second body') if, and only if:
(a) the second body:
(i) holds the legal power to elect the majority of directors in the first
body;
(ii) holds a majority of the legal voting power in the first body; or
(Hi) holds a majority of the capital in the first body; or
(b) the first body is a subsidiary of a subsidiary of the second body. '125
(b) Preferred definition of 'control'
It has been shown that, while the concept of 'subsidiary' in s 46 of the
Corporations Act is readily susceptible to objective measurement, this is not
true of the concept of control in s 5 0 A A of the Corporations Act, based on the
Australian Accounting Standards and also used in s 259E of the Corporations
Act. Instead, it requires a subjective evaluation.126 The ideal would be to
The 'power' in paras (i) and (ii) refers to the legally enforceable power as stated in Mount Edon (1994) 12 A C S R 727 and Bluebird Investments (1994) 13 A C S R 271. 126 See para 2.3.2.1 (a) above.
53
combine the objective measurement in the definition of 'subsidiary' with the
wide scope of the concept of 'control'. It is therefore suggested that the
definition of 'subsidiary' should be retained and that a new definition of
'control' should be inserted into the Corporations Act}21 This new definition of
control should incorporate the definition of holding/subsidiary, with the
amendments suggested in paragraph 2.3.2.1(a) above.
As far as the definition of control is concerned, it is conceded that it should be
expanded so that it encompasses more than just the holding/subsidiary
definition. However, compared to the current position, making use of the
definition of 'control' in s 5 0 A A of the Corporations Act as recommended by
C A S A C will bring about a lot of uncertainty, and also involve a waste of
resources when parties attempt to prove the existence of control. Instead, it is
suggested that the expanded part of the definition of control should be less
uncertain than the definition contained in s 5 0 A A of the Corporations Act and
as far as possible objectively ascertainable. It is submitted that this m a y only be • • r* 198
achieved if certain presumptions of control are used.
In the above context s 47 of the Corporations Act already contains a
presumption of control. Section 47 of the Corporations Act provides that the
composition of the board is deemed to be controlled if the other company can
appoint or remove all, or the majority, of the directors of the company. Section
47 of the Corporations Act specifically states that it does not limit the
circumstances in which a company is taken to control the composition of
another company's board. There is no reason w h y this deeming provision
should not be extended.
First, it is submitted that the presumption of control should be extended to the
other two instances of the current definition of 'holding company'. At the
127 In other words, you have to work both with the definition of holding company and the
definition of control. 128 O n the facts in Mount Edon (1994) 12 A C S R 727, the judge found that there did not exist a
relationship of control. If the definition of control were followed as suggested, then there would
be a 'controlled company' relationship.
54
moment the only presumption in s 47 of the Corporations Act relates to the
power of one company to control the composition of the board of another.
Extending the presumption in this way will mean that one company will also be
deemed to control another company where the one company holds the majority
of the voting power in the other company, and where the one company holds
the majority of the capital in the other company.129 In other words, the three
instances of the current holding company/subsidiary definition (with
amendments as suggested in paragraph 2.3.2.1(a) above) should be expressly
stated to be three instances of deemed 'control' in the proposed new provision.
Secondly, it is submitted that the presumption of control should also be
extended beyond the three instances in which a holding company/subsidiary
relationship is established, capturing the notion that companies should not
escape the definition of holding company/subsidiary so easily. In this regard, s
50AA(1) of the Corporations Act provides that control is established where one
company has the capacity to determine the outcome of decisions about the
second entity's financial and operating policies. The fact that this subsection
refers to capacity to control instead of actual control is a step in the right
direction. It is therefore submitted that the notion of capacity to control rather
than actual control should be retained in the proposed new definition of control.
The fact that s 50AA of the Corporations Act refers to both the 'financial' and
'operating' policies may, however, potentially be problematic. If the capacity to
control exists only in respect of one of these policies and not the other, no
control will exist for purposes of s 5 0 A A of the Corporations Act. This was
specifically stated to be the case in s 259E of Pt 2J.2 of the Corporations Act,
relating to cross-holdings. The wording used in Pt 2J.2 and that used in s 5 0 A A
of the Corporations Act is very similar, as pointed out above. B y way of
analogy, therefore, no control will exist for purposes of s 5 0 A A of the
Corporations Act unless the controlling company has the capacity to control
both the financial and operating policies of the controlled company. It is
submitted that requiring one company to have the capacity to control both the
See s 46 of the Corporations Act.
55
operating policies as well as the financial policies of another company for
purposes of 'control' defeats the purpose of making the net wider. In most cases
it will be very difficult to prove that one company had the capacity to control
both the operating and financial policies of another company.
It used to be sufficient to have, for example, the majority of the shares issued in
another company in order to qualify as holding company and be potentially
liable under, say, s 588V of the Corporations Act. Holding the majority share
capital would, however, only comply with capacity to control the 'operating
policies'. It would not comply with capacity to control the 'financial policies'
as required by s 5 0 A A of the Corporations Act. It is therefore submitted that,
instead of requiring the capacity to control both the operating and financial
policies, it will be better to hold a holding company potentially liable for the
debts of its insolvent subsidiary where the holding company holds a strategic
position w ithin t he d ecision-making o rganisation o f t he s ubsidiary. 13° S uch a
strategic position gives the holding company the power to influence the
business affairs of the subsidiary directly or indirectly. This would imply that
having the capacity to control the 'operating policies', which would include
decisions on the incurring of debts, is sufficient.
In summary, it is suggested that a presumption of control should arise where
there has been compliance with an established set of formal criteria.131 These
established criteria are:
(a) the holding of a majority of capital,
(b) the holding of a majority of the voting power,
(c) the holding of the power to elect the majority of directors, or
(d) the holding of financial, contractual or any other agreements which are able
to create the strategic controlling position stated above.132
JE Antunes, Liability of Corporate Groups - Autonomy and Control in Parent-Subsidiary Relationships in US, German and EU Law - An International and Comparative Perspective, (1994) (Liability of Corporate Groups) at 390ff. 131 Ibid. See also J Dabner, 'Insolvent trading: an international comparison' (1994) 7 Corp &
Bus Law J 49 at 66-73.
56
Accordingly, it is suggested that the following n e w provision should be inserted
into the Corporations Act as s 46A:
'WHEN ONE BODY CORPORATE CONTROLS ANOTHER BODY
CORPORATE
46A (1) A body corporate (the 'second body') is taken to control another
body corporate (the first body') where:
(a) the second body:
(i) holds the power to elect the majority of directors in the
first body;134
(ii) holds a majority of the voting power in the first body;
(Hi) holds a majority of the capital in the first body; or
(iv) otherwise holds a strategic position within the decision
making organisation of the first body that gives the second body the
power to influence the business affairs of the first body directly or
indirectly.
(2) The second body holds the strategic position referred to in subsection
(l)(a)(iv) of this section where there is prima facie proof that the second body
holds financial, contractual, or any other agreements which are able to create
such a strategic controlling position.'
Proposed subsection (l)(a)(iv) encapsulates the notion oi capacity to control (as
opposed to actual control), as currently contained in s 5 0 A A of the
Corporations Act. It should be noted that, while the word 'determine' is used in
the current definition, it is suggested that 'influence' should be used instead, as
'determine' could invoke a dispute as to whether it was actually dominant or
not.
Antunes, Liability of Corporate Groups, above n 130, 390ff. Alternatively, instead of (i)-(iii), one could also state that the companies fall under the
definitions of holding company and subsidiary. '" This incorporates the current presumptions of control in s 47 of the Corporations Act.
57
2.3.2.2 Wholly-owned groups to choose whether enterprise principles
apply
The suggestion by CASAC that wholly-owned corporate groups should have a
choice whether to 'opt in' to be a consolidated group governed by single
enterprise principles m a y also be criticised. The criticism m a y be summarised
by some submissions received by C A S A C opposing the concept of
consolidation for wholly-owned groups, the reasons advanced being fourfold,
namely:135
• group companies would lack the necessary incentive to 'opt-in', and as a
result voluntarily extend liabilities from individual companies that form part
of the group to other group members;
• the proposal is at odds with the concept of the 'corporate veil' and the
entrepreneurial spirit that encourages appropriate risk-taking;
• the proposed single enterprise principles do not take into account that
circumstances m a y exist in which the interests of the group companies are
different from those of their holding company;
• the considerable complexities of an 'opt-in' approach m a y outweigh any
possible advantages to be obtained by it.
It is submitted that the main shortcoming of the CASAC proposal is contained
in the first submission opposing consolidation for wholly-owned groups,
namely, that it fails to provide sufficient incentives for corporate group
companies to choose the consolidation solution.136 While it might be argued
that the other reasons put forward in the submissions for opposing the concept
of consolidated groups as proposed by C A S A C could perhaps be overcome, if
companies do not voluntarily choose to adopt this system of regulation, that is
the end of the matter. In discussing the incentive to become a consolidated
corporate group, C A S A C identifies four issues that would be particularly
135 CASAC Final Report, above n 61, para 1.98.
58
relevant, namely, directors' duties, tort liability, sale of individual group
companies, and consolidated corporate groups seeking to 'opt-out' from that
status:
• As far as directors' duties are concerned, CASAC mentions that it might be
a possible incentive that the directors of each wholly-owned group
company could act in the overall corporate group interest without taking
into account the interests of their particular group company.138 However,
C A S A C concedes in the same paragraph that the Corporations Act already
allows directors of solvent wholly-owned group companies to act in the
interests of the holding company alone, whether the wholly-owned
corporate group is consolidated or not.139
• As regards tort liability, CASAC states that few wholly-owned corporate
groups would voluntarily choose to be consolidated groups if it meant that
collective tortious liability applied. C A S A C then suggests that this
disincentive problem might be overcome by allowing selective 'opting-in'.
In other words, a holding c ompany could nominate which of its wholly-
owned subsidiaries should be included in a particular consolidated group,
so that various subsidiaries could be excluded from consolidation. Once
again, however, C A S A C concedes that it m a y in certain instances be very
difficult to identify in advance the potential tort liability of specific
companies, a nd t hus also t he p otential c ost i mplications o f a d ecision t o
consolidate the group companies.
• On the issue of the sale of group companies, CASAC points out that the
holding company and each group company in a consolidated corporate
group would be collectively liable for the contractual debts of all group
companies. The question thus arises whether any wholly-owned company
5 See further V Priskich, 'CASAC's proposals for reform of the law relating to corporate groups' (2001) 19 C&SU 360 at 361-363 and, in general, V Priskich, 'Liability for insolvent group companies in Australia: regulatory regimes and reform proposals' (2002).
C A S A C Final Report, above n 61, para 1.85. See further the discussion in Ch 4 para 4.2.
59
in a consolidated corporate group could be sold to an outsider and, if so,
whether existing creditors of that company should have any residual rights
against the corporate group under the principle of collective liability. Any
prohibition on selling off a wholly-owned group company in a consolidated
corporate group to an outsider would be a significant disincentive to 'opt
in'. However, in the absence of any residual group liability, the existing
creditors of the company to be sold off would be at a serious disadvantage
if the sale were to proceed. This would particularly affect creditors who
contracted with a specific group company while relying on the collective
group liability of the consolidated corporate group and not only the assets
of that company.
• As far as the issue that a consolidated corporate group may wish to de-
consolidate some or all of its group companies is concerned, C A S A C is of
the view that, without this right, wholly-owned corporate groups might be
reluctant to become consolidated. This would mean that, regardless of any
change in the overall financial circumstances or internal functions of the
group, they would be irrevocably governed by single enterprise principles.
Should they retain the right of de-consolidation, the question arises (similar
to the position under the sale of group companies) whether existing
creditors should have any residual rights against each company in the
formerly consolidated group.
In Chapter 10 this issue of choosing whether to adopt enterprise principles is
addressed again in paragraph 10.2. The model proposed in that chapter provides
for holding companies to choose, though impliedly, whether they wish to
adhere to a separate legal entity regime, or whether they wish to ignore
effectively the separate legal status of the subsidiary and opt for a single
enterprise regime instead. Unlike the C A S A C proposal that makes provision for
consolidation only for wholly-owned groups, the model proposed in Chapter 10
makes provision for consolidation for both wholly-owned as well as partly-
owned corporate groups.
See the discussion of s 187 of the Corporations Act in Ch 5 para 5.4.2.
PIERCING THE CORPORATE VEIL
Background 60
Fraud 61
1 Limited to exceptional cases 61
2 Further restriction on lifting the veil 66
Agency
1 Extent of control 70
2 Authorisation to contract 72
Single economic unit 74
Evaluation of position of group creditors 95
3 PIERCING THE CORPORATE VEIL
3.1 Background
Limited liability remains the cornerstone of company law not only in England
where it originated but also in Australia and other Commonwealth countries. In
these countries the courts have undertaken veil p iercing restrictively, and the
separate identity of the company will be disregarded only in exceptional
circumstances.1 This will be the case where the corporate personality is abused
for fraud or improper conduct, where a company is a mere fagade so that the
true facts are concealed, or where the public interest has to be protected or the
company has been incorporated to evade legal obligations.2 These exceptions to
the separate legal entity principle are of general application, whether or not
corporate groups are involved.3
Under the entity liability approach the holding company is generally liable only
for its o w n individual debts, as it is seen as a separate legal entity from the other
group companies. Although the courts have recognised the fact that corporate
groups are a reality, their approach when it comes to lifting the veil in corporate
groups is - like their approach to lifting the corporate veil generally - extremely
conservative.5 It is evident from the decisions of the High Court in Walker v
1 For an empirical study of the Australian cases relating to the doctrine of piercing the corporate veil, see I Ramsay and D Noakes, 'Piercing the corporate veil in Australia' (2001) 19 C&SU 250. This study, that includes all Australian cases up to 31 December 1999, found (at 261) that an argument to pierce the veil was accepted in about 38.5% of the cases, which is lower than in the United States (about 40%) and in the U K (about 47%). For empirical studies of the frequency with which courts pierce the corporate veil in other jurisdictions, see R Thompson, 'Piercing the corporate veil: an empirical study' (1991) 76 Cornell L Rev 1036 (in the United States) andC Mitchell, 'Lifting the corporate veil in the English courts: an empirical study' (1999) 3 Com Fin dlnsolv LR 15 (in the U K ) . 2 For a summary of the situation in which the courts have lifted the corporate veil, see HAJ Ford, R P Austin and I M Ramsay, Ford's Principles of Corporations Law (2001), paras 4.350-
4.420. 3 For a doctrinal and economic analysis of veil piercing, see S M Bainbridge, 'Abolishing veil
piercing' (2001) 26 Iowa J Corp L 479. 4 PI Blumberg, 'The corporate entity in an era of multinational corporations' (1990) 15
Delaware J Corp L 283. 5 Technically speaking there is a difference between piercing the corporate veil and lifting the
corporate veil. See further the discussion in Ramsay and Noakes, above n 1, 251-252. The distinction between the meaning of the two terms is not widely recognised in Australia with the courts sometimes using them as alternatives. The terms are used interchangeably in this thesis.
61
Wimborne6 and Industrial Equity Ltd v Blackburn1 that the Australian judiciary
is reluctant to pierce the veil in corporate groups.8 Also in the recent decision in
Bray v F Hoffman-La Roche Lt£ the Federal Court held that the fact that the
Australian subsidiaries were directed and controlled by an overseas holding
company, as part of the holding company's global enterprise, was not sufficient
to pierce the corporate veil.10 It was held that something more than the indirect
legal and commercial capacity of the holding companies to control and direct
the subsidiaries, plus the holding company's involvement in implementing the
impugned cartel arrangement, was required to lift the corporate veil between the
group companies.11 The current position in Australia on the separate entity
doctrine in the context of corporate groups is reflected in the judgment of the 19 •
English Court of Appeal in Adams v Cape Industries pic, discussed in detail
below.
3.2 Fraud
3.2.1 Limited to exceptional cases
1 "\
Adams v Cape has become a classic on piercing of the corporate veil m the
common law. This is because the English Court of Appeal dealt with
disregarding the separate entity doctrine in the context of a corporate group on
three grounds, namely fraud, the existence of an agency relationship, and the
single economic unit theory. According to one commentator piercing the
6 (1976) 137 C L R 1. 7 (1977) 137 C L R 567. 8 In fact, in their empirical study Ramsay and Noakes, above n 1, 263-264 found that Australian courts were less likely to pierce the veil where a holding company is behind the veil (in about 32.6% of cases) than where human shareholders stand behind the company (in about 42.4% of cases). Courts in the United States also pierce the corporate veil less frequently in a group context than against individual shareholders: R Thompson, 'Piercing the veil within corporate groups: corporate shareholders as mere investors' (1999) 13 Conn JnlInt'l L 379 at 386. 9 Unreported, [2002] F C A 243, Merkel J, 13 March 2002. 1072>z'rfpara72. "/Z?zrfpara80. 12 [1991] 1 All ER 929 (Adams v Cape). See also S Griffin, 'Holding companies and subsidiaries - the corporate veil' (1991) 12 Co Law 16. 13 [1991] 1 All E R 929.
62
corporate veil in this case received 'the most exhaustive treatment that it has yet
received in the English (or Scottish) courts'.14 Before discussing the case of
Adams v Cape,15 however, it is convenient to briefly deal with the original two
textbook examples of cases where the corporate veil was lifted on the ground of
fraud. These two cases are referred to in most subsequent cases dealing with
lifting the corporate veil that involved a facade or sham.
The first case is Gilford Motor Co Ltd v Home.16 Gilford Motor Co employed
M r H o m e as its managing director under a contract containing a post-contract
non-solicitation clause. W h e n his contract expired M r H o m e set up a company
to carry on a competing business. In the English Court of Appeal, Lord
Hanworth M R said that the company was a cloak or sham, a mere device for
enabling M r H o m e to breach his contract. Accordingly, the court issued an 1 "7
injunction against both M r H o m e and the company. The second case is Jones
v Lipman}* which followed the decision in Gilford}9 In this case M r Lipman
sold his house to M r Jones. M r Lipman subsequently attempted to avoid being
compelled to convey the property to M r Jones by incorporating a limited
liability company and conveying the property to the company. Russell J ordered
specific p erformance against both M r Lipman and the company on the basis
that the company was merely a device and a sham or mask.
90
In Adams v Cape the piercing of the veil argument was used in an
unsuccessful attempt to bring an English company, the holding company of a
corporate group with subsidiaries in the United States, within the jurisdiction of
the United States courts. The simplified facts are as follows. Cape Industries pic
(Cape) was a large multinational company incorporated in England that
exploited asbestos mines in South Africa. The asbestos was processed and
brought onto the market by an English subsidiary, Capasco Ltd (Capasco), and
14 P Davies, Gower's Principles of Modern Company Law (1997), 166. 15 [1991] 1 All ER 929. 16 [1933] All ER 109 (Gilford). 17 Ibid 119. 18 [1962] 1 W L R 832 (Jones). 19 [1933] All ER 109.
63
an American subsidiary, North American Asbestos Corp ( N A A C ) . In the
beginning of the seventies employees of a subsidiary of N A A C , w h o contracted
asbestosis, instituted action against certain companies in the Cape group,
including N A A C itself, Cape and Capasco. This resulted in a settlement.
N A A C was dissolved in 1978 but Continental Productions Corp (CPC),
incorporated in 1977, continued its activities. Although C P C was not a
subsidiary of Cape, it was incorporated with the financial assistance of the
latter. After N A A C ' s dissolution the asbestosis sufferers instituted a second
series of actions against Cape and Capasco in the United States.
Cape and Capasco alleged that, since they were English companies and did not
have any assets in the United States, the American court did not have
jurisdiction to decide the matter. From a tactical point of view they decided not
to appear before the American judge, because this could be regarded as
voluntary subjection to the jurisdiction of the American court. Default judgment
was granted against Cape and Capasco for damages. The plaintiffs commenced
execution procedures in England, where the defendants had assets. The main
question for determination was whether the American court indeed had
jurisdiction. If the answer were in the negative, the judgment would not be
recognised.
The plaintiffs admitted that Cape and Capasco were not physically present in
the United States, but alleged, however, that they w ere present in the United
States via their subsidiary N A A C . Furthermore, they were of the opinion that,
since the dissolution of N A A C , Cape and Capasco were involved with the
American asbestos industry via CPC. Although C P C was not a subsidiary of
Cape, it acted on the instructions of Associated Mineral Corp ( A M C ) , a wholly
owned subsidiary of Cape that had been incorporated in Lichtenstein. The
plaintiffs argued that the interposition of A M C between Cape and C P C served
as proof of Cape's involvement in the American market since Cape could
continue reaping profits of the asbestos industry without further risks of tortious
20 [ 1991 ] 1 All ER 929.
64
actions being instituted against it in the United States. The plaintiffs contended
that the v eils o f N A A C and C P C should b e 1 ifted: to decide the q uestion o f
jurisdiction Cape and Capasco had to be treated as one entity. In the court at
first instance Scott J rejected the claim.21 The plaintiffs took the matter on
appeal. The Court of Appeal confirmed the judgment of Scott J.
The judgment of the Court of Appeal in Adams v Cape22 is of great importance
for the question to what extent the courts can decide when to pierce the
corporate veil on grounds of fraud. It deals in detail with the allegation of the
plaintiffs that the formation and use of C P C and A M C in the 'alternative
marketing arrangements of 1978 were a device or sham or cloak for grave
impropriety on the part of Cape or Capasco'.23 According to the plaintiffs the
sham entailed removing the assets of Cape and Capasco from the jurisdiction of
the United States court so that they could not be held liable for asbestos claims
there, while they could continue to trade in the United States.24 The Court of
Appeal formulated the question that had to be answered as follows:25
The question of law which we now have to consider is whether the arrangements regarding NAAC, A M C and CPC made by Cape with the intentions which we have inferred constituted a fa9ade such as to justify the lifting of the corporate veil so as that CPC's and AMC's presence in the United States should be treated as the presence of Cape/Capasco for this reason if no other.
In answering this question the Court of Appeal relied on Jones26 to find that,
'where a fa9ade is alleged, the motive of the perpetrator m a y be highly
material' 21 T his i s s ignificant b ecause S cott J i n t he c ourt a q uo w as o f the
opinion that it was not the motive, but rather the 'nature of the arrangements'
that was of importance.28 Furthermore, the Court of Appeal stated that
principles c ould v ery r arely b e d istilled from p revious d ecisions t o a ssist t he
21 Times Law Reports, 23 June 1988. 22 [1991] 1 All ER 929. 23 Ibid 1022. uIbid. 25 Ibid 1024. 26 [1962] 1 W L R 832. 27 Adams v Cape [1991] 1 All ER 929 at 1024. 2* Ibid 967.
65
court in deciding whether a fa9ade was used when a company was incorporated.
The Court of Appeal concluded that in the case of A M C there was clearly a
facade, but that it would not be of any assistance for the plaintiffs because
A M C had not carried on any activity in the United States.29 Thus, the presence
of Cape in the United States could not be construed via A M C . The Court of
Appeal found that the crucial factor was the relationship between Cape/Capasco
and CPC, because C P C was without doubt carrying on business in the United
States.30 Lennarts criticises the Court of Appeal on this point, stating that Slade *X 1
LJ did not take the matter further - despite the reference to Jones - as far as
the eventual fraudulent motive of Cape was concerned. She is of the opinion
that Slade LJ limited it to the 'nature of the arrangements', just like the court a
32
quo.
The relevant ground to be considered for piercing the corporate veil in this case
was the allegation by the plaintiffs that a separate legal entity was used to avoid
'such rights of relief as third parties may in the future acquire'. The Court of
Appeal decided, however, that the court was not entitled to lift the corporate
veil against one group company merely because the corporate structure had
been used to ensure that the liability in respect of particular future activities
would fall on another group member. Cape was legally entitled to organise the
affairs of the group in this manner and to expect the court to apply the principle
in Salomon v Salomon & Co Ltd. 4 There was no fraud where a corporate group
was organised with the intention to limit potential liability. It can therefore be
concluded that in corporate groups the courts will only pierce the corporate veil
on the ground of fraud in very exceptional cases. This could not be established
Ibid 1025. It was found by Scott J at first instance that A M C was 'no more than a corporate name' (at 967) and that A M C was a 'creature of Cape' (at 969). This was confirmed on appeal (at 1025). 30 Ibid 1025. 31 [1962] 1 W L R 832.
M L Lennarts, Concernaansprakelijkheid - Rechtsvergelijkende en Internationaal Privaatrechtelijke Beschouwingen (1999) at 153. 33 Adams v Cape [1991] 1 All ER 929 at 1026. 54 [1897] AC 22 (Salomon v Salomon). See Adams v Cape [1991] 1 All ER 929 atl026.
66
in casu. It is not sufficient if the holding company uses subsidiaries to limit its
potential liability.
3.2.2 Further restriction on lifting the veil
For a number of years after Adams v Cape, 6 Creasey v Breachwood Motors
Ltd had been a classic example on lifting of the corporate veil on the ground
of fraud, from which it was distinguished on the facts.38 M r Creasy worked for
Breachwood Welwyn Ltd (Welwyn) as its general manager. Welwyn carried on
a garage business. F and S were the shareholders and directors of both Welwyn
and Breachwood Motors Ltd (Motors). Motors carried on similar business
elsewhere. W h e n Welwyn summarily dismissed M r Creasey he instituted action
against the company for wrongful dismissal. Pending the action, F and S
informally transferred Welwyn's business to Motors, and Welwyn ceased
trading. Motors paid all Welwyn's liabilities, except in relation to M r Creasey.
The latter proceeded with his action, but Welwyn did not further defend it and
its defence was struck out for failure to give particulars. Judgment was entered
for M r Creasey for damages to be assessed. W h e n Welwyn was subsequently
struck off the register and dissolved, M r Creasey applied for an order that
Motors be substituted for Welwyn as defendant.
Both at first instance and on appeal the court held that it was appropriate to lift
the corporate veil as the separate entity doctrine had been abused. O n appeal M r
Richard Southwell Q C , sitting as a deputy judge of the High Court, held that,
by not piercing the corporate veil, the transfer of assets from Welwyn to Motors
would enable the Breachwood Group to evade responsibility for the contingent
liabilities to M r Creasey for breach of his contract of employment. Therefore
the court was justified in lifting the corporate veil and treating Motors as liable
35 Unfortunately the court did not give clear guidelines as to what would constitute such a
fa9ade. 36 [1991] 1 All E R 929. 37 [1993] B C L C 480 (Creasey). 38 Creasey was also distinguished on the facts from Woolfson v Strathclyde Regional Council
1978 SC (HL) 90 (discussed in para 3.4 below): see Creasey [1993] B C L C 480 at 492.
67
for the remaining liability of Welwyn.39 Richard Southwell Q C said that the
most important factor in the case was that F and S, and through them Motors,
deliberately ignored the separate corporate personalities of Welwyn and
Motors. There was no justification for their conduct in deliberately shifting
Welwyn's assets and business into Motors in disregard of their duties as
directors and shareholders, not least the duties created by Parliament as a
protection to all creditors of a company.
The decision in The Tjaskemolen relied on Creasey. In The Tjaskemolen
the defendant applied for a discharge or reduction of the amount of security
provided to procure the release of a vessel from arrest. One of the grounds
relied on in bringing the application was that, at the time of the issue of the
writ, the defendant was not the beneficial owner of the vessel. This was because
the latter had previously sold it to another company within the same group. The
plaintiff contended that the supposed sale was not a bona fide transaction for
valuable consideration. Clarke J accepted that submission. His Honour found in
particular that it was never intended that the supposed buyer should pay a full
price t o t he s upposed s eller.44 C larke J c oncluded t hat t he a lleged a greement
was a sham or facade that did not have the effect of divesting the defendant of
beneficial ownership of the vessel. Referring to Creasey45 Clarke J said:46
" Creasey [1993] B C L C 480 at 492-493.
It does not make any difference whether the company was originally incorporated with an intention to deceive or not. What is important is whether or not it is being used as a sham during the transactions in question: see Davies, above n 14,174. 41 [1997] 2 Lloyd's Rep 465 at 470-471. 42 [1993] B C L C 480. 43 [1997] 2 Lloyd's Rep 465. " Ibid 414. 45 [1993] B C L C 480.
[1997] 2 Lloyd's Rep 465 at 471. See also Yukong Line Ltd of Korea v Rendsburg Investments Corp of Liberia [1998] 4 All E R 82 where the English court refused to pierce the corporate veil when funds were transferred to a group company with the purpose of putting those funds out of the plaintiffs reach. This case was distinguished on the facts from several previous cases relied on by counsel for the plaintiff, including Gilford [1933] All E R 109, Jones [1962] 1 W L R 832, Creasey [1993] B C L C 480 and The Tjaskemolen [1997] 2 Lloyd's Rep 465. The charterparty in Yukong was found not to be a sham as the arrangement recorded by it was in accordance with what was intended and the charterparty was not entered into with a view to defeating any pre-existing contractual obligation: [1998] 4 All E R 82 at 95.
68
That c ase i s t hus a n e xample o f p iercing t he v eil where a ssets a re d eliberately transferred from A to B in the knowledge that to do so will defeat a creditor's claim or potential claim, even if that has not proved to be the purpose of doing so. The Judge in that case would have regarded the case as even stronger if the purpose of the transaction was to defeat the creditor's claim. I agree with the reasoning in Creasey. The cases have not worked out what is meant by 'piercing the corporate veil'. It may not always mean the same thing. But in the present context the cases seem to me to show that, where the alleged transfer is a sham or a fa9ade, it will not have the effect of transferring the beneficial ownership of the transferor in the vessel concerned.
Despite the decisions in Creasey41 and The Tjaskemolen, however, the
decision of the English Court of Appeal in Ord v Belhaven Pubs Ltd49 has
further restricted the chances that a court will pierce the veil on the ground of
fraud in a group situation after Adams v Cape.50 Ord51 overruled the decision in
Creasey52 In Ord52 Belhaven Pubs Ltd (Belhaven) was a subsidiary of Ascot
Holdings pic (Holdings). Together with another subsidiary of Holdings, Ascot
Estates Ltd (Estates), Belhaven was the legal owner of a number of public
houses and hotels. After M r and Mrs Ord purchased a 20-year lease of the
public house from Belhaven they sued it for damages, alleging that the
statements by Belhaven about its turnover and profitability were false.
Subsequently the group of companies had to a large extent been reorganised as
a result of a crisis in the property market. There was a write-down in the value
of the properties owned by Belhaven and Estates. Belhaven transferred all its
public houses to Estates, which in rum transferred all its hotels to B elhaven.
The transfers took place against the net book value and did not have any effect
on the balance sheets of the two companies.
Holdings subsequently bought all the hotels from Belhaven. Holdings paid
more than the net book value, by which the loss on the balance of Belhaven was
rectified. As a result of the reorganisation Belhaven was without debts but
ceased trading and was inactive. M r and Mrs Ord thereupon requested the court
47 [1993] B C L C 480. 48 [1997] 2 Lloyd's Rep 465. 49 [1998] 2 B C L C 447 (Ord). 50 [1991] 1 All ER 929. 51 [1998] 2 B C L C 447. 52 [1993] B C L C 480. 53 [1998] 2 B C L C 447.
69
to replace Belhaven as a defendant with Estates and Holdings. The English
Court of Appeal overturned the judgment of the court a quo and ruled that
piercing the corporate veil could not be justified on the facts. It found that
neither the companies nor their directors had acted improperly. With reference
to Adams v Cape54 the English Court of Appeal found that a bona fide
reorganisation of a group was proper, even if this had the result that one of the
subsidiary companies could not provide any recourse for a contingent
liability.55
What was startling, however, is that, in the course of its judgment, the English
Court of Appeal in Ord56 not only distinguished Creasey51 on the facts, but
went further to find that it could no longer serve as a precedent.58 This caused a
stir in legal circles, with a number of commentators pointing out that the facts
in the two cases were totally different, so that it was unnecessary to overrule
Creasey. In Creasey ° i t w as c learly a case o f asset s tripping, while i t w as
found in Ord" that there was no asset stripping. Some writers interpret the fact
that Ora3 overruled Creasey62 to mean that the door on piercing the corporate
veil has been all but closed as an option for contingent creditors.64 The
prospects of a court lifting the veil of incorporation appear increasingly remote
in these circumstances.65
54 [1991] 1 All ER 929. 55 Ord [1998] 2 BCLC 447 at 458. 56 [1998] 2 BCLC 447. 57 [1993] BCLC 480.
See further CA Png, 'Creasey v Breachwood Motors: a right decision with the wrong reasons' (1999) Co Law 122 at 124; D Bromilov, 'Creasey v Breachwood: mistaken identity leads to untimely death' (1998) Co Law 201 at 210; A Walters, 'Round up: Company Law -business as usual?' (1998) Co Law 226 at 226. 59 [1993] BCLC 480. See Lennarts, above n 32, 155-156 60 [1993] BCLC 480. 61 [1998] 2 BCLC 447. 62 Ibid. 63 [1993] BCLC 480. 64 Walters, above n 58, 226. 65 Ibid 221.
70
3.3 Agency
3.3.1 Extent of control
For the court to pierce the corporate veil in a corporate group on the basis of
agency, the extent of control that the holding company has over its subsidiary is
crucial.66 This can be deduced from one of the leading cases on this issue,
Smith, Stone and Knight Ltd v Birmingham Corporation.61 In this case the
holding company claimed damages for expropriation by which its subsidiary
had been prejudiced. Atkinson J concluded that the subsidiary was an agent of
the holding company after answering all the following questions in the
affirmative:68
(a) W a s the profit of the business in reality the profit of the holding
company?
(b) Did the holding company appoint the directors of the subsidiary that
carried on the business?
(c) W a s the holding company the head and brain behind the business?
(d) Did the holding company control the business?
(e) W a s the profit made as a result of the skill and direction of the holding
company?
(f) Did the holding company exercise effectual and constant control over
the subsidiary?
Both Hotel Terrigal Pty Ltd v Latec Investments Ltd (No 2)69 and Spreag v
Paeson Pty Ltd10 followed the decision in Smith, Stone and Knight. In
66 A Wilkinson, 'Piercing the corporate veil and the Insolvency Act 1986' (1987) 8 Co Law 124 at 125. The mere fact that there is a one-person company (see, eg, Salomon v Salomon [1897] A C 22) or a wholly-owned subsidiary (see, eg, Adams v Cape [1991] 1 All E R 929) is,
however, insufficient. 57 [1939] 4 All E R 116 (Smith, Stone and Knight). 68 Ibid 121. 69 [1969] 1 N S W R 676 (Hotel Terrigal). Cf Dennis Wilcox Pty Ltd v Federal Commissioner of Taxation (1988) 79 A L R 267 at 273-274, where the agency argument for lifting the veil was rejected by the Full Federal Court and it was stated that the decision in Hotel Terrigal should be limited to the application of equitable principles regarding the exercise of a mortgagee's power
of sale.
71
Spreag12 Sheppard J in the Federal Court of Australia held that a holding
company could be held liable pursuant to s 52 of the Trade Practices Act 1974
(Cth) under certain circumstances. A n example of such a circumstance would
be where a subsidiary without its own separate finance and management made a 71
misrepresentation in rare circumstances like those in Smith, Stone and Knight.
The Full Federal Court in Balmedie Pty Ltd v Nicola Russo14 has, however,
recently re-confirmed that a company 'does not become an agent for its
shareholders simply because of the fact that they are shareholders'.75
Another important case i n this context is Re FG (Films) Ltd. An American
company agreed to assist an English company with the making of a film. The
president of the American company was a director of and held 9 0 % of the
shares i n t he E nglish c ompany. T he E nglish c ompany w as i ncorporated w ith
only £100, did not employ any staff and had no place of business apart from its
registered office. The costs of making the film amounted to £80 000. The
question that arose was whether a film could be registered as a British film
under the Cinematograph Films Act 1938 on the basis that an English company
was the maker of the film. The court found that the participation of the English
company was almost negligible and that it could only be regarded as agent for
the American company that financed the making of the film under the
directions of its president. Apart from the criterion of control, it was important
in this case that the capital of the English company was hopelessly inadequate
for the company to carry on business independently.
After analysing FG Films11 and other cases, Schmitthoff concluded, in 1976,
that the agency construction afforded the most convenient way to overcome the
/u (1990) 94 ALR 679 (Spreag). 71 [1939] 4 All ER 116. 72 (1990) 94 ALR 679. 73 [1939] 4 All ER 116. 74 Unreported, Federal Court, Ryan, Whitlam and Goldberg JJ, 21 August 1998. 75 Ibid 13. 76 [1953] 1 W L R 483, [1953] 1 All ER 615 (FG Films). 77 Ibid.
72
strict interpretation of the rule in Salomon v Salomon1* in corporate groups.
According to Schmitthoff it was easier to pierce the corporate veil on the basis
of agency than it was on grounds of abuse of the corporate form.79 Schmitthoff
went even further to suggest that, in the case of wholly-owned subsidiaries,
there should be a rebuttable presumption that the holding company used the
subsidiary as its agent and that the holding company was liable as principal for
the debts of the subsidiary. ° This proposal by Schmitthoff was, however, never
accepted and his conclusion that agency affords good prospects to pierce the
veil in corporate groups does not look justifiable any longer.81 To date agency
as a basis to pierce the veil in corporate groups has been applied extremely
rarely.
3.3.2 Authorisation to contract
The fact that it is extremely difficult to pierce the corporate veil on the basis of
agency is corroborated by the decision in Adams v Cape*2 Here the plaintiffs
alleged that Cape was present in the United States through its 'agents' C P C and
N A A C . The English Court of Appeal found on the facts that a very substantial
part of the business carried on by N A A C at the relevant time was its own
business in every sense. Even more important, according to the English Court
of Appeal, was the fact that N A A C had no general authority to bind
Cape/Capasco to any contracts and the fact that N A A C 8 3 never concluded any
transaction in a way that bound Cape/Capasco contractually. The English Court
of Appeal concluded that the activities of N A A C were its own activities
exclusively, and not those of Cape/Capasco. N A A C could therefore not be
regarded as an agent of the holding company. The English Court of Appeal
found that there was an even stronger case to be made out to find that C P C was
8 [1897] A C 22. 9 C M Schmitthoff, 'Salomon in the shadow' (1976) JBL 305 at 309 and 311. 0 C M Schmitthoff, 'The wholly owned and the controlled subsidiary' (1978) JBL 218 at 226. 1 Wilkinson, above n 44, 125-126. 2 [1991] 1 All ER 929. 3 With or without authority from Cape/Capasco obtained beforehand.
73
not an agent of Cape/Capasco because, unlike N A A C , C P C was not even a
subsidiary of Cape.
Adams v Cape*4 suggests that courts will regard a subsidiary as an agent of its
holding company only in exceptional cases. It follows from this judgment that,
before agency can be proved, at least part of the activities exercised by the
subsidiary should in reality be activities of the holding company. This will not
be the case where the subsidiary enters into contracts for the holding company
in its own name. O n the facts there would have to be an extremely high degree
of c ontrol b y t he h olding company o ver t he s ubsidiary b efore a c ourt would
conclude that an agency relationship in fact existed.
Lennarts is of the opinion that, unlike the position in Smith, Stone and Knight
and FG Films,*1 the consideration in Adams v Cape was not so much the
extent of control that Cape had over the subsidiary. The pivotal point was
rather the formal question whether N A A C and C P C were authorised to enter
into contracts on behalf of Cape. This view corresponds with that of Davies in
that he infers from Adams v Cape90 that the corporate veil can be lifted 'when it
can be established that the company is an authorised agent of its controllers or
its members, corporate or human.'91
Lennarts continues by saying that, if this view is correct, it means that the
English Court of Appeal in Adams v Cape92 has given a formal restrictive
interpretation to the concept of agency. This is different from the position after
Smith, Stone and Knight92 and FG Films.94 In the light of Adams v Cape95 the
84 [1991] 1 All ER 929. 85 See also P Davies, in: Palmer's Company Law (1992), para 2.1522 (who is in agreement with this view). 86 [1939] 4 All ER 116. 87 [1953] 1 W L R 483, [1953] 1 All ER 615. 88 [1991] 1 All ER 929. 80
Lennarts, above n 32, 161-162. 90 [1991] 1 All ER 929. 91 Davies, above n 14, 173. 92 [1991] 1AUER929. 93 [1939] 4 All ER 116.
74
possibility of piercing the veil in corporate groups on the basis of agency
appears remote indeed.96 Moreover, it is clear that the proposal by Schmitthoff
that there should be a rebuttable presumption that the subsidiary is the 'agent'
of the holding company is no longer viable.97 Lennarts states that the English
Court of Appeal in Adams v Cape9* was correct in refusing to presume an
agency relationship between two companies in the same group as a matter of
99
course.
3.4 Single economic unit
In England in the seventies the question arose whether, apart from fraud and
agency, the corporate veil could also be lifted if the facts or considerations of
equity justified that different group companies should be treated as one
economic unit.100 Lord Denning introduced the radical proposition that
holding/subsidiary companies should be regarded as single entities because of
their operation as an economic unit in Littlewoods Mail Order Stores Ltd v Mc
Gregor (Inspector of Taxes)}01
I decline to treat the [subsidiary] as a separate and independent entity. The doctrine laid down in Salomon v Salomon & Co Ltd has to be watched carefully. It has often been supposed to cast a veil over the personality of a limited company through which the courts cannot see. But that is not true. The courts can and often do draw aside the veil. They can, and often do, pull off the mask. They look to see what really lies behind. The legislature has shown the way with group accounts and the rest. And the courts should follow suit. I think we should look at the [subsidiary] andseeitasitreally is -1he wholly-ownedsubsidiary ofthe taxpayers. It is the creature, the puppet, of the taxpayers in point of fact; and should be so regarded in point of law.
94 [1953] 1 W L R 483, [1953] 1 All E R 615. 95 [1991] 1 All E R 929. 96 Davies, above n 14, 173. 97 Lennarts, above n 32, 161. 98 [1991] 1 All E R 929. 99 Lennarts, above n 32,161. 100 See R C Schulte, Groups of Companies: The Parent-Subsidiary Relationship and Creditors'
Remedies (1999), 65. 101 [1969] 3 All E R 855 at 860. See also McKenzie v Gianoutos & Booleris [1957] N Z L R 309.
75
Lord Denning once more adhered to this liberal view102 in DHN Food
Distributors Ltd v Tower Hamlets LBC.m The facts were as follows. D H N
conducted a business from premises owned by its wholly-owned subsidiary,
Bronze Investments Ltd (Bronze). Bronze did not have any employees or bank
account, and did not carry on any trading activities. The London Borough of
Tower Hamlets purchased the premises. If D H N itself had owned not only the
business but also the land, it would have received a sizeable amount disturbance
payment in respect of the business, such payment being an integral part of the
purchase price, although separately assessed. Since the premises were owned
by Bronze, D H N was treated before the Land Tribunal as a periodic yearly
tenant of Bronze. As a result D H N was only entitled to compensation as
specified under s 20(1) of the Compulsory Purchase Act 1965, which read as
follows:
If a person having no greater interest in the land as tenant from year to year ... is required to give up possession ... before the expiration of his term or interest in the land he shall be entitled to compensation for the value of his unexpired term or interest... and for any loss or injury he may sustain.
The disturbance payment to which DHN was entitled was a very small amount
because it was assessed on the basis that D H N could only expect to occupy the
premises until the earliest date that its tenancy could be terminated by notice.
The appeal by DHN was allowed.104 Lord Denning called for the recognition of
the corporate group in these circumstances, saying that this should be an
exception to the separate entity doctrine. O n the basis of the special
circumstances it was proper to look at the realities of the situation and pierce
the corporate veil. In other words, the fact that D H N and Bronze were separate
102 A similarly liberal view was held by Cumming-Bruce LJ in Re A Company [1985] BCLC 333 (CA) at 337-338. In that case the court stated that the case law points in the direction of piercing the corporate veil to ensure that justice prevails 'irrespective of the legal efficacy of the corporate structure'. But cf Re Securitibank Ltd (No 2) [1978] 2 N Z L R 136; Bentley Poultry Farm Ltd v Canterbury Poultry Farmers Association (1989) 4 N Z C L C 64,780.
" [1976] 3 All E R 462 (DHN v Tower Hamlets). See further D Sugarman and F Webb, 'Three-in-one: trusts, licences and veils' (1977) 93 LQR 170; D Powles, 'The 'see-through' corporate
veil' (1977) 40 MLR 337; D Hayton, 'Contractual licences and corporate veils' [1977] CLJ 12 104 Hayton, above n 103, 13.
76
legal entities should be ignored and the companies treated as a single economic
entity. A sizeable disturbance payment should therefore be made to DHN as if
it o wned t he p remises a nd t hus c ould e xpect toe arry o n b usiness from s uch
premises indefinitely.105
The decision in DHN v Tower Hamlets106 seemed to be only a short step away
from the proposition that the courts may pierce the corporate veil whenever it is • 1A7
just and equitable to do so. In reaching his conclusion that a holding
company and its subsidiary should be treated as a single economic unit,108 Lord
Denning MR relied on Gower's view that there was a general tendency to
ignore the separate legal entity.109 Lord Denning stated:110
We all know that in many respects a group of companies are treated together for the purpose of general accounts, balance sheet and profit and loss account. They are treated as one concern. Professor Gower in his book on company law [LCB Gower The Principles of Modern Company Law 3rd ed (London: Stevens & Sons, 1969) at 216] says: 'there is evidence of a general tendency to ignore the separate legal entities of various companies within a group, and to look instead at the economic entity of the whole group.' This is especially the case when a parent company owns all the shares of the subsidiaries, so much so that it can control every movement of the subsidiaries. These subsidiaries are bound hand and foot to the parent company and must do just what the parent company says. A striking instance is the decision of the House of Lords in Harold Holdsworth & Co (Wakefield) Ltd v Caddies. So here. This group is virtually the same as a partnership in which all the three companies are partners. They should not be treated separately so as to be defeated on a technical point. They should not be deprived of the compensation which should justly be payable for disturbance. The three companies should, for present purposes, be treated as one, and the parent company, D H N , should be treated as that one. So D H N are entitled to claim compensation accordingly.'''
Ibid. 105
106 [1976] 3 All E R 462. 107 See Sugarman and Webb, above n 103, 174. 108 DHNv Tower Hamlets [1976] 3 All E R 462 at 860. 109 L C B Gower, Gower's Principles of Modern Company Law (1969), 216. 110 DHN v Tower Hamlets [1976] 3 All E R 462 at 467. 111 Harold Holdsworth & Co (Wakefield) Ltd v Caddies [ 1955] 1 All E R 725 related to the interpretation of a service agreement. Caddies had been appointed managing director of the holding company of the group. It was argued that he could not be ordered to devote his whole time solely to duties in relation to the affairs of the subsidiaries since these were separate legal entities under the control of their own boards of directors. This argument was rejected as too technical. Caddies' service agreement was found to be an agreement in re mercatoria, to be
construed in the light of the facts and realities of the situation (Lord Reid at 738). Since this case does not throw any further light on the issue presently under discussion, it is not discussed
further.
77
More recently, however, commentators have started questioning whether there
is, in fact, a tendency to lift the corporate veil in these circumstances.112 The
subsequent decision by the House of Lords in Woolfson v Strathclyde Regional
Council"2 also does not support Lord Denning's view.114 In Woolfson115 MT
Woolfson and Solfred Holdings Ltd (Solfred Holdings) were co-owners of five
premises next to one another, in which M & L Campbell Ltd ( M & L Campbell)
carried on business. M r Woolfson and his wife were the shareholders in both
M & L Campbell and Solfred Holdings. The Strathclyde Regional Council
expropriated the premises.
Apart from compensation for the value of the expropriated immovable property,
Mr Woolfson and Solfred Holdings also claimed damages for the disturbance of
business of M&L Campbell. They relied for authority on DHN v Tower
Hamlets116 for the proposition that Mr Woolfson, M&L Campbell and Solfred
Holdings should be regarded as one economic unit. The House of Lords
confirmed the decision of the Scottish Court of Appeal, in which their claim
was rejected. Although some commentators pointed out that Woolfson111 was
distinguishable from DHN v Tower Hamlets}1* they conceded that the case
would probably have had the same outcome even if the facts were identical.119
See, eg, F G Rixon, 'Lifting the Veil Between Holding and Subsidiary Companies' (1986) 102 LQR 415; S Ottolenghi, 'From Peeping Behind the Corporate Veil, to Ignoring it Completely' (1990) 53 MLR 338; L Gallagher and P Ziegler, 'Lifting the Corporate Veil in the Pursuit of Justice' (1990) JBL 292 at 297; R Baxt, 'Tensions between commercial reality and legal principle - should the concept of the corporate entity be re-examined?' (1991) 65 ALJ 352. 113 1978 SC (HL) 90 (Woolfson). 14 In the recent N e w Zealand case of Official Assignee v 15 Insell Avenue [2001] 2 N Z L R 492, Paterson J pointed out (at 502) that the N e w Zealand Court of Appeal in Savill v Chase Holdings (Wellington) Ltd [1989] 1 N Z L R 257 confirmed, in line with the decision in Woolfson 1978 SC (HL) 90, that the corporate veil should be pierced 'only where special circumstances exist indicating that it is a mere fa9ade concealing the true facts'. CfChen v Butterfield (1996) 7 N Z C L C 261,086. I151978SC(HL)90. 1I6[1976]3A11ER462. ,I71978SC(HL)90. 118 [1976] 3 All E R 462. 19 Rixon , above n 112, 419; LS Sealy, Cases and Materials on Company Law (1992) at 61 fii
78
In Lonrho Ltd v Shell Petroleum Co Ltd Lord Denning M R showed greater
regard for the s eparate entity doctrine than in DHNv Tower Hamlets}21 His
Lordship was of the view that it was possible to rebut the 'presumption' of
economic unity in a corporate group. The facts were as follows. Lonrho Ltd
(Lonrho) was involved in a commercial arbitration against Shell Petroleum Co
Ltd (Shell) and British Petroleum Co Ltd (BP). Shell and B P were the holding
companies o f c ertain p artially and w holly-owned s ubsidiaries i ncorporated i n
South Africa and the former Rhodesia. The question before the English Court
of Appeal was whether either Shell or B P was obliged to discover documents
that were the property of the respective subsidiaries. In particular, the court had
to decide whether these documents of the subsidiaries were in the 'possession,
custody or power' of the relevant holding company.122 The subsidiaries
contended that they were not obliged to make disclosure, on the ground that it
was not in their interest, as such disclosure would potentially expose their
officers to criminal proceedings.
Lord Denning MR appreciated that the position was different from that of 'a
one m a n company - or a 100 per cent company - which is operating in this
country, with the self-same directors, or a 100 percent parent with various
subsidiaries. It is important to realise that the subsidiaries of multinational
companies have a great deal of autonomy in the country concerned.'123 His
Lordship found that the issue of effective control was fundamental to the whole
notion of the corporate group as an economic entity.124 Shaw LJ agreed with
this view, stating that 'a document can be said to be in the power of a party for
the purpose of disclosure only if... on the factual realities of the case [the party
is] virtually in possession (as with a one-man company in relation to documents
of the company)'.x 25
120 [1980] 1 WLR 627; affirming [1980] 1 QB 358. 121 [1976] 3 All ER 462. 122 [1980] 1 WLR 627 at 635. 123 [1980] lQB358at372. 124 C/Ch 10 para 10.2.2.2. 125 [1980] lQB358at375.
79
The holding companies had voting control of their subsidiaries. The issue in
this case, however, was whether the holding companies had 'power' over the
documents of their subsidiaries. After considering previous authority, including
Littlewoods Mail Order Stores Ltd v Mc Gregor (Inspector of Taxes)126 and
DHNv Tower Hamlets}21 Lord Denning MR stated:128
[I]t seems to me that even if we lift up the veil in this case: even if we look, as we can, at all the shareholdings and at all the directors: even if we look at the rules of management and the articles o f association: in this particular case it is entirely different. Although the parent companies may have owned 100 per cent or 50 per cent each of the shares in the subsidiaries, it seems to m e that in regard to the documents which are in the possession of the South African and Rhodesian companies, the parent companies have no 'power' over them.
The holding companies had sufficient voting control to exercise the 'power' to
remove the directors of the subsidiaries and to replace them with directors that
would carry out the wishes of the holding company. In the circumstances,
however, this was not a feasible solution. It may not have had much effect, as
each director had to comply with his duties and act in the interests of the
subsidiary. A s an altemative s olution the holding c ompany c ould ensure that
the articles of association of the subsidiary were amended to give shareholders
a right to inspect company documents. Under normal circumstances, however, a
shareholder has no obligation to do any of these things.
The issue of regarding the group as one entity was considered again by the N e w
South Wales Supreme Court in Pioneer Concrete Services Ltd v Yelnah Pty 1 9Q
Ltd. This case involved a dispute between major competitors in the ready-
mixed concrete business. Hi-Quality Concrete (Holdings) Pty Ltd was the
holding company for a large group of companies controlled by Messrs
llb [1969] 3 All E R 855. 127 [1976] 3 All E R 462. 128 [1980] lQB358at373. 129 (1986) 5 N S W L R 254 (Yelnah). See further Bluecorp Pty Ltd (in liq) v ANZ Executors and Trustee Co Ltd (1995) 18 A C S R 566 at 568-569 for certain relevant factors that a court may take into account when considering whether to pierce the corporate veil on the ground that a group enterprise exists. Australian courts will, however, generally not pierce the veil in the context of corporate groups on the ground of control alone: Heytesbury Holdings Pty Ltd v City ofSubiaco (1998) 19 W A R 440 at 451. See also Briggs v James Hardie & Co Pty Ltd (1989) 16 N S W L R 549 at 577.
80
Hargreaves, Ward and Armstrong and which was known as the Hi-Quality
Group. Hi-Quality Concrete ( N S W ) Pty Ltd was a member of this group and a
wholly-owned subsidiary of the holding company (the subsidiary). In 1982
Hargreaves, Ward and Armstrong together with the subsidiary and the holding
company entered into a deed with Pioneer Concrete Services Ltd (Pioneer) to
supply concrete. Under this deed, however, 'Hi-Quality' was defined
specifically as Hi-Quality Concrete ( N S W ) Pty Ltd (the subsidiary). This is
significant because it appeared that the parties had deliberately chosen not that
there should be a covenant by the holding company but rather a covenant by the
subsidiary which covenant was to be guaranteed by the holding company - a
very different sort of obligation.130
In 1985 the holding company entered into transactions that Pioneer alleged
were in breach of the 1982 deed. The defendants (comprising certain parties to
the 1985 transactions and members of the Hi-Quality Group) denied any breach
of the 1982 agreement on the ground that the 1985 transactions had been
entered into by the holding company which deliberately did not join in the
promises under the 1982 deed. Pioneer maintained that it was unreal to treat the
companies as being otherwise than forming part of a group, because 'some
directors took the view that the company c'est moi'.131 It was submitted that:132
'[T]he family motto of the Ward, Hargreaves and Armstrong families should be 'Les Compagnies Ces Sont Nous et Nous Sont Les Compagmes'. They (and their counsel) habitually refer to and conceive of themselves as Hi-Quality, the Hi-Quality Group ... (various transcript references and references to the interrogatories are then given and the submission continues) there is no distinction between parent and subsidiary or any member of the Hi-Quality group and the Group itself. The Group is virtually a partnership between Messrs Ward, Hargreaves and Armstrong. ... The companies in the Group are puppets dancing at the bidding of their directors ...' In reply it was put that the doctrine of the corporate veil is '... out of place in the world of Hi-Quality, a world in which the doctrine of Salomon's case [1897] A C 22 is unknown. In that world human
realities, not corporate formalities, reign.'133
130 Yelnah (1986) 5 N S W L R 254 at 264. m Ibid265. 132 Ibid. mIbid.
81
Of the utmost importance to the decision regarding the 'human reality' factor
was the fact that the agreements between Pioneer and the members of the group
were drafted by an expert and settled between solicitors on their clients'
instructions.134 Although the holding company was a party to the 1982 deed, the
specific provision defining 'Hi-Quality' under the deed to be the subsidiary
meant that the holding company had deliberately not joined in the promises
under the deed. The holding company, by its actions in 1985, could therefore
not b e i n b reach o f t he 1982 d eed. T he s ubsidiary and t he h olding company
were separate legal entities and the court could not impute the promise by the
subsidiary to the holding company. Young J observed the principle of 'special
circumstances' suggested by Lord Keith of Kinkel in Woolfson and held that
the principle of piercing of the corporate veil did not apply in this case.
Young J stated:137
In my view the plaintiffs [ie Pioneer's] submissions take the DHN case too far and it is only if the court can see that there is in fact or in law a partnership between companies in a group or alternatively where there is a mere sham or fa?ade that one lifts the veil. The principle does not apply in the instant case where it would appear that there was good commercial purpose for having separate companies in the group performing different functions even though the ultimate controllers would very naturally lapse into speaking of the whole group as'us'.138
Another case often referred to in this context is Multinational Gas and
Petrochemical Co v Multinational Gas and Petrochemical Services Ltd}29
although it did not deal with the issue of lifting the corporate veil on the ground
of the 'single economic unit' theory as such. In Multinational Gas140 three oil
companies located in France, the United States and Japan respectively, were the
134 Ibid 264. 1 3 51978SC(HL)90.
T w o further grounds on which the court held that the corporate veil should not be lifted were (1) because it was impossible to infer agency on the facts and (2) because the separate corporation had not been formed for the sole purpose or for the dominant purpose of evading a contractual or fiduciary obligation (cf Guildford [1933] All E R Rep 109). 137 Yelnah (1986) 5 N S W L R 254 at 267. 138 DHN v Tower Hamlets [1976] 3 All E R 462 was also distinguished in subsequent Australian cases. See, eg, Dennis Wilcox Pty Ltd v Federal Commissioner of Taxation (1988) 79 A L R 267 at 274 (Jenkinson J) and State Bank of Victoria v Parry (1990) 2 A C S R 15 at 32 139 [1983] 3 W L R 492 (Multinational Gas). wIbid.
82
only shareholders in Multinational Gas and Petrochemical Co (MGP),
incorporated in Liberia. M G P carried on the business of dealing in liquefied gas
products.141
For fiscal reasons a separate management company, Multinational Gas and
Petroleum Services Ltd ( M G P Services), was incorporated in the United
Kingdom to provide advice to M G P and carry out management functions.
Employees of the three oil companies were appointed as directors of M G P from
time to time. Again for fiscal reasons the directors' meetings of M G P were held
outside England on all relevant occasions. The directors of M G P took a highly
speculative decision to purchase oil tankers for lease. The decision had
disastrous results. Both M G P and M G P Services went insolvent.142
The liquidator of MGP instituted proceedings against MGP Services on the
grounds that it was negligent in giving advice and performing management
functions for M G P . H e instituted action against M G P Services to enable him to
hold also the three oil companies liable for payment. That was where the best
recourse possibilities lay.143 The liquidator requested the court for leave to sue
the directors of M G P and the three oil companies, as they were outside the
jurisdiction of the court. The court first had to investigate whether it had
jurisdiction to take notice of the claim. T w o grounds were alleged on which the
jurisdiction of the English court could be based. The first was that the alleged
tort of negligence had been committed within its jurisdiction.144 The second
ground was that the three oil companies were 'proper parties' to the claim that
had b een i nstituted b y t he s ummons ' properly b rought against a p erson duly
served within the jurisdiction'.145 The English Court of Appeal confirmed the
decision of the court a quo, refusing to affirm that an English court had
jurisdiction.
141 Ibid 497. 142 Ibid 498. 143 Ibid 498-499. 144 Ibid 499.
83
With regard to the first ground of authority the English Court of Appeal
considered that the alleged tort by the directors of M G P could not have taken
place within England. The Court of Appeal treated the claim against the three
oil companies as derived from the action against the directors. Because of this,
the Court of Appeal refused to allow that summons be issued against the three
oil companies.146 With regard to the second ground, the English Court of
Appeal had to consider inter alia whether an action against the three oil
companies would have a reasonable chance of success. In other words it had to
decide whether the three oil companies were in any way liable to the creditors
of the company. If the answer was 'No', the three oil companies could not be
regarded as 'proper parties to the action' and leave to issue summons should be
refused. The majority of the English Court of Appeal held that there was no
cause of action against the three oil companies. The claim on the grounds of
negligence against the directors and the three oil companies failed because the
shareholders unanimously consented to the decision of the directors.
It is interesting to note that not one of the judges in Multinational Gas14
considered whether there was a single economic unit, on the basis of which the
three oil companies could have been held liable. This has caused some
commentators to argue that, like Woolfson}49 Multinational Gas150 is a
rejection of the decision of the English Court of Appeal in DHN v Tower
Hamlets because of the strict application of the separate entity doctrine by
the court. Others have argued that Multinational Gas152 can only be seen as an
implicit rejection of the single economic unit theory.153
Ibid 500-501 (Lawson J); 504-505 (May LJ); 515-516 (Dillon J). 147 Ibid 501-502 (Lawton LJ); 516-522 (Dillon LJ). But cf the judgment of May LJ at 513, who disagreed on this point. 148 [1983] 3 W L R 492. 1491978SC(HL)90. 150 [1983] 3 W L R 492. 151 See Rixon, above n 112, 422; Wilkinson, above n 44, 126. 152 [1983] 3 W L R 492.
See Lennarts, above n 32, 164-7.
84
What is clear, however, is that the liberal view in DHN v Tower Hamlets154 is
wholly inconsistent with the later view in Adams v Cape155 where the single
economic unit theory was explicitly rejected. In Adams v Cape156 the court
expressly discarded the 'single group entity' argument that separate companies
in a group could be treated as one economic unit on grounds of fairness. It
observed that a company is entitled to arrange the affairs of its group in such a
manner that the business carried on in another jurisdiction is the business of the
subsidiary and not that of the holding company. The court stated that the entity
principle could not be disregarded merely because it was just to do so157 - the
treatment of different companies as one economic unit should be limited to
cases where a reasonable interpretation of a particular statute or contractual
term required it.158
In 1991, the same year that Adams v Cape159 was decided in England, Qintex
Australia Finance Ltd v Schroders Australia Ltd160 came before the Supreme
Court of N e w South Wales. Schroders Australia Ltd (Schroders) sold Japanese
yen on behalf of a member of the Qintex group. The proceeds were made
payable to Qintex Television Ltd (QTL), but were mistakenly paid into the
account of Qintex Australia Finance Ltd (QAFL). Both of these companies
were members of the Qintex group.
At more or less the same time one of the companies in the Qintex group
instructed Schroders to purchase a forward contract for Japanese yen. Certain
losses were incurred on this contract, as a result of which monies were owed to
Schroders. To reduce the debt Schroders appropriated money from the account
of Q A F L held by Schroders on its behalf. Q A L F alleged that the loss was that
154 [1976] 3 All ER 462.
'"[1991] 1 All E R 929. 156 Ibid. 157 Adams v Cape [1991] 1 All E R 929 at 1020. A Muscat, The Liability of the Holding Company for the Debts of its Insolvent Subsidiary (1996) at 254 describes this judgment as
'remarkably narrow and conservative' and 'retrogressive'. 158 Adams v Cape [1991] 1 All E R 929 atl019. It should be noted here that the English Court of Appeal qualified DHN v Tower Hamlets [1976] 3 All E R 462 as a case in which different companies were regarded as one entity because a reasonable interpretation of the statute
required it.
85
of the other entity in the Qintex group on behalf of which Schroder acted when
the loss was incurred. Schroders argued that it had always treated the Qintex
group as one and that there was no distinction between the various companies
that made up the group. The identity of the entity in the Qintex group on whose
behalf Schroders had purchased the futures exchange contract was uncertain.
The legal question that arose was whether the separate legal identities of the
different companies in the Qintex group could be ignored, so that the debts of
the group could be treated as one. Rogers CJ was of the view that, even though
the companies generally acted as a group for business purposes, creditors
should look to the specific company within the group with which they had
dealt.161 In casu, the onus was on the creditors to establish which one of the
companies within the Qintex group had entered into the relevant futures
exchange contract.162 This meant that Schroders could not look to other
companies in the group to repay the debts of the company with w h o m it had
contracted. Despite the fact that entity law was clearly followed, his Honour
suggested that commercial practice was not reflected by the rigid distinction
between various companies in a group and that a certain degree of reform was
necessary.163 Rogers CJ stated:164
It may be desirable for Parliament to consider whether this distinction between the law and commercial practice should be maintained. This is especially the case today when the many collapses of conglomerates occasion many disputes. Regularly, liquidators of subsidiaries, or of the holding company, come to court to argue as to which of their charges bears the liability ...
159 [1991] 1 All E R 929. 160 (1991) 9 A C L C 109 (Qintex v Schroders). 161 Ibid 110. 162 Ibid III. 163 Qintex v Schroders (1991) 9 A C L C 1 09 at 1 11. In this context, R Austin, ' Problems for directors in corporate groups' in M Gillooly (ed), The Law Relating to Corporate Groups
(1993) 133 at 138 says: 'Entity law fails to reflect the commercial understanding of the parties in such a case, and is capable of producing substantial injustice.' Some commentators, however,
do not see the need for reform in this area of the law, eg S Fridman, 'Removal of the corporate
veil: suggestions for law reform in Qintex Australia Finance Ltd v Schroders Australia Ltd' (1991) 19 A Bus L Rev 211. 164 Qintex v Schroders (1991) 9 A C L C 109 at 111.
86
As well, creditors of failed companies encounter difficulty when they have to select from amongst the moving targets the company with which they consider they concluded a contract. The result has been unproductive expenditure on legal costs, a reduction in the amount available to creditors, a windfall for some, and an unfair loss to others. Fairness or equity seems to have little role to play.
The same issue came before the English court in Atlas Maritime Co SA v
Avalon Maritime Ltd, The Coral Rose (No I)}65 Avalon Maritime Ltd (Avalon)
was a wholly-owned subsidiary of Marc Rich & Co A G (Marc Rich), a Swiss
company. Avalon was incorporated in Gibraltar for tax reasons. Avalon bought
a damaged ship, the Coral Rose, for almost U S $ 8 million. This was made
possible through a loan from Marc Rich. While the reparation work to the ship,
which was also financed by Marc Rich, was under way, Avalon negotiated to
sell the ship, Avalon's only substantial asset, to a company from Liberia, Atlas
Maritime Co S A (Atlas).166
Atlas alleged that it concluded a valid sale agreement with Avalon in respect of
the Coral Rose. Avalon denied this. Atlas instituted arbitration proceedings
against Avalon in which it claimed damages on the ground of breach of
contract. Pending the outcome of these proceedings, Atlas successfully applied
to the English Court for a Mareva injunction (now known as a 'freezing order')
to freeze assets of Avalon to the amount of US$ 3 million. The injunction order
stated that Avalon could sell the Coral Rose on condition that it transferred
from the profit an amount of U S $ 3 million to a frozen account. Avalon
subsequently sold the ship to a third party for US$ 10,7 million. U S $ 3 million
was transferred to a frozen account in accordance with the court order. The rest
of the money was transferred to Marc Rich.
Avalon attempted to obtain discharge of the Mareva injunction so that it could
pay the balance of the debt to Marc Rich. The variation of the court order would
165 [1991] 4 All E R 769 (Atlas Maritime). See also TSB Private Bank International SA v Chabra
[1992] 1 W L R 231. 166 Atlas Maritime [1991] 4 All E R 769 at 772-773.
87
have exhausted the funds covered by the Mareva injunction.168 At first instance
the application was rejected. Hobhouse J was of the view that the relationship
between Avalon and Marc Rich was not a normal debtor-creditor relationship,
but that it should much rather be regarded as an agency relationship.
The judgment of Hobhouse J was confirmed on appeal, but on different
grounds. Neill, Stocker and Staughton LJJ were of the unanimous opinion that
there was no agency relationship whatsoever.169 Neill LJ stated that two
features about the case were of considerable importance in answering the
question whether the debt to the holding company could result in the variation
of the injunction. First, the money made available by the holding company
should not be regarded as 'a debt incurred in the course of ordinary routine
trading' but as 'moneys advanced in effect as trading capital'.170 Secondly,
account should be kept of the close link between Avalon and Marc Rich when 171
balancing the interests of Marc Rich and Atlas.
Neill LJ emphasised initially that in this case there was no piercing of the
corporate veil in the sense that the one company was regarded as the alter ego 1 79
of the other. But then he continued by stating that, in the exercise of a
discretion in relation to an injunction, the 'eye of equity' can look behind the
corporate veil in order to do justice.173 In other words, the liabilities of Avalon
should be treated as the liabilities of Marc Rich and the corporate veil should to
In the English case law it has been accepted that that a Mareva injunction could be varied in certain circumstances. This will be the case where it is necessary to enable those that have to comply with the prohibition 'to make payments in good faith that he considers he should make in the ordinary course of business': Iraqi Ministry of Defence v Arcepey Shipping Co SA (Gillespie Bros & Co Ltd Intervening), The Angel Bell [1980] 1 All E R 480 at 487, [1981] Q B
65 at 73 (Robert Goff J). In other words, Mareva injunctions may be varied to enable the defendant to pay normal trading debts.
|J9 [1991] 4 All E R 769 at 774 (Neill LJ), 777 (Stocker LJ) and 779 (Staughton LJ). Ibid 776. In other words, it is not a trading debt incurred in the normal course of business but
rather the loan capital of Avalon. Because the purpose of the application was to enable Avalon to avoid its responsibilities to Atlas, it was just and convenient to refuse the variation of the injunction. 171 Ibid 176. mIbid. mIbid.
88
this extent be lifted. Neill LJ saw this as in accordance with Adams v Cape}14
where Slade LJ accepted that such an approach was correct in an appropriate
case.175 Neill LJ continued:176
In m y view, as I have already indicated, the court must look at all the circumstances of the case. As Slade LJ explained in Adams v Cape Industries pic [1991] 1 All E R 929 at 1020, [1990] Ch 433 at 537, a holding company is free to arrange the affairs of its group in such a way that the business of the group in a particular country or for a particular project is carried on by a subsidiary. In such an event there is no presumption of agency and the company and the subsidiary can be regarded as two separate entities. But when it comes to considering the exercise of a discretion and the scope of injunctive relief it is then legitimate to look at all the circumstances and to examine the nature of the debt and the identity of the creditor. In the present case I have no doubt that justice requires that the Mareva injunction should be maintained in respect of this sum of $US
3m.
Similar considerations led Stocker LJ to reach the same conclusion on the same
grounds.177 In this regard Stocker LJ stated that repayment by Avalon to Marc
Rich would not be 'carrying on business in the ordinary way' or 'in the
ordinary course of business'.178 It would be, in effect, the evasion of the 17Q -
underlying purpose of the Mareva injunction. Stocker LJ concluded that,
should it be necessary to lift the corporate veil t o ascertain the reality of the 1 QC\
situation, it would be legitimate in the context of a Mareva injunction.
Also Staughton LJ seemed prepared to lift the veil, first pointing out the i oi
difference between piercing and lifting the corporate veil:
To pierce the corporate veil is an expression that I would reserve for treating the rights or liabilities or activities of a company as the rights or liabilities or activities of its shareholders. To lift the corporate veil or look behind it, on the other hand, should mean to have regard to the shareholding in a company for some legal purpose. The distinction can be seen in the illuminating judgment of Slade LJ in Adams v Cape Industries pic [1991] 1 All E R 929 at 1024-1025,
[1990] C h 433 at 542-543.
74 [1991] 1A11ER929. 75 Ibid 1024. 76 Atlas Maritime [1991] 4 All E R 769 at 776. 77 Ibid 111-11% (Stocker LJ); 779-780 (Staughton LJ). 78 Ibid 111. 19 Ibid.
*°Ibid. 81 Ibid 779.
89
According t o S taughton LJ i t w as n ot n ecessary to p ierce t he corporate v eil,
which would entail treating the liabilities of Avalon as liabilities of Marc Rich.
It was sufficient to lift the veil or look behind it, so as to ascertain that Marc
Rich is the holding company of Avalon, its wholly-owned subsidiary:
[I]t is enough to lift it [the corporate veil] or look behind it, so as to ascertain that Marc Rich is as to 100% the ultimate parent of Avalon. ... In m y judgment it is wholly proper, in deciding whether to permit payment by Avalon at this stage of the moneys claimed by Marc Rich, to have regard to the fact that Marc Rich is the ultimate parent of Avalon as to 100%. It is also right to regard the moneys sought to be repaid as in effect the loan capital of Avalon.
All three judges were unanimously of the opinion that in this case
reasonableness and justice (equity) required that the Mareva injunction should
stay u naltered. T hey t ook i nto a ccount t he e conomic e ntity o f t he group a nd
concluded that the loan from Marc Rich to Avalon, a wholly owned-subsidiary,
could not be regarded as a normal trade debt. The money should be regarded as
the loan capital of Avalon. Repayment of the loan to Marc Rich could lead to
the prejudice of other creditors. It will mean that the interests of the holding
company are protected at the expense of outside parties.
Although t he c ourt i n A tlas Maritime1*21 reated t he h olding c ompany and its
subsidiary as one economic unit, the case involved more than mere economic
integration. It does not, therefore, alter the legal principle stated in Adams v
Cape}*4 Indeed, the court in Atlas Maritime1*5 referred to Adams v Cape1*6 and
confirmed that a holding company m a y freely arrange the affairs of the group
so that the business of the corporate group is carried on by a subsidiary in a
specific country or for a specific project.187 The corporate veil was lifted in
182 Ibid 779-780. 183 [1991] 4 All ER 769. 184 [1991] 1 All ER 929. 185 [1991] 4 All ER 769. 186 [1991] 1 All ER 929. 187 [1991] 4 All ER 769 at 776.
90
1 Rfi
Atlas Maritime simply on the ground that a reasonable interpretation of a
legal rule required it.
More recently, in Re Polly Peck International pic (in administration)1*9 the
English court continued the strict approach of Adams v Cape190 in the context of
the double proof of debts in inter-connected insolvency administrations for an
international group of companies.191 In Polly Peck192 the holding company
created a wholly-owned subsidiary for the sole purpose of issuing bonds to a
group of foreign banks and lending the bond proceeds back to the holding
company. The repayment obligations of the subsidiary towards the banks were
guaranteed by the holding company.
The holding company exercised complete control of every aspect of the
financing arrangements. The holding company went into administration in 1990
and a scheme of arrangement was approved in M a y 1995. The scheme of
arrangement i ncluded a provision p rohibiting ' double p roof b y any creditor.
The subsidiary went into liquidation in March 1995. The bondholders lodged
claims against the holding company on the strength of its guarantee of the
subsidiary's bond issue. The liquidators of the subsidiary lodged a proof of debt
in the winding up of the holding company for the inter-company loan made to
the holding company. The scheme supervisors of the holding company argued
that the veil should be lifted and the subsidiary should not be entitled to prove
in the winding up of the holding company. They argued that the money owed to
the subsidiary under the loan was the same as the money owed to the
bondholders under the guarantee, and to keep the veil intact by admitting proof
of debt would be contrary to the rule against double proof.
188 [1991] 4 All E R 769. 189 [1996] 2 All E R 433 (Polly Peck). See on this case D Petkovic, 'Piercing the corporate veil
in capital markets transactions' (1996) 15 IBFL 41. 190 [1991] 1 All ER 929. 191 The rule against double proof is a long-standing principle of the law of bankruptcy, and has applied in the winding-up of companies since the Companies Act 1862 (UK). According to the
rule against double proof there is only to be one dividend in respect of what is in substance the same debt, although there may be two separate contracts: Re Oriental Commercial Bank (1871) 7 Ch App 99 at 101. See also Re Fenton; Ex parte Fenton Textile Association (No 2) [1932] 1 Ch 178 and Re Sass: Exparte National Provincial Bank of England [1896] 2 Q B 12.
91
The question that arose was whether the relationship of complete control
justified the holding company and subsidiary being treated as one entity
economically for purposes of the administration of the holding company. This
would mean that any claims by the subsidiary should be ignored in the
distribution of dividends.193 In other words, the question was whether the
subsidiary had a right to claim against the insolvent holding company.
The Chancery Division of the High Court in England refused once again to
pierce the veil and treat the holding company and its subsidiary as one
economic unit. Robert Walker J followed Adams v Cape and rejected the
suggestion of economic unity or, alternatively, that a further exception should
be added to the statement of principle by the Court of Appeal in that case.195
Although there was little substance to the operation of the subsidiary, the court
found that it was more than a mere facade. There was therefore no legal basis
on which the group of companies could be regarded as a single economic unit.
Although the subsidiary did not have any purpose other than to issue the bonds,
had no separate independent management or bank account, and had a very
small amount of paid-up capital, the court refused to pierce the corporate veil.
Robert Walker J rejected the view that the separate identities of the companies
should be ignored because, in substance, they constituted a single economic
196
enterprise.
Robert Walker J also rejected the submission that the exception to the rule in
Salomon v Salomon w as j ustified b ecause a r ule o f 1 aw founded i n p ublic
policy (the rule against double proof) would be frustrated by ignoring the
economic reality of a single group and stated: '[T]he authorities ...show that
substance means legal substance, not economic substance (if different), and that
192 [1996] 2 All ER 433. 193 Ibid44\ (Robert Walker J). 194 [1991] 1A11ER929. 195 [1996] 2 All ER 433 at 448. 196 Ibid. 197 [1897] A C 22.
92
... the separate legal existence of groups of companies is particularly important
when creditors become involved.'198 Although the creditors undoubtedly
extended credit to the subsidiary on the basis of the credit of the holding
company, and the effect of adhering to the rule in Salomon v Salomon199 was to
give the bondholders two bites at the cherry in the administration of the group,
the court was concerned with legal and not economic substance.200
In Wimborne v Brien201 the New South Wales Court of Appeal had the
opportunity to order that, in winding-up a company, a liquidator should have
regard to the overall benefit of the group. The facts were as follows. M r
Wimborne (the husband) and his wife each controlled half the shares in
Langrenus Pty Ltd (Langrenus), a member of a group of companies. The
husband separated from his wife and the wife commenced proceedings in the
Family Court seeking a property settlement. A deadlock relating to the conduct
of the affairs of Langrenus arose between the husband and wife as a result of
which the court ordered that Langrenus, which was solvent, should be wound
up on the just and equitable ground. Brien was appointed liquidator of
Langrenus. From then onwards Brien was involved in litigation relating to the
affairs of Langrenus.
On the one hand the solicitors for the husband urged Brien effectively to merely
pay outstanding debts and otherwise maintain Langrenus' assets pending the
outcome of the Family Court proceedings.202 The basis for the husband's claim
pending the outcome of the Family Court proceedings depends essentially on
the proposition that, because of the interlocking and related ownership of the
198 Polly Peck [1996] 2 All ER 433 at 448. 199 [1897] AC 22. 200 Polly Peck [1996] 2 All ER433 at448. See also^G vEquiticorp Industries Group Ltd [1996] 1 NZLR 528, where the New Zealand Court of Appeal similarly refused to lift the veil in the case of a subsidiary as it did not find any reason to depart from the principle in Salomon v
Salomon [1897] A C 22. 201 (1997) 23 ACSR 576. For commentary, see eg R Baxt, 'Is corporate law reform needed? -
The courts do not recognise commercial reality in assessing corporate groups' (1997) 71 ALJ
830. 202 Wimborne v Brien (1997) 23 ACSR 576 at 581.
93
various companies in the group, they should be treated as a single entity. As
all the companies were going to be transferred to the husband in the settlement
of the Family Court proceedings it did not matter which assets or liabilities
were in which company.204 It was therefore argued for the husband that the
liquidator should merely preserve the company's assets pending the outcome of
those proceedings, otherwise the liquidator would be incurring unnecessary
costs. O n the other hand the solicitors for the wife urged Brien in the course of
the winding up to proceed with his investigations and getting in of assets in the
usual way and drew attention to a number of matters which were alleged to call
for investigation.
The New South Wales Court of Appeal rejected the argument that the different
group companies should be treated as one economic unit. It held that the duty of
the liquidator was to the company as a separate legal entity, its shareholders and
its creditors, and not to the group as a whole. The N e w South Wales Court of
Appeal referred to Walker v Wimborne206 and rejected the notion of the group
as a whole.207 It held that, except in regard to limited statutory exceptions, the
law did not recognise a 'group' of companies. Each company therefore had to
be treated as a separate entity.208 Despite having had the opportunity to take a
'group perspective', the court held that the liquidator's duties were owed to the
company itself, its shareholders and creditors.209
In the same year Tamberlin J in the Federal Court gave judgment in
Repatriation Commission v Harrison?10 M r and Mrs Harrison applied for
service pensions under the Veterans' Entitlements Act 1986 (Cth). The pensions
were subject to an income and assets test. The Harrisons were the only
203 Ibid. mIbid. 205 Ibid. 206 (1976) 137 C L R 1. 207 Wimborne v Brien (1997) 23 A C S R 576 at 581 (Dunford AJA).
Ibid.
210
209 Ibid.
(1997) 24 A C S R 711. The matter was remitted to the Administrative Appeals Tribunal. See further R Baxt, 'The corporate veil remains' (1998) 16 C&SU 49 at 50-51.
94
shareholders in two companies whose only substantive assets were debts owed
to the companies by them. They were also directors of the companies.211 The
Repatriation Commission reduced the level of the Harrisons' pensions on the
basis that the shares had value. They appealed to the Administrative Appeals
Tribunal (AAT), arguing that the net value of their assets should be taken into
account and that the shares had no net value to them. W h e n the A A T accepted
this argument, the Repatriation Commission appealed on the basis that the A A T
acted contrary to law in piercing the corporate veil, that the A A T erred in
holding that the Harrisons' net assets should be taken into account, and that the
shares had no value.212
Tamberlin J held the view that it was inappropriate to follow a pragmatic
economic approach.213 His Honour allowed the appeal by the Repatriation
Commission, holding that the service pension of the Harrisons should have
been reduced as a result of their shares in these companies being included as
part of their assets for the purpose of the Veterans' Entitlements Act 1986 (Cth).
Tamberlin J did not refer to the comments of Rogers CJ in Qintex v
Schroders, 14 but rather relied on the traditional approach to the separate entity
doctrine as laid down in Salomon v Salomon215 when he said:216
The separate legal existence and identity of corporate entities from that of their shareholders and corporators or directors is well-settled in corporations law and, subject to limited exceptions, it currently represents the law of Australia: see Walker v Wimborne ... and Briggs v James Hardie...
It should be noted that Rogers AJA (as he then was) stated in Briggs v James
Hardie & Co Pty Ltd211 that the corporate veil would not be lifted as a matter of
211 Repatriation Commission v Harrison (1997) 24 A C S R 711 at 712. 212 Ibid. 213 Ibid 715. Cf the approach advocated by Rogers CJ in Qintex v Schroders quoted earlier in para 3.4. 14 His Honour also probably did not have available the judgment in Wimborne v Brien (1997)
23 A C S R 576: see Baxt, 'The corporate veil remains', above n 210, 50-51. 215 [1897] A C 22. 216 Repatriation Commission v Harrison (1997) 24 A C S R 711 at 715. 217 (1989) 16 N S W L R 549.
95
918
fact where one company exercised complete control over another. But, as
Baxt points out, Rogers A J A dealt with a set of facts completely different from
the set of facts in Repatriation Commission v Harrison?19 While conceding that
Tamberlin J noted the limited exceptions to the principle in Salomon v
Salomon?20 Baxt is of the opinion that the judge was much too conservative
and technical in not acknowledging that there was a further exception that could
be applied to the facts of the case.221 Tamberlin J suggested that the Harrisons
or someone in a similar position should be put at a disadvantage for making use
of a scheme for reasons clearly allowed by the law, ie arranging their affairs in
such a way as to take advantage of certain taxation and other benefits. The
effect of the decision was to enforce the separate legal status of the companies
involved despite the commercial reality that the companies and the natural
persons were indistinguishable, and despite the fact that the result obtained was
unjust.
3.5 Evaluation of position of group creditors
Piercing of the corporate veil is the most frequently used, though invariably
unsuccessful, technique under general law for escaping the severe restrictions
of the separate entity doctrine and for holding a holding company liable for the
debts of its subsidiary in appropriate circumstances. It has, however, serious
disadvantages. The case law emerging from the doctrine of piercing the
corporate veil is extremely discretionary and unpredictable, with no clear
principles, and it has led to a number of irreconcilable decisions and much
Repatriation Commission v Harrison (1997) 24 A C S R 711 at 716. See also the decision of the N S W Court of Appeal in James Hardie & Co Pty Limited v Putt Matter, unreported, N S W Supreme Court, 22 May 1998 (at 434) where the court rejected the argument that the corporate veil should be lifted on the ground that the company was a mere fa9ade for the incorporator as the holding company had complete control of the other company involved. 219 Baxt, 'The corporate veil remains', above 210, 50-51. 220 [1897] A C 22. See Repatriation Commission v Harrison (1997) 24 A C S R 711 at 716. 221 Baxt, 'The corporate veil remains', above 210, 50. 12 N o clear principles emerge from the case law from which it is possible to predict when the courts will or will not lift the veil. See further Ford, Austin and Ramsay, above n 2, para
[4.400]. The courts have reached contradictory results in cases that had virtually identical facts: see, eg, DHN v Tower Hamlets [1976] 3 All E R 462 and Woolfson 1978 S C (HL) 90. Even the judiciary has recognised that it is notoriously difficult to discern any established approach by
96
99"̂
confusion. It 1 s, m oreover, apparent t hat courts will o nly 1 ift t he c orporate
veil in very special circumstances 224
Apart from the above-mentioned shortcomings, the doctrine of piercing the
corporate veil is of limited utility, particularly in corporate groups. The reason
for this is that the objectives of the doctrine are different today from what they
were when it was created. 5 Piercing the corporate veil arose in equity to
authorise courts to prevent the use of the corporate form where it was b eing
abused for fraudulent purposes. Today, however, this is rarely the objective in
corporate litigation. Most of the time it is sought to expose all the assets of the
corporate group to the combined obligations of the corporate group.226 The
reason the law remained committed to the single entity doctrine was to
rationalise the situations that arose while keeping in mind the decision in 997
Salomon v Salomon rather than effectively implementing the policies and
objectives of the law in this regard.228
99Q
T o date the call of Rogers CJ in Qintex v Schroders has been left
unanswered. It must be admitted that the decisions in cases such as Wimborne v
Brien220 and Repatriation Commission v Harrison?21 as well as earlier
the courts to the question of lifting the corporate veil: Hallam v Ryan (1990) 5 N Z C L C 66,123 at 66,148 (Smellie J). What is clear, however, is that the courts are at present reluctant to treat a
group of companies as a single legal entity. 223 P Blumberg, Transcript of Symposium held at Connecticut in 1998, (1999) 13 ConnJInt'lL
397 at 439-440. See also J Farrar, 'Fraud, fairness and piercing the corporate veil' (1990) 16 Can Bus Ll 474 at 478, who describes the case law authority on piercing the corporate veil as
'incoherent and unprincipled'. See further Bainbridge, above n 3, who argues that the fact that the standards by which veil-piercing is effected are vague, leaving judges great discretion, has led to uncertainty and lack of predictability, increasing transaction costs for small businesses. 224 See also S Watson, 'Who hides behind the corporate veil? Finding a way out of the 'legal quagmire" (2002) 20 C&SLJ 198, who argues at 213 that, on the rare occasions when the courts decide to lift or pierce the corporate veil, they are recognising that the company was not a legal entity separate from its controller. While it is not conceptually justifiable to make shareholders liable since limited liability of shareholders is the fundamental principle of
company law, no such difficulty exists in making controllers liable. 225 Farrar, above n 223, 478. 226 Ibid. 227 [1897] A C 22. 228 See N James, 'Separate legal personality; legal reality and metaphor' (1993) 5 Bond L Rev
217 at 226. 229 (1991) 9 A C L C 109. 230 (1997) 23 A C S R 576.
97
decisions such as Walker v Wimborne232 and the other decisions discussed in
this chapter that follow an entity approach, are correct in the light of the
traditional doctrine. However, a pragmatic answer is needed to the question
posed by Rogers CJ in Qintex v Schroders232 more than a decade ago.234 It is
submitted that this should be done by way of legislative reform as suggested in
Chapter 10.
231 (1997) 24 ACSR 711. 232 (1976) 137 CLR 1. 233 (1991) 9 ACLC 109. 4 Baxt, "The corporate veil remains', above n 210, 50-51.
4 DIRECTORS' DUTIES: GENERAL PRINCIPLES
4.1 Background 98
4.2 Fiduciary duty to act in interests of company 99
4.2.1 Objective test laid down in Charterbridge 100
4.2.2 Subjective test laid down in Walker v Wimborne 102
4.2.3 Implied recognition of Charterbridge test after Walker v 105 Wimborne
4.2.4 Express recognition of Charterbridge test after Walker v 109 Wimborne
4.3
4.3.1
4.3.2
4.3.3
4.4
4.4.1
4.4.2
4.4.3
4.4.4
4.5
4.5.1
4.5.2
4.5.3
Nominee directors: notion of 'dual loyalty'
Traditional approach
Pragmatic approach
Notion of 'dual loyalty' similar to Charterbridge test
Duty of care, skill and diligence
Scope of duty
Statutory formulation of duty
Overlap with fiduciary duty
Overlap with insolvent trading provisions
Evaluation of position of group creditors
Fiduciary duty to act in interests of company
Nominee directors
Duty of care, skill and diligence
112
113
114
118
121
121
126
130
133
134
134
136
137
4 DIRECTORS' DUTIES: GENERAL PRINCIPLES
4.1 Background
It is a long-established principle of company law that directors owe certain
duties to their company. Although this principle developed in the context of
directors of single companies, it is equally true of directors of group
companies.1 A distinction is generally made between directors' fiduciary duties
on the one hand and their duties of skill, care and diligence on the other. In the
group context it is essentially the fiduciary duties of directors that feature in the
case law, more particularly the duty to act bona fide in the interests of the
company and for a proper purpose.4 Since there are only traces of breaches of
directors' duty of care in the case law relating to groups of companies, this duty
will be considered only in so far as it is relevant for the present discussion.
' See, generally, S Haddy 'A comparative analysis of directors' duties in a range of corporate
group structures' (2002) 20C&SLJ 138. 2 Permanent Building Society v Wheeler (1994) 12 A C L C 674 (Wheeler) at 679-680 and 687. The duty of care and diligence arises under statute, while the duty of care and skill is a common-law one. Hereafter the latter duty will be referred to as the 'duty of care' unless the
context requires otherwise. 3 The other two categories of fiduciary duties are the duty of directors to avoid a conflict of
interest and the duty not to fetter discretion. Except where it is appropriate in considering the position of nominee directors, directors' fiduciary duties to avoid conflicts of interest and to retain their discretion in general will not be examined because they shed no further light on the
particular responsibilities of directors in company groups. 4 Different schools of thought exist as to whether the duty to act bona fide and for a proper purpose is one or two duties. It is unnecessary for the purposes of this thesis to determine which one is preferable. In respect of the different views, see eg, LS Sealy, 'Directors' 'wider' responsibilities -problems conceptual, practical and procedural' (1987) 13 Mon ULR 164; JR Birds, 'Proper Purposes as a Head of Directors' Duties' (1974) 37 MLR 580; LS Sealy, "Bona Fides' and 'Proper Purposes' in Corporate Decisions' (1989) 15 Mon ULR 265; S Worthington,
'Directors' Duties, Creditors' Rights and Shareholder Intervention' (1991) 18 MULR 121; P D Giugni and JL Ryan, 'Company directors' spheres of responsibility: Primary and secondary
duties' (1988) NZU 437 at 438.
99
4.2 Fiduciary duty to act in interests of company5
Directors are required to act bona fide in the interests of the company as a
whole. The standard formulation of this duty is found in In re Smith and
Fawcett Ltd6 where Lord Greene M R held that directors 'must exercise their
discretion bona fide in what they consider - not what a court m a y consider - is
in the interests of the company, and not for any collateral purpose'. 7 This
formulation has been reiterated in subsequent case law.8 The interaction
between the subjective and objective elements of this formulation is important.
If one emphasises the subjective requirement that directors themselves must
view their conduct to be for the benefit of the company, the genuine belief by
the directors that their conduct is in good faith in the interests of the company
would be sufficient to comply with their duty. However, it has been recognised
for many years that this duty is not wholly subjective and that an objective
limitation to the directors' discretion is required.9 This objective limitation was
encapsulated by the so-called 'amiable lunatic' test, expressed by B o w e n LJ in
a classic passage in Hutton v West Cork Railway Co}0
Bona fides cannot be the sole test, otherwise you might have a lunatic conducting the affairs of the company, and paying away its money with both hands in a manner perfectly bona fide yet perfectly irrational.
J Cilliers, 'Directors' duties in corporate groups - Does the green light for the enterprise approach signal the end of the road for Walker v Wimborne!' (2001) 13 Aust Jnl of Corp Law 109. 6[1942]lCh304. 7/6u/306. 8 See, eg, Equiticorp Finance Ltd (in liq) v Bank of New Zealand (1993) 11 A C L C 952 (Equiticorp v BNZ) discussed in Ch 5 para 5.2.1.
This objective limitation can also be found in In re Smith and Fawcett Ltd [1942] 1 Ch 304 by
the reference to the notion that directors m a y not exercise their discretion for a collateral or improper purpose. 10 (1883) 23 C h D 654 at 671.
100
Thus, although the formulation of this duty is predominantly subjective, a court
will intervene if no reasonable (rational) director can conclude that the action
taken is in the interests of the company.11
The uncertainty as to whether the duty of directors to act bona fide in the
interests of their company should be formulated subjectively or objectively is
perpetuated in the case law involving groups of companies, although with a
different slant. W h e n dealing with a group of companies the question is whether
directors comply with this duty only when they subjectively believe that they
are acting bona fide in the interests of their company, or whether it is sufficient
if they consider the interests of the group as a whole.
On a strict application of entity principles the answer to the first-mentioned
situation is in the affirmative: directors are required to believe subjectively that
they are acting in the interests of their particular company. The latter situation
arises where directors do not specifically consider the interests of their
particular group company. It allows the court to play a more interventionist role
by determining whether reasonable directors would have believed that a
particular act that was in the group interest was also in the interest of their
separate company. The case law in favour of the view that the interests of the
group m a y be taken into account requires that the conduct of the directors must
be, objectively speaking, in the interests of their particular company.
4.2.1 Objective test laid down in Charterbridge
19
In Charterbridge Corporation Ltd v Lloyds Bank Ltd Pennycuick J laid down
an objective test to establish whether directors breached their fiduciary duty to
act in the interests of their company. Pomeroy Developments (Castleford) Ltd
(Castleford) provided a charge over its property as security for loans to
Pomeroy Developments Ltd (Pomeroy). Although Castleford was not
11 See also Heron International Ltd v Lord Grade (1983) BCLC 244; R v Sinclair (1968) 1 WLR 1246. 12 [1970] 1 Ch 62 (Charterbridge).
101
technically a subsidiary of Pomroy, they had a c o m m o n shareholding,
directorate and office, so that Pomeroy controlled Castleford. It was established
on the facts that, although the directors of Castleford failed to give separate
consideration to the interests of their company, they had considered the
interests of the group as a whole. In deciding whether the charge was for the
benefit of Castleford, Pennycuick J found that it was unnecessary for directors
to consider the interests of each group company separately.
Pennycuick J stated that, on the one hand, it was too strict a test to say that, in
the absence of separate consideration, the directors should be regarded as not
having acted for the benefit of the company. T his would lead to the absurd
result that where directors do not specifically apply their minds to the interests
of the particular company every time they enter into a transaction, such
transaction would be ultra vires and void, even if it is in fact for the benefit of
the company.13 O n the other hand, he stated that it was not enough to look only
to the benefit of the group as a whole. In attempting to reconcile theory with
practice and entity interests with group interests, Pennycuick J formulated a
new test. H e stated:14
The proper test, I think, in the absence of actual separate consideration, must be whether an intelligent and honest man in the position of a director of the company concerned, could, in the
whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company.
This test is objective. If the Charterbridge test is applied, the court has to be
satisfied that the director of a particular group company (usually a subsidiary)
could reasonably have concluded that the transaction was for the benefit of such
company if he had considered the matter. The court in Charterbridge15 held that
the charge was valid, as it was for the benefit of Castleford. It regarded the
derivative benefits accruing to Castleford, as material. Not only did Castleford
Ibid 74. This is an unfortunate use of the term 'ultra vires' - it is really an abuse of power, not an absence of power. This view has been confirmed in subsequent Australian cases. See, eg, Hawkesbury Development Co Ltd v Landmark Finance Pty Ltd [ 1969] 2 N S W R 782. 4 Charterbridge [1970] 1 Ch 62 at 74. See also J Hill, 'Corporate groups, creditor protection and cross guarantees: Australian perspectives' (1995) 24 Can Bus LJ 321 at 350 15 [1970] lCh62.
102
look to Pomeroy for its own day to day management and not only did Pomeroy
guarantee to pay the rent, but Pomeroy also provided expertise and other
commercial assistance to Castleford. The collapse of Pomeroy would have been
disastrous for Castleford and, if everything went according to plan, the
obligation under the guarantee and legal charge would never have
materialised. In Reid Murray Holdings Ltd (in liq) v David Murray Holdings
Pty Ltd11 Mitchell J subsequently applied the Charterbridge test in Australia.
4.2.2 Subjective test laid down in Walker v Wimborne
In Walker v Wimborne, however, where the directors of a group company
authorised it to make loans to other companies in the group, the High Court in a
decision delivered by Mason J, with whose judgment Barwick CJ concurred,
adopted a less flexible approach. The High Court held that, since each company
in a group was regarded as a separate legal entity, a group of companies could
not be treated as a single enterprise for the purpose of transferring funds
between the companies constituting the group.19 It was therefore the duty of the
directors to consider the interests of their particular company alone and not the 9fl
interests of the group as a whole when entering into intra-group transactions.
This case can be seen as a strict subjective formulation of directors' fiduciary
duties in a group context.
The High Court found that, in adopting the policy of moving around funds
where they were needed in the group, the directors had disregarded their duty to
Brennan J in Northside Developments Pty Ltd v Registrar General (1990) 176 C L R 146
likewise recognised derivative benefits. 17 (1972) 5 SASR 386 (ReidMurray) at 402. 18 (1976) 137 C L R 1. 19 For detailed discussion of Walker v Wimborne (1976) 137 C L R 1 and the law affecting directors and majority shareholders in companies forming part of a group, see R Baxt and D Harding, 'Duties of directors and majority shareholders in groups of companies - tension between commercial convenience and legal obligations' (1977) 9 Comm Law Assoc Bull 127. 20 Walker v Wimborne (1976) 137 C L R 1 at 7. See also R Baxt, 'Commercial Law Note' (1976) 50 AU 591-593. Subsequently Kirby P in Parker v NRMA (1993) 11 A C S R 370 stated at 376:
'The directors of each company [in a corporate group] owed separate duties to each [company].
It was not open to the directors to ignore these separate duties or to conceive of themselves as
owing a higher, larger or broader duty to the group'.
103
take into account the separate interests of each individual company. The High
Court held that the directors of the lending company had breached their
fiduciary duties because the company advancing the funds did not receive any
commercial benefit from the transaction.22 It was not sufficient that the loans
would be for the overall benefit of the group. Strictly speaking, the companies
in Walker v Wimborne23 were only associated companies and did not form part
of the same group in the sense that they were not technically holding and
subsidiary companies. The same principle was, however, subsequently
confirmed by the High Court in Industrial Equity Ltd v Blackburn24 in the
context of companies forming part of the same group.
O n a strict application of the rule in Salomon v Salomon & Co Ltd the *\S J-J
decision in Walker v Wimborne is correct. There are, however, practical and
theoretical objections to the judgment of Mason J in the context of groups of
companies. In practice it will be very difficult, if not impossible, to consider the
interests of a particular company that forms part of a group alone, without
taking into account the interests of the rest of the companies in the group. In
other words, one cannot consider the interests of such an individual company in
a vacuum and ignore the fact that it operates as part of a group. The suggestion
that directors of a group of companies should ignore the interests of other
companies within the group is not only against normal business practice but
also unrealistic.
Barwick CJ concurred with Mason J on this issue, while Jacobs J did not comment on this particular matter.
See the discussion of 'commercial benefit' in Ch 5 para 5.2 and, in particular, 'uncommercial transactions' in para 5.2.3. 23 (1976) 137 C L R 1.
(1977) 137 C L R 567 at 577. This has been reaffirmed on numerous occasions. See, eg, Qintex Australia Finance Ltd v Schroders Australia Ltd (1991) 9 A C L C 109 at 111; Equiticorp v BNZ (1993) 11 A C L C 952 at 984. 25 [1897] A C 22 (Salomon v Salomon).
(1976) 137 C L R 1. This decision is a strict application o f the rule in Salomon v Salomon [1897] A C 22. 17 The decision in Walker v Wimborne (1976) 137 C L R 1 is a strict application of the rule in Salomon v Salomon [1897] A C 22.
104
The theoretical objection m a y be stated as follows. Generally directors owe
fiduciary duties to the company. Mason J stated that directors, in discharging
this duty towards the company, must take into account the interests of creditors.
However, if one takes the argument of Mason J - that there has to be a definite
consideration of the interests of the particular company involved - through to its
logical conclusion, directors in exercising their fiduciary duties should also
specifically consider the interests of creditors of that particular company. This
would imply that directors should consider the interests of such creditors at the
expense of the interests of other parties, such as other group companies.
Analogous to this situation is the position of trustees of a discretionary trust.
Although creditors do not have proprietary interests in the assets of a company,
the directors have a duty to consider their interests. Similarly the beneficiaries
of a d iscretionary t rust have n o p roprietary i nterest i n t he t rust p roperty, b ut
they do have a right to complain if the trustees do not exercise their discretion 9R
at all. The difference lies in the exercise of the discretion. If the trustees do
not exercise their discretion in favour of the beneficiaries, they have, of course,
no right to complain. But they have the right to complain if the trustees apply
their discretion outside the class, for example, if they exercise their discretion in
favour of B's children and not A's children, as stipulated by the trust
instrument. This is a capricious exercise of their power and the court will set it 90
aside on the application of A's children.
The p osition i s n ot t he same for c reditors. It i s i mportant t hat d irectors o nly
have a duty to consider, and not a duty to act in, the interests of the creditors.
Apart from the situation where directors act in the interests of shareholders at
the expense of creditors in the context of insolvency, individual creditors
cannot complain if the directors act in the interests of other parties, for example
See Re Coleman (1888) 39 Ch D 443. CfRe Smith [1928] 1 Ch 915. See, eg, Re Hay's Settlement Trust 1982 1 W L R 202; McPhail v Doulton [1971] A C 424.
105
other companies in the group.30 The beneficiaries of a discretionary trust have
the right to complain in the case of a capricious exercise of power, as they are
the only ones with locus standi to institute an action. Where a company is
liquidated, however, it is the liquidator of the company and not the creditor
itself who should institute a claim against the director on behalf of the
company.
4.2.3 Implied recognition of Charterbridge test after Walker v
Wimborne
Australian courts generally adopted the approach taken by Mason J in Walker v
Wimborne,21 although in several cases the parties themselves agreed to accept
the test laid down in Charterbridge32 and the cases were decided on that basis.
The first such case was Linter Group v Goldberg where Southwell J in the
Supreme Court of Victoria recognised that the Australian law on this point was
as formulated by Mason J in Walker v Wimborne? Southwell J stated that a
director owed a fiduciary duty to the particular company of which he was a
director, and not to other companies, whether or not they were part of the same
group.35 However, because the parties agreed among themselves that the matter
should be decided on the basis of the test set out in Charterbridge?6 Southwell
J applied that test.
There are numerous subsequent cases in which the parties themselves agreed to
accept the test laid down in Charterbridge?* In Spedley Securities Ltd (in liq) v
For a discussion of the duty to take into account the interests of creditors, see Ch 5 par 5.3. Cf Patrick Stevedores Operations No 2 Pty Ltd v Maritime Union of Australia (1998) 27 ACSR 521; (1998) 27 ACSR 535, which is discussed in Ch 5 par 5.2.2. 31 (1976) 137 CLR 1. 32 [1970] lCh62. 33 (1992) 7 ACSR 580 (Linter). 34 (1976) 137 CLR 1. 35 (1992) 7 ACSR 580 at 620. 36 Ibid. 37 Ibid 622. 38 [1970] lCh62.
106
Greater Pacific Investments Pty Ltd (in liq)29 Cole J followed his own
unreported judgment in Australian National Industries Ltd v Greater Pacific
Investments Pty Ltd (in liq)(No 3).40 In both these cases Cole J in the Supreme
Court of N e w South Wales (Commercial Division) found, in accordance with
Walker v Wimborne, that failure to consider the interests of the particular
company was in itself a breach of duty.42 However, just like Southwell J in
Linter,43 Cole J was requested by the parties to apply the Charterbridge test to
their case, which he did.44 In Spedley45 Cole J modified the Charterbridge test,
stating that the question is whether an intelligent and honest m a n in the position
of that particular director could reasonably believe that his actions were for the
benefit of that specific company.46 This approach causes the inquiry to be more
subjective and has been criticised as being unrealistic.47
On the facts of Linter,4* Australian National Industries49 and Spedley50 it did
not really matter which test was applied, as far as the results were concerned.
The c onduct o f t he d irectors w as s o egregious that t hey w ould h ave b een i n
breach of their fiduciary duty towards the company irrespective of whether the
subjective formulation of Walker v Wimborne51 or the objective formulation of
Charterbridge52 was applied. O n a different set of facts, however, the test to be
applied could well make a difference to the result.
39 (1992) 7 ACSR 155 (Spedley). 40 Unreported, SC NSW, 50441/1989, Cole J, 14 December 1990 (Australian National
Industries). 41 (1976) 137 CLR 1. 42 Australian National Industries, unreported, SC NSW, 50441/1989, Cole J, 14 December
1990 at 77; Spedley (1992) 7 ACSR 155 at 164. 43 (1992) 7 ACSR 580. 44 Australian National Industries, unreported, SC NSW, 50441/1989, Cole J, 14 December
1990 at 79; Spedley (1992) 7 ACSR 155 at 164. 45 (1992) 7 ACSR 155. 46 Ibid 164. 47 See, eg, RP Austin, 'Problems for directors within corporate groups' in M Gillooly (ed), The
Law Relating to Corporate Groups (1993) 133 at 143. 48 (1992) 7 ACSR 580. 49 Unreported, SC NSW, 50441/1989, Cole J, 14 December 1990. 50 (1992) 7 ACSR 155. 51 (1976) 137 CLR 1. 52 [1970] 1 Ch 62.
107
Significant comments on a director's fiduciary duty to act in the best interests
of his company in a group context were made in Equiticorp v BNZ. Both at
first instance and in the N e w South Wales Court of Appeal the parties accepted
the test laid down in Charterbridge.54 Although it was therefore unnecessary
for either court to make a finding on the test that should be applied, the obiter
statements by the respective judges of appeal on this issue are in principle
important.
In Equiticorp v BNZ55 the directors in question utilised funds from two
companies in the group to satisfy the debt of a related sibling company. This
was an intra-group lateral transaction. It was alleged on behalf of the two
companies that their directors breached their fiduciary duties towards them
respectively by acting in the interests of the group rather than in the separate
interests of each of them. The main thrust of the argument on behalf of the two
companies was that no specific consideration had been given to their interests.
In applying the Charterbridge test Giles J in the court at first instance found on
the facts that there was no breach of fiduciary duty.56 His Honour distinguished c-j
Walker v Wimborne on the basis that, by assisting the holding company, the
relevant companies could obtain derivative benefits.58 It would therefore be
reasonable for an intelligent and honest director to believe that the application
of the liquidity reserve of two group companies to discharge the debts of a third
group company would be beneficial to the first-mentioned companies as
members of the group. In this way the group could retain credibility with their
bank.
Equiticorp vBNZ( 1993) 11 ACLC 952 at 1,017-1,019. 54[1970]lCh62.
"(1993)11 ACLC 952. 56 Equiticorp Financial Services Ltd (NSW) v Equiticorp Financial Services Ltd (NZ) (1992) 9 ACSR 199. 57 (1976) 137 CLR 1. 8 Equiticorp Financial Services Ltd (NSW) v Equiticorp Financial Services Ltd (NZ) (1992) 9 ACSR 199 at 240.
108
Clarke and Cripps JJA delivered the majority judgment on appeal and applied
the Charterbridge test, as agreed by the parties.59 Like Giles J at first instance,
their Honours found that the directors had not breached their fiduciary duty to
act in the best interests of the individual companies. The use of the liquidity
reserve was for the benefit of the two subsidiary companies. Since loss of
support by the bank would have resulted in financial disaster for the whole
group, both subsidiary companies had a direct interest in maintaining the bank's
support. These derivative benefits to the two subsidiary companies that
provided the charge justified the action of the directors. In the course of their
joint judgment, however, Clarke and Cripps JJA expressed reservations about
the test laid down in Charterbridge?0 Their Honours recognised that
Pennycuick J's test in Charterbridge was devised to be applied only in limited
circumstances - when the directors had not considered the interests of the
particular company at all - to avoid what would otherwise be an absurd result.
They preferred the view that there was an automatic breach of duty where the
directors h ad n eglected to c onsider the i nterests o ft heir i ndividual c ompany,
provided that, where the transaction was objectively beneficial to the company,
no consequences would flow from such a breach.
Kirby P, who gave the minority judgment on appeal, emphasised that in the
Charterbridge62 case itself it was stated that each group company was a
separate legal entity and that the directors of a particular company had to take
into account the interests of that company separately. Although Kirby P also
applied the Charterbridge test, he reached the opposite conclusion to that
reached in the joint judgment.63 His Honour was of the view that the serious
and chronic liquidity problems of the companies in question warranted an
intelligent and honest director to consider their interests separately.64 This was
so even though it was not argued at the trial that either of these two companies
59 Equiticorp v BNZ (1993) 11 ACLC 952 at 954. 60 76w/1,018-1,019. 61 Ibid 1,019. 62 [1970] lCh62. 63 Equiticorp v BNZ (1993) 11 ACLC 952 at 983-5. 64/6W983.
109
had b een i nsolvent at t he t ime t hat t he t ransaction i nvolving t he u se o f their
liquidity reserves took place.
It is curious that the parties in most of the cases subsequent to Walker v
Wimborne66 agreed to accept that the Charterbridge test should be followed.
The party accusing the directors of breaching their fiduciary duty in each case
certainly would have wanted the stricter test, namely the one in Walker v
Wimborne,61 to apply, as this would more readily lead to a finding of a breach
of fiduciary duty. A possible explanation for this is that in practice it would be
very difficult, if not impossible, to consider the interests of a particular
company that formed part of a group alone, without taking into account the
interests of the other companies in the group. This could also be an indication
that the less strict Charterbridge test is more in tune with the requirements of
commercial reality.
4.2.4 Express recognition of Charterbridge test after Walker v
Wimborne
The Supreme Court of Victoria in Farrow Finance Co Ltd (in liq) v Farrow
Properties Pty Ltd (in liq)6* went a step further in the direction of treating the
companies constituting a corporate group as an enterprise rather than as
separate entities.69 Although this judgment cannot, of course, override the
judgment of the High Court in Walker v Wimborne?0 it is nevertheless
bi Ibid 981. 66 (1976) 137 C L R 1. 61 Ibid. 68 (1997) 26 A C S R 544 (Farrow). 69
As support for the argument that the courts are adhering to a so-called 'commercial' approach in the context of nominee directors, see the discussion of Japan Abrasive Materials Pty Ltd v Australian Fused Materials Pty Ltd (1998) 16 A C L C 1172 in para 4.3.3 below, where Templeman J (at 1,180) expressly applied the Charterbridge test to establish whether the directors had breached their fiduciary duties. 70 (1976) 137 C L R 1.
110
important, as it was the first express recognition of the Charterbridge test by
the courts after Walker v Wimborne.11
In view of Hansen J's conclusion that the loan was not made for a proper
purpose, it was not necessary for his Honour to decide whether the conduct of
the directors of Farrow Finance Co Ltd (FFC) was in the best interests of the 79
company. Hansen J, however, concluded that, by making the loan the
directors of FFC in any event also would have breached their fiduciary duty to
act in the best interests of the company.73 In considering whether the directors
had breached this duty, Hansen J referred to the pragmatic approach of the
majority on appeal in Equiticorp v BNZ?4 This is that there was an automatic
breach of duty where the directors have failed to consider their company's
interests. However, this was subject to the condition that, where it was
objectively to the benefit of the company, no consequences would flow from
such a breach.75 Without referring to Walker v Wimborne16 at all, his Honour
stated:77
However, in order to determine whether the making of the loan amounted to a breach of the fiduciary duty to act in the best interests of FFC, it is necessary to go further than this. To establish such a breach (or at least, a breach of any consequence), the plaintiff would need to prove not only that the directors failed to consider the interests of FFC but that an intelligent and honest director in their position would have concluded, in the face of all the relevant facts and circumstances, that the loan was not in the best interests of FFC.
This statement can also be interpreted, however, as stating that the failure to
consider the interests of a company does not per se constitute a breach of
fiduciary duty and that, to establish a breach of fiduciary duty, the actions of the
directors have to fail the Charterbridge test. There is little doubt that Hansen J
more readily accepted the Charterbridge test than was the case in Equiticorp v
71 Ibid. 72 Ibid. (1997) 26 A C S R 544 at 585. It should be noted that Hansen J refers to the fiduciary duty
to act for proper purposes as distinct from the fiduciary duty to act in the best interests of the company. See n 4 above. 73 Farrow (1997) 26 A C S R 544 at 585. 74 (1993) 11 A C L C 952. 75 (1997) 26 A C S R 544 at 580-581. 76 (1976) 137 C L R 1. 77 (1997) 26 A C S R 544 at 584.
Ill
BNZ?* to such an extent that it is arguably a denial of the law as laid down in
Walker v Wimborne?9 when he said:80
I have no evidence before me which would indicate that Farrow or the other directors honestly thought at any time that the making of the loan was in the best interests of FFC. Consequently, whether or not the transaction was in breach of Farrow's (or any director's)
fiduciary duty to act in the best interests of FFC is to be answered by applying the Charterbridge test.
The difference between this statement of Hansen J and the approach adopted by
the majority in Equiticorp v BN2?] is clear. In Farrow*2 his Honour stated that
to ascertain whether there was a breach of fiduciary duty the Charterbridge
test should be applied. In Equiticorp v BNZ, *3 however, the majority stated that
the directors would be in breach of their fiduciary duty if they did not consider
the interests of their company separately but that no consequences would flow
from such a breach if they could satisfy the Charterbridge test. While the
decision in Equiticorp v BNZ*5 is still in accordance with Walker v Wimborne, 87 QQ .
the decision in Farrow is not. The effect of the judgment in Farrow is that a
group of companies should not be seen as different entities but as one
enterprise.
Subsequently the N e w South Wales Court of Appeal also held the view that the • RQ
test in Charterbridge should be applied. In Linton v Telnet Pty Ltd Giles JA,
who delivered the unanimous judgment,90 accepted the application of the
78 (1993) 11 ACLC 952. 79 (1976) 137 CLR 1. 80 (1997) 26 ACSR 544 at 581. 81 (1993) 11 ACLC 952. 82 (1997) 26 ACSR 544. 83(1993)11 ACLC 952. 84 This is a strict interpretation of Walker v Wimborne (1976) 137 CLR 1. 85 (1993) 11 ACLC 952. 86 (1976) 137 CLR 1. 87 (1997) 26 ACSR 544. 88 Ibid. 89 (1999) 30 ACSR 465 (Linton).
Beazley JA and Sheppard AJA concurred.
112
Charterbridge test.91 His Honour did so on the basis that the Charterbridge test
had been applied - even if by agreement between the parties - many times in
Australia and that the respondent in Linton92 did not seek to depart from the
approach in Charterbridge but, instead, adopted it.93
4.3 Nominee directors: notion of 'dual loyalty'
The fiduciary duty of directors to act bona fide in the interests of their company
entails that they act in the interests of the company as a whole.94 This means
that, as a general rule, they o w e this duty to the shareholders as a collective
group and not to individual shareholders. Difficulties arise, however, where
nominee directors are appointed. 5 In practice nominee directors are basically
there to serve the interests of their nominators, for example, the holding
company, or a particular creditor.96 In the group context the director is the
representative of a controlling or significant shareholder. Nominee directors are
appointed by the holding company to look after the interests of only one of the
shareholders of the subsidiary, namely, its own. 7 Nominee directors thus find
themselves in an invidious position. In a corporate group context they face a
potential conflict between their fiduciary duty to act in the interests of the
subsidiary and their duty to act in the interests of the holding company that has
nominated them.
91 Curiously enough, in Linton (1999) 30 A C S R 465 no reference was made to Farrow (1997)
26 A C S R 544. 92 (1999) 30 A C S R 465. 93 Ibid 471-472. For examples of where the Charterbridge test had been applied, see Reid Murray (1972) 5 SASR 386 and Australian National Industries, unreported, SC N S W ,
50441/1989, Cole J, 14 December 1990. 94 The expression 'the company as a whole' includes creditors where insolvency intervenes. 95 It should be noted that die concept of a nominee director does not directly apply to wholly-owned group companies, as there is only one shareholder. 96 RS Nathan, 'Controlling the puppeteers: reform of parent-subsidiary law in N e w Zealand'
(1986) 3 Canterbury L Rev 1 at 8. 97 Usually a nominee director is appointed to the board of a subsidiary by the holding company by exercising its voting power at the subsidiary's general meetings, or in terms of a contract between the holding company and the subsidiary, or in terms of the subsidiary's constitution.
113
4.3.1 Traditional approach
The formulation of directors' duties to act bona fide in the interests of the
company as a whole and for a proper purpose implies that nominee directors
appointed by the holding company are bound to put the interests of the
subsidiary's shareholders ahead of the interests of the holding company.98 It
furthermore implies that nominee directors are required to place the interests of
the subsidiary's creditors before the interests of the holding company where the
subsidiary is insolvent or near insolvent.99 This is an application of the separate
entity doctrine rather than enterprise principles, as the interests of the group are
subordinated to the interests of the subsidiary.
In the English c ase, Scottish Co-operative Wholesale Society Ltd v Meyer} °
Lord Denning followed a strict entity approach regarding the duties of nominee
directors of non-wholly owned subsidiaries.101 The company constitution in this
case provided for the appointment of nominee directors. His Lordship found
that where the holding company and the minority shareholders of a subsidiary
had divergent interests, a nominee director's overriding duty was to take into
account the interests of the subsidiary's shareholders, and not those of its
appomter. ' This was also the approach taken by Lord Denning in Boulton v
Association of Cinematography, Television and Allied Technicians,103 where it
was h eld t hat t he n ominee d irector s hould e xercise a n i ndependent j udgment
and not subordinate the interests of the subsidiary to the holding company. In
this regard his Lordship said:104
See further Austin, above n 47, 143-147.
This is so in the light of recent case law. See the discussion in Ch 5 para 5.3. 100 [1958] 3 All E R 66.
A strict view was also followed in Breckland Group Holdings Ltd v London & Suffolk Properties Ltd (1988) 4 B C C 542.
In other words, the interests of the subsidiary's shareholders should be placed ahead of the interests of the majority shareholder (the holding company). In Aberdeen Railway Co v Blaikie
Bros (1854) 1 Macq 461 at 471-472 Lord Cranworth proposed a rale which requires directors to avoid situations in which there could be actual or possible conflict. This rule has always posed problems for nominee directors. 103 [1963] 2 Q B 606. 104 Ibid 626-627.
114
Or take a nominee director, that is, a director of a company who is nominated by a large shareholder to represent his interests. There is nothing wrong in it. It is done every day. Nothing wrong, that is, so long as the director is left free to exercise his best judgment in the interests of the company which he serves. But if he is put upon terms that he is bound to act in the affairs of the company in accordance with the directions of his patron, it is beyond doubt unlawful...or if he agrees to subordinate the interests of the company to the interests of his patron, it is conduct oppressive to the other shareholders for which the patron can be brought to book.
In Australia the s ame s trict approach w as followed b y S treet J i n Bennetts v
Board of Fire Commissioners ofNSW}05 Although this was not in a company
law context, it is submitted that the principle laid down in this case is equally
applicable when groups of companies are involved.106 The court adopted strict
entity principles and held that the most important duty of members of a
statutory board is to serve the interests of that board. If conflicts of interests
exist they must give preference to serving the interests of the board rather than
the interests of those who elected them to the board.
4.3.2 Pragmatic approach
Both in Australia and N e w Zealand, however, attempts have been made to place
the position of nominee directors on a more realistic basis. A pragmatic
approach was adopted in a number of cases where the courts have refused to
intervene despite the fact that directors acted solely in the interests of the
persons who appointed them and not in the interests of their company. It may
be said that the courts adopted 'a less uncompromising approach in an effort to
• 108
recognise the reality of commercial activity.'
In Levin v Clark the company articles made provision for the appointment of
nominee directors. Although a creditor of the company (and not the holding
105 (1967) 87 W N (Pt 1) (NSW) 307. 106 See Austin, above n 47, 143-147. 107 See, in general, P Crutchfield, 'Nominee directors: the law and commercial reality' (1992) 20 A Bus L Rev 109 at 122; Justice E W Thomas, 'The role of nominee directors and the liability of their appointors' in F Macmillan Patfield (ed), Perspectives on Company Law: 2 (1997) at
235. 108 Thomas J in Dairy Containers Ltd v NZI Bank Ltd [1995] 2 N Z L R 30 (Dairy Containers) at
96. 109 [1962] N S W R 686.
115
company) appointed the nominee directors, the principle laid d o w n in this case
is useful. It was argued that the nominee directors did not act in the interests of
the company because they acted exclusively in the interests of the creditor of
the company for whose benefit they had been appointed. Jacobs J found that the
articles, together with the sale and mortgage agreements, constituted an
attenuation of the directors' fiduciary duty and that this implied that the
nominee directors should act in the interests of the party w h o appointed
them.110 This did not necessarily mean that they were not also acting in the
interests of their company. In this regard Jacobs J stated:
To argue that a director particularly appointed for the purpose of representing the interests of a third party, cannot lawfully act solely in the interests of that third party, is in m y view to apply the broad principle, governing the fiduciary duty of
directors, to a particular situation, where the breadth of the fiduciary duty has been narrowed, by agreement amongst the body of the shareholders ... It does not follow, in m y opinion, that by acting in the interests of the mortgagee, and solely in the interests of the mortgagee, those directors necessarily cease to act in the interests of the company.
Jacobs J also delivered the judgment in Re Broadcasting Station 2GB Pty
Ltd.112 In contrast to the situation in Levin v Clark}13 the constitution of the
company in this case did not specifically provide for the appointment of
nominee directors. Instead, it made provision for the appointment of two
additional directors.114 Jacobs J was satisfied, however, that the directors
appointed to 2GB's board by the controlling shareholder were, to all intents and
purposes, the nominees of the latter.115 His Honour held that nominee directors
did not breach their fiduciary duty by acting in the interests of their appointer.
Jacobs J conceded that the directors would most likely follow the appointer's
wishes without closely analysing the issues and denied any right in the
company to have every director approach each company problem with a
completely open mind. To require that of each director of a company, he said,
110 Dairy Containers [1995] 2 N Z L R 30 at 96. 111 Levin v Clark [1962] N S W R 686 at 700 and 701. 112 [1964-5] N S W R 1648 (Re Broadcasting Station 2GB). 113 [1962] N S W R 686. 1,4 [1964-5] N S W R 1648 at 1663. 1,5 Ibid.
116
would be to ignore the realities of company organisation, and would make the
position of a nominee director impossible.116 Jacobs J also held, however, that
directors would have breached their duty if it could be proved that they would
have acted in the same way, believing that they were not acting in their
company's best interests.117
In the same vein as the court in Levin v Clark,"8 Mahon J in the New Zealand
case Berlei Hestia (NZ) Ltd v FernyhoughU9 recognised that the fiduciary
duties of nominee directors may be adjusted by specifying in the articles of
association that they owe particular duties to their appointers. The nominee
directors must, however, bona fide believe that such a responsibility is in the
interests of the company as a whole.120 Mahon J stated:121
In the present case this business undertaking, stripped of its corporate shell, is a trading partnership between two organisations operating in different countries. They agreed, when the company was incorporated, that each partner nominate three directors, and they impliedly agreed, as the articles show, that one class of directors was at liberty to bring the board's functions to a standstill when a disagreement arose, and that disagreement would almost certainly have its origin in a dispute between the two sets of shareholders. These consequences were all well known to the corporators when the articles were drawn. As a matter of legal theory, as opposed to judicial precedent, it seems not unreasonable for all the corporators to be able to agree upon an adjusted form of fiduciary liability, limited to circumstances where the rights of third parties vis-a-vis the company will not be prejudiced. The stage has already been reached, according to some commentators, where nominee directors will be absolved from suggested breach of duty to the company merely because they act in furtherance of the interests of their appointers, provided that their conduct accords with bona fide belief that the interests of the corporate entity are likewise being advanced.
In the course of his judgment Mahon J recognised the apparent anomaly
between the strict liability imposed on directors where they have benefited from
their fiduciary relationship, and the latitude granted by the law where a person
XX6Ibid. 117 Ibid. O n the evidence it could not be proved that the nominee directors were of the opinion
that their conduct was not in the interests of their company. 118 [1962] N S W R 686. 119 [1980] 2 N Z L R 150 (Berlei Hestia). In this case the company's constitution provided for
appointment of nominee directors. 120 See further R Teele, 'The necessary reformulation of the classic fiduciary duty to avoid a conflict of interest or duties' (1994) 22 A Bus L Rev 99 at 103 n53. 121 Berlei Hestia [1980] 2 N Z L R 150 at 166.
117
was a director of two rival companies.122 In this regard his Honour was of the
view that different considerations should apply depending on which one of the
two situations was applicable. It made perfect sense to hold directors liable if
they made use of their fiduciary positions to benefit themselves.123 However,
Mahon J stated that it was not reasonable to prevent a director from sitting on
the b oards o f t wo c ompeting c ompanies m erely b ecause h e t hen c ould, i f h e
were dishonest, breach his fiduciary duty to one of the two companies in
question. In other words, serving on both boards would not per se be a breach
of his fiduciary duty to one of the companies.124
Thomas J in Dairy Containers summarised the position on nominee directors 1 9fi
in Australia and N e w Zealand after Levin v Clark, Re Broadcasting Station
2GBni and Berlei Hestian* as follows:129
O n the basis of these decisions nominee directors need not necessarily approach company law problems with an open mind and they may pursue their appointer's interests provided that, in the event of a conflict, they prefer the interests of the company. In such circumstances the breadth of the fiduciary duty has been narrowed b y a greement a mongst t he b ody o f sh areholders. I n o ther words, t he corporators have agreed upon an adjusted form of fiduciary obligation.130
122 Ibid 161. 123 Ibid. 124 Ibid 161 and 165. See further A S Sievers, 'Finding the right balance: the 2 G B case revisited' (1993) 3 Aust Jnl of Corp Law\. A similar realistic approach to the problems of nominee directors was adopted in the converse to the normal fact situation in the N e w Zealand case of Trounce and Wakefield v NCF Kaiapoi Ltd (1985) 2 N Z C L C 99,422 and by Beaumont J in the Federal Court of Australia in Molomby v Whitehead and the ABC (1985) 63 A L R 282.
[1995] 2 N Z L R 30. This case is discussed in more detail in Ch 6 para 6.3. 126 [1962] N S W R 686. 127 [1964-5] N S W R 1648. 128 [1980] 2 N Z L R 150. 129 [1995] 2 N Z L R 30 at 96.
This approach finds support the j udgment o f D eane J i n Hospital Products Ltd v United States Surgical Corporation (1984) 156 C L R 41. The majority of the High Court (Gibbs CJ,
Wilson and Dawson JJ) held that HPI did not owe any fiduciary duty to U S S C and that, as a result, the relief that U S S C was entitled to was limited to recovery of damages for breach of contract. Their Honours rejected the existence of a fiduciary relationship in view of the commercial character of the arrangement between the parties, because of their having dealt at arm's length and on an equal footing. In a dissenting judgment Mason J found that a fiduciary duty did indeed exist and that a constructive trust should be imposed for its breach (at 100). Although Deane J would also have allowed a constructive trust in favour of U S S C on the ground of equitable fraud, his Honour found, like the majority, that a fiduciary relationship did not exist between U S S C and HPI. Deane J conceded that the conclusion that the overall relationship between U S S C and HPI was not fiduciary did not preclude the possibility that, within or arising from that relationship, a more restricted fiduciary relationship might exist (at 123). It appears from this case that, compared to other jurisdictions, the High Court is much less
118
4.3.3 Notion of 'dual loyalty' similar to Charterbridge test
It appears from the case law discussed that nominee directors may act in the
interests of their appointers as long as this is consistent with the interests of the
company. The important thing that emerges from these judgments is that they
afford judicial recognition to the reality that nominee directors are subject to the
wishes of their appointer who, in a group of companies, is invariably the
holding company. Nominee directors will not breach their fiduciary duty if they
act in accordance with the wishes of their nominator provided their actions are
also in the interests of their o w n company. Mahon J in Berlei Hestia121 pointed
out that cases such as Levin v Clark122 and Re Broadcasting Station 2 GB?33
have attempted to harmonise the 'theoretical doctrine of undivided
responsibility' with commercial reality.134 They have done so on the basis that,
because the company articles allow a certain creditor or shareholder to
nominate directors, they owe a special responsibility to their nominators. This
duty they owe over and above the duty that they owe to the shareholders as a
group, since the company articles were drafted with the interests of the
company as a whole in mind.135
The view adopted in Levin v Clark}36 Re Broadcasting Station 2GB1 7 and
Berlei Hestia13* does not depart from the general principle that directors have to
act bona fide in the interests of their company as a whole and for a proper
purpose. Although the cases have recognised the dilemma of nominee directors,
they have not been able to temper the strict application of the fiduciary
willing to impose a fiduciary relationship in commercial settings. For a comparison of the position in Australia, Canada and New Zealand on this issue, see S White, 'Commercial relationships and the burgeoning fiduciary principle' (2000) 9 Griffith LR 98. 131 [1980] 2 NZLR 150. 132 [1962] N S W R 686. 133 [1964-5] N S W R 1648. 134 Berlei Hestia [1980] 2 NZLR 150 at 165-166. 135 Ibid. 136 [1962] N S W R 686. 137 [1964-5] N S W R 1648. 138 [1980] 2 NZLR 150.
119
obligations. In none of these cases is it suggested that a nominee director
who acts in the interests of the person w h o has appointed him can perform such
an a ct i f h is c onduct i s n ot b ona fide i n t he i nterests o f h is c ompany. T hese
cases are, therefore, not authority for the proposition that there has been a
relaxation of the duty of good faith as far as nominee directors are concerned.140
The approach followed in these cases should preferably be described as similar
to that followed in Charterbridge141 rather than to regard it as asserting that
nominee directors owe a lower fiduciary duty to their company than other
directors. Nominee directors m a y take into account the interests of their
appointer, the holding company, as long as their act or actions are also bona
fide in the interests of their o wn company, the subsidiary. Thus one can say that
in the case of nominee directors the courts have also embarked on an enterprise
approach and are moving away from an entity approach in order to deal with
the problem in a businesslike manner.
Support for the argument that the courts are adhering to a 'commercial'
approach along the lines of Charterbridge142 can be found in a recently reported
case on nominee directors.143 In Japan Abrasive Materials Pty Ltd v Australian
Fused Materials Pty Ltd144 Templeman J expressly applied the Charterbridge
test to establish whether the nominee directors had breached their fiduciary
duties.145 Templeman J found that, as was the case in Levin v Clark}46 the
shareholders had by agreement narrowed the scope of the directors' fiduciary
duties. In accordance with the shareholders' agreement, the nominee directors
See also Nathan, above n 96, 8.
This is in line with Recommendation 6 by C A S A C in its Corporate Groups Final Report (May 2000), reading as follows: 'The Corporations Law [now: Corporations Act 2001 (Cth) [Corporations Act)] should not contain specific provisions dealing with the fiduciary duties of nominee directors of partly-owned group companies. These directors should be subject to the same fiduciary duties as all other company directors.' 141 [1970] ICh 62.
ZIbid-5 This approach has been introduced by Levin v Clark [1962] N S W R 686. The phrase
'commercial assessment' is used by R Baxt, 'Lost opportunity' (September 1998) Charter 58 at 59 where he refers to the test in Charterbridge [1970] 1 Ch 62. 144 (1998) 16 A C L C 1172 (Japan Abrasive Materials). 145 Ibid 1,180.
120
were entitled to vote entirely in accordance with the wishes of the shareholders
that nominated them.147 They were not found to have acted in breach of their
fiduciary duties.148
The pragmatic approach followed by the court in Levin v Clark149 and the
subsequent cases supporting it seems to work w ell when one is dealing w ith
solvent companies. Different considerations apply, however, where insolvency
intervenes. This is because nowadays the interests of the company include the
interests of its creditors where the company is insolvent or near insolvent. As
discussed in Chapter 5, the interests of creditors then become paramount and
the interests of shareholders diminish accordingly.150
From the above discussion of the case law it is clear that in respect of solvent
companies shareholders m a y by agreement narrow the scope of the directors'
fiduciary duty to act in the interests of the company. The 'interests of the
company' in this context usually means the shareholders as a whole. Unlike
shareholders, however, creditors do not have any say in the attenuation of the
directors' fiduciary duty. Furthermore, it should be borne in mind that the
doctrine of constructive notice of documents that could be searched in the office
of the regulatory authority still applied when these cases were decided.151 The
doctrine of constructive notice of documents lodged with ASIC has been
abolished, except in relation to company charges.152 Hence, creditors will not
even be presumed to know about an attenuation of the duties of directors in the
company's constitution.
146 [1962] N S W R 686. 147 (1998) 16 A C L C 1172 at 1,177. 148 Ibid 1,196. 149 [1962] N S W R 686. 150 See para 5.3. 151 Third parties were deemed to know what they could have discovered if they had searched. 152 The effect of this abolition is that nobody has constructive notice of the company's constitution. This was done by the insertion of s 68C in the Companies Act 1981 by s 34 of the Companies and Securities Legislation (Miscellaneous Amendments) Act 1983 Nol08. There is now constructive notice only in respect of documents lodged with ASIC with respect to
121
The question arises whether the court in the above three cases would have
reached the same conclusion if the general creditors' interests were at stake. If
the court did not apply the strict standard expected of directors, it could be
guilty of a dereliction of duty. The court in Kinsela v Russell Kinsela Pty Ltd
and the cases that followed it found that shareholders were not entitled to ratify
a breach of directors' duty to act in the interests of their company if the
company was insolvent or on the brink of insolvency. This is so because it is
really the creditors' interests that are at stake then. For the same reasons, where
a company is carrying on business under insolvent circumstances, shareholders
should not be allowed to agree that the duty to act in the interests of the holding
company take precedence over the fiduciary duty to act in the interests of the
subsidiary as a whole.154 This would work unfairly towards creditors.
4.4 Duty of care, skill and diligence
4.4.1 Scope of duty
Early case law required a remarkably low standard of care. In Re City Equitable
Fire Insurance Co LtdX55 Romer J stated that a director does not need to show a
greater degree of skill than m a y reasonably be expected from a person of his
knowledge and experience. There was no objective minimum standard of care
and the courts took into account the subjective knowledge and experience of the
director in question. The courts were reluctant to impose onerous standards of
care because traditionally directors were not appointed on the grounds of their
business acumen. They were rather appointed because of their reputation or title
and they often knew very little, if anything, about business.
registrable charges given by way of security over company property: s 130 of the Corporations Act. 153 (1986) 4 N S W L R 722. See further Ch 5 para 5.3.2.
This should be the case whether this agreement is contained in the articles (constitution) or in a shareholders' agreement. 155 [1925] Ch 407.
122
The low standard of care required by earlier cases did not keep pace with the
change in community attitudes and expectations over the years.156 To rectify the
situation the Cooney Report recommended in 1989 that the legislation should
be changed to impose elements of an objective standard of care on directors.157
In 1992 the legislature adopted these recommendations by amending the then s
232(4) o f t he C orporations L aw. S hortly a fter t he p ublication o f t he C ooney
Report the courts started raising the standard of care expected of directors158
and also established that the standard of care was essentially objective.159
Despite recommendations by the Cooney Committee to this effect, however, no
legislation was enacted giving guidance as to when directors were entitled to
delegate to and rely on third parties, except in the context of the insolvent
trading provisions.160
The leading Australian judgment on directors' duty of care, including the issue
of delegation and reliance, is AW A Ltd v Daniels}61 cited on appeal as Daniels
v Anderson. A public company instituted action against its previous auditors
for negligence arising from their preparation of financial statements involving
foreign c urrency transactions. The auditors failed to bring to the attention o f
AWA's board the activities of one of the employees of AW A that led to a loss
of almost $50 million, and the fact that AWA's internal control system was
deficient. Cross-claims were instituted against some of the directors of AW A,
See generally, S Worthington, "The duty to monitor: a modern view of the directors' duty of care' in F Macmillan Patfield (ed), Perspectives on Company Law: 2 (1997) at 181. 157 Commonwealth of Australia: Senate Standing Committee on Legal and Constitutional Affairs, Report on the Social and Fiduciary Duties and Obligations of Company Directors,
Chaired by Senator Cooney (Official Hansard Report) Canberra (1989). 158 See in this regard Tadgell J's statements in Commonwealth Bank of Australia v Friedrich
(1991)9 A C L C 946 (Friedrich). 159 See Vrisakis v ASC (1993) 9 W A R 395. 160 The Companies and Securities Law Review Committee conceded in its Report on Company Directors and Officers: Indemnification, Relief and Insurance, Report N o 10 (May 1990) paras 38 and 39 that although directors could delegate their powers to third parties, there were certain responsibilities that they could not delegate. See now the defence in s 588H(3) in relation to the duty on directors to prevent insolvent trading in s 588G of the Corporations Act. 161 (1992) 10 A C L C 933 (A WA v Daniels). 162 (1995) 13 A C L C 614. It has been applied subsequently, notably in Duke Group Ltd (in liq) v Pilmer (No 2) (2000) 78 SASR 216. Cf Pilmer v Duke Group Ltd (in liq) (2001) 180 A L R
249. See also L Nicholls, 'Pilmer v Duke Group Ltd (in liq)' (2001) 19 C&SU 397.
123
including the managing director. All the other directors involved were
non-executive directors.
The managing director and the non-executive directors claimed not to have
understood the finer points of the risk involved in foreign currency dealings.
They furthermore claimed that the size of the company left them no other
choice than to rely heavily on senior management for advice in this regard and
that, therefore, they could not be held responsible. If this were correct, an even
stronger case could be made out for arguing that the directors of a holding
company, or the holding company itself, could not be held responsible for the
actions of their subsidiary of which they were not aware.
At first instance Rogers CJ found that the auditors were negligent, and that
A W A was liable for contributory negligence, but found the non-executive
directors not liable. Rogers CJ furthermore found that the managing director
was liable for negligence in his personal capacity. Rogers C J adhered to the
traditional view that, in the absence of any reason for suspecting an
impropriety, directors were 'entitled to rely without verification on the
judgment, information and advice of the officers so entrusted'.164 In the view of
Rogers CJ the reliance would only be unreasonable where the director was
aware of circumstances so manifest that no person with any degree of prudence,
acting for himself, would have relied on it.165 Subsequent judgments of the
Supreme Court of Western Australia, delivered before the judgment of the
Non-executive directors do not receive special treatment from the courts, despite the fact that they are not involved in the day-to-day running of the business and are accordingly less involved: Friedrich (1991) 9 A C L C 946. O n the distinction between the roles of executive and non-executive directors, see, eg, A Chernov, 'The role of corporate governance practices in the development of legal principles relating to directors' in IM Ramsay (ed), Corporate Governance and the Duties of Company Directors (1997) 33 and 37; R Baxt, 'One ' A W A case' is not enough: the turning of the screws for directors' (1995) 13 C&SLJ 4\4 at 421. 164 AWA v Daniels (1992) 10 A C L C 933 at 1015. It is clear that Rogers CJ accepted the test of permissible delegation as set out in Re City Equitable Fire Insurance Co Ltd [1925] Ch 407 at 428. 165 AWA v Daniels (1992) 10 A C L C 933 at 1,015. For a further discussion of this approach, see
P Redmond, 'Safe harbours or sleepy hollows: does Australia need a statutory business judgment rule?' in IM Ramsay (ed), Corporate Governance and the Duties of Company Directors (1997) 185 and 187.
124
Court of Appeal in Daniels v Anderson166 was handed down, endorsed the view
held by Rogers CJ.167
The Court of Appeal of N e w South Wales in Daniels v Anderson16* was in
agreement with the findings by Rogers CJ, apart from the fact that the
managing director was held not liable to contribute in his personal capacity.169
The Court of Appeal found that his negligence should instead be taken into
account when considering how the loss should be apportioned between A W A
and the auditors. However, on appeal the majority disagreed with the reasoning
of Rogers CJ at first instance, stating that his view did not accurately reflect the
extent of directors' duties in m o d e m company law.170
Clarke and Sheller JJA agreed with a decision by the Seventh Circuit Court of
Appeal171 in the United States that a director may not rely on the judgment of
others, especially where there has been notice of mismanagement.172 Their
Honours found that the duty of care was 'not merely subjective, limited by the
director's knowledge and experience or ignorance or inaction'.173 They agreed
with P ollock J i n Francis v United Jersey B ank114 a s t o w hat t he 1 aw i n t he
United States, Australia and elsewhere generally has come to expect of
directors. Directors have a duty to the company to take reasonable care in the
"* (1995) 13 ACLC 614. 167 See ASC v Gallagher (1993) 11 W A R 105; Vrisakis v ASC (1993) 9 W A R 395; Wheeler (1994) 12 ACLC 674. 168 (1995) 13 ACLC 614. 169 For a discussion of the case see J Cassidy, 'Standards of conduct and standards of review: divergence of the duty of care in the United States and Australia' (2000) 28 A Bus L Rev 180. 170 This applies.to both executive and non-executive directors. Cases that have followed the decision in Daniels v Anderson (1995) 13 ACLC 614 include Re Property Force Consultants Pty Ltd (1995) 13 ASCLC 1051, Gamble v Hoffmann (1997) 24 ACSR 369, Duke Group Ltd (in liq) v Pilmer (1998) 27 ACSR 1, Duke Group Ltd v Pilmer (No 2) [2000] SASC 418, and Australian Securities Commission v Donovan (unreported, Federal Court, Cooper J, 20 August
1998). 171 Federal Deposit Insurance Corporation v Bierman 2 F3d 1424 (1993). 172 Daniels v Anderson (1995) 13 ACLC 614 at 665-666. See now s 180(1) of the Corporations
Act, discussed in para 4.4.2 below. 173 Daniels v Anderson (1995) 13 ACLC 614 at 666. 174 432 A 2d 814 (1981) at 821-823.
125
performance of their office. In this regard their Honours quoted with approval
the following statement by Pollock J:175
Because directors are bound to exercise ordinary care, they cannot setup as a
defense lack of the knowledge needed to exercise the requisite degree of care. If one feels that he has not had sufficient business experience to qualify him to perform the duties of a director, he should either acquire the knowledge by inquiry, or refuse to act.
Clarke and Sheller JJA rejected the idea of adjusting the standard of care
downwards. However, their Honours found that it was possible to have an
upward adjustment of the duty of care in the sense that directors could be held
to a more stringent test if they had been appointed on the basis that they
possessed special skills or experience.177
Can J in Gamble v Hoffmann11* also agreed with the view of the majority in 1 "7Q
Daniels v Anderson on not being able to adjust the standard of care
downwards. In Gamble v Hoffmann1*0 it was contended that, in ascertaining
whether the duty of care was breached, the court should take into account the
fact that the director in question had left school at a very early age, did not have
any tertiary qualifications and spent his life marketing and selling fruit and
vegetables. Carr J, however, doubted whether subjective factors such as these
should be taken into account to lower the standard of care and stated obiter}*1
175 Francis v United Jersey Bank 432 A 2d 814 (1981) at 821-3. 176 Daniels v Anderson (1995) 13 A C L C 614 at 664-668. See further G Stapledon, 'The CLERP proposal in relation to section 232(4): the duty of care and diligence' (1998) 16 C&SLJ 144. See also M J Trebilcock, 'The Liability of Company Directors for Negligence' (1969) 32 MLR 499 at 510-511; A L MacKenzie, 'A Company Director's Obligations of Care and Skill' (1982) JBL 460 at 470. The English courts are also moving in the direction of an objectively measured minimum standard that is not affected by any lack of experience and knowledge on the part of the director in question: see Re D'Jan of London Ltd [1994] 1 B C L C 561 at 563. ^ Daniels v Anderson (1995) 13 A C L C 614 at 667-668.
(1997) 24 A C S R 369 (Gamble). This case is discussed in more detail in para 4.4.3 below (1995) 13 A C L C 614. (1997) 24 A C S R 369. Ibid 313.
178
179
180
181
126
As Ipp J pointed out in Vrisakis v ASC (1993) 9 W A R 395 at 451; 11 A C S R 162 the ambit of the duty and the standard of care depend on the particular circumstances. However, the test is essentially objective, that is did the officer exercise the degree of care and diligence that a reasonable person in a like position in a corporation would exercise in the corporation's circumstances? I doubt whether the factors which [counsel] advanced would justify a lower standard of care. They might exclude any suggestion of special skills other than those acquired by extensive experience in the fruit and vegetable markets. However, there was no such suggestion in the present matter.
It should be noted that, although Carr J used the language of the then s 232(4)
of the Corporations Law, his Honour was addressing the directors' common-
law duty to exercise reasonable care, as established in Daniels v Anderson}*2
Gamble v Hoffmann involved an application by a liquidator under s 598 of
the Corporations Law, which refers, inter alia, to 'negligence'. Carr J equated
this with a breach of the common-law duty to exercise reasonable care.184
4.4.2 Statutory formulation of duty
As alluded to above, since the decision in Daniels v Anderson1*5 there has been
a conflict in the case law of the various states on whether directors are in breach
of their duty of care if they delegate matters or if they rely on information
provided by third parties. In an attempt to clarify the situation, the CLERP Act i QZ:
effectively reformulated the existing duty to exercise care and diligence. The
duty of 'care and diligence' is currently found in s 180(1) of the Corporations
Act. This subsection has replaced the former s 232(4) of the Corporations Law.
It provides for a qualified objective reasonable person test. Pursuant to s 180(1)
182 (1995) 13 A C L C 614. 183 (1997) 24 A C S R 369. 184 For a more detailed analysis of the development of the duty of care, see A Sievers, 'Farewell to the sleeping director - the modem judicial and legislative approach to directors' duties of care, skill and diligence' (1993) 21 A Bus L Rev 111; A Sievers, 'Directors' duty of care: what is the new standard?' (1997) 15 C&SLJ 392; J Cassidy, 'Has the 'sleeping' director finally been laid to rest?' (1997) 25 A Bus L Rev 102; A Comerford and L Law, 'Directors' duty of care and the extent of 'reasonable reliance and delegation" (1998) 16 C&SLJ 103; the Hon Justice Ipp, 'The diligent director' (1997) 18 Co Law 162. 185 (1995) 13 A C L C 614. 186 See the 'New Directors' Duties and Corporate Governance Provisions' of the Corporate Law Economic Reform Program Act 1998 (Cth). See further Sievers, 'Directors' duty of care: what is the new standard?', above n 184; J Bird, 'The duty of care and the CLERP reforms' (1999) 17 C&SU 141 and J Hill, 'CLERP: What it means for corporate Australia' (2000) Ausil
Com Sec 18.
127
of the Corporations Act directors or other officers are required to exercise their
powers and discharge their duties with the degree of care and diligence that
reasonable persons would exercise:
(a) if they were directors or officers in the corporation's circumstances; and
(b) if they occupied the offices held by, and had the same responsibilities
within the corporation as, the directors or officers.
In a previous draft the objective reasonable person test was qualified by a third
requirement in the proposed s 180(l)(c).188 This requirement, which has since
been removed, stated that the directors had to exercise their powers and
discharge their duties with the degree of care and diligence that a reasonable
person would exercise if they had the director or other officer's experience. The
rationale for the proposed amendment was stated as clarifying that a director's
background, qualification and position could be taken into account in 1 SO
ascertaining compliance with the standard of care. ' It is uncertain what
prompted the removal of this third requirement.190 It is submitted, however, that
such removal as well as the current wording of s 180(l)(a) and (b) indicate that
the particular background and qualifications or experience of directors m a y not
be taken into account to lower their statutory duty of care. It m a y only raise
their statutory duty of care.191
Section 180(2) provides for a so-called 'business judgment rule' offering
directors a safe harbour from personal liability for breaches of the duty of care
and diligence where they have taken honest, informed and rational business
judgments.192 The business judgment rule in s 180(2) is closely modelled on the
The only change from s 232(4) of the Corporations Law to s 180(1) of the Corporations Act is the addition of para (b). 188 C L E R P Draft Paper N o 3.
Ibid. For criticism of this previous draft, see Stapledon, above n 176.
If the particular personal characteristics of a director were indeed relevant, there is no reason why para (c) should have been removed from the revised C L E R P proposals.
It is interesting to note that this is the approach taken by the Privy Council in Royal Brunei Airlines Sdn Bhd vTan[\995] 3 All E R 97.
O n the statutory business judgment rule, see, eg, R Baxt, 'New Corporate Governance
Provisions - Business Judgment Rule and Statutory Derivative Actions', paper delivered on 11 August 1998 at the Hyatt Regency Hotel, Adelaide (seminar held by the Australian Institute of
128
business judgment rule of the American L a w Institute.193 This rule was
introduced partly to quell concern that the decision in Daniels v Anderson194
had introduced an unreasonably high standard of care and diligence. It is
justified on the ground that it will promote entrepreneurial risk-taking and, as a
result, increase shareholder wealth.195 Under the business judgement rule
contained in s 180(2), a director will be taken to have complied with the duty of
care if certain preconditions are satisfied. The preconditions are that the director
made a business judgment:
• in good faith for a proper purpose;
• did not have a material personal interest in the matter;
• was appropriately informed about the matter; and
• rationally believed that the judgment was in the best interests of the
corporation.
A number of limitations exist that m a y restrict the level of protection the
business judgment rule provides to creditors. It is important in this context that
the rule does not protect all actions taken and decisions made by directors. It
protects only 'business' judgments, namely decisions to take or refrain from
taking certain action in respect of matters relevant to the company's business
Company Directors - South Australian and Northern Territory Divisions) ('New Corporate Governance Provisions') at 11; L Law, 'The business judgment rule in Australia: a reappraisal since the A W A case' (1997) 15 C&SLJ 174; J Farrar, 'Towards a statutory business judgment rule in Australia' (1998) 8 Aust Jnl of Corp Law 327; A Greenhow, 'The statutory business judgement rule: putting the wind into directors' sails' (1999) 11 Bond LRev 33; M Berkahn, 'A Statutory Business Judgment' (1999) 3 South Cross ULR 215; R Baxt 'Directors' duty of care and the new business judgment rule in the twenty-first century environment' in I Ramsay (ed), Key Developments in Corporate Law and Trusts Law (2002), 15 Iff. 193 Section 4.01(c), American Law Institute, Principles of Corporate Governance (1994). See further D DeMott, 'Directors' duty of care and the business judgment rule: American precedents and Australian choices' (1992) 4 Bond L Rev 133; C Hansen, 'The duty of care, the business judgment rule, and the American Law Institute corporate governance project' (1993) 48 Bus Law 1355; D DeMott, 'Legislating business judgment- a comment from the United States' (1998) 16 C&SU575. 194 (1995) 13 A C L C 614. 195 C L E R P Directors' Duties and Corporate Governance: Facilitating Innovation and Protecting Investors, Proposals for Reform: Paper N o 3 at 22-23. See further A Cameron, 'The perspective of the Australian Securities Commission on the enforcement of directors' duties and
the role of the courts: a comment' in IM Ramsay (ed), Corporate Governance and the Duties of Company Directors (1997) 205-206; Australian Institute of Company Directors, Duty of Care
and the Business Judgment Rule: Submission to Department of Treasury/CLERP, June 1997 at
3.
129
operations.196 In this regard the Explanatory M e m o r a n d u m to the C L E R P Bill
suggests that, while protection might be given under the business judgment rule
to an ordinary decision of directors, no protection would be available for
directors' judgments in particular areas such as insolvent trading. The reason
for this is that the business judgment rule does not operate in relation to any
other provisions of the Corporations Act where a sanction or remedy is
prescribed.
The provisions of the Corporations Act introduced by the CLERP Act further
intended to elucidate the circumstances in which it was appropriate for directors
to delegate their functions and rely on the advice of experts when they are
making decisions.198 The current s 189 of the Corporations Act states that
directors' reliance on the advice or information provided by particular third
parties when making decisions will prima facie be regarded as reasonable,
provided certain conditions have been met. Furthermore, the current s 190 of
the Corporations Act expressly states that the board of directors is not
responsible for the exercise of a power by a delegate, provided that two
conditions are satisfied. The first condition is that the directors must reasonably
believe that the delegate would act in conformity with the duties imposed on
them by the Corporations Act and the constitution of the company. The second
condition is that the directors must reasonably, in good faith and after proper
inquiry, where appropriate, believe that the delegate was reliable and competent
in relation to the power delegated.199
The current provisions seem to be in line with the view of the majority on
appeal in Daniels v Anderson?00 This is, in a nutshell, that the standard of care
is essentially objective and that subjective factors such as the particular
196 Section 180(3) of the Corporations Act.
Para 6.8. A n example would be undertaking a new business activity. O n reliance and delegation, see, eg, R Baxt, 'New Corporate Governance Provisions', above
n192,13-14. 199 xx
Reasonable delegation or reliance by directors does not mean that they have breached their duty of care, even in the absence of the C L E R P reform proposals. See Comerford and Law, aboven184. 200 (1995) 13 ACLC 614.
130
director's background and knowledge should only play a role in elevating the
requisite standard. The fact that directors m a y delegate to or rely on certain
third parties, provided it is reasonable in the circumstances, also emphasises the
objective element contained in the standard of care.
4.4.3 Overlap with fiduciary duty
In many of the cases discussed under the breach of the duty to act bona fide in
the interests of the company the directors could just as well have been found
guilty of a breach of their duty of care, had this been the question before the
court. As there are, however, only a few instances where the directors' duty of
care in the context of groups of companies has been referred to in the case law,
this duty will not be examined in much detail. The following comments indicate
a degree of overlap between directors' fiduciary duty to act in the interests of
the company and their duty of care and the confusion in distinguishing between
the two duties in a corporate group situation.
There was a hint of a breach of a director's duty of care in a group situation in
Australian National Industries. In this case the directors effected the transfer
of the assets of one company (GPI) to another company to obtain funds to lend
to a third party. Cole J found that one of the directors had breached his duty to
GPI 'to act with due diligence ... That is so because he gave no consideration — 9ft9
at all [to] whether those transfers of assets were in the interest of GPI.' Thus,
even after recognising that this was a breach of the duty of care, Cole J
proceeded w ith t he r est o f t he j udgment o n t he b asis t hat i t w as a b reach o f
fiduciary duty?02
201 Unreported, SC N S W , 50441/1989, Cole J, 14 December 1990. 202 Ibid 11 (own emphasis). 203 In most of the other cases the fact that the directors did not take into account the interests of a particular company was seen as a breach of their fiduciary duty and not a breach of their duty
of care.
131
Although this was not in a group context, the more recent decision in Gamble v
Hoffmann204 provides a good illustration of the confusion that exists in our case
law in distinguishing between directors' fiduciary duty to act in the interests of
their company and their duty of care and diligence. M r and Mrs Hoffmann were
the directors and sole shareholders of Tallimba Pty Ltd (Tallimba) and
Sunhaven Nominees Pty Ltd (Sunhaven). They, together with others, had given
personal guarantees under a lease entered into by Sunhaven, which
subsequently became insolvent. M r Hoffmann instructed Tallimba, which held
no shares in Sunhaven,205 to release Sunhaven from its lease obligations by
paying t he 1 andlord t he sum o f $ 80 0 00. S ome time 1 ater T allimba w as a lso
liquidated.
The liquidator of Tallimba brought an action against Mr Hoffmann for alleged
negligence and breach of his duty of skill, care and diligence to the company
under s 598 of the Corporations Law by causing it to pay the $80 000. It is
clear from the judgment that M r Hoffmann did not understand the separate
entity doctrine. H e did not see Tallimba, Sunhaven and himself as separate
legal entities. H e saw them all as 'one and the same thing'.206 Being under this
mistaken belief, M r Hoffmann would not have given separate consideration to
the interests of Tallimba when he instructed it to pay the $80 000. The only 9fi7
interests that he considered were his own and those of the other guarantors.
Although the director in Gamble v Hoffmann20* did not consider the interests of
his company separately, the Federal Court did not find a breach of fiduciary
duty but rather a breach of duty of care. Carr J stated that their duty of care
required the directors to take two steps. First they had to establish what benefit
Tallimba would derive from making the payment on behalf of Sunhaven.
Secondly, if there were any benefit to be derived, the directors had to ascertain
whether there was any reasonably foreseeable prospect of detriment to
204 (1997) 24 A C S R 369. 205 Ibid 376. 206 Ibid 318. 207 Ibid 377.
132
Tallimba.209 There is a striking resemblance between the first step to establish
breach of a duty of care - that is whether the transaction was (objectively
speaking) for the benefit of Tallimba - and the Charterbridge test, which is
used to establish whether there has been a breach of fiduciary duty.210
91 1
In Farrow, discussed above and decided in the context of a corporate group,
Hansen J also cast doubt on whether the failure of a director to take into
consideration the interests of his specific company would constitute a breach of
his fiduciary duty to act in its interests. Hansen J seemed to favour the view that
such an omission would rather constitute a breach of the director's duty of care
where he said:212
I have some doubts whether the inactivity of directors (ie, a complete failure to act, as opposed to a positive act which is knowingly detrimental to the interests of the company) can be said to be a breach of fiduciary duty in addition to being a breach of the directors' duty of due diligence.
91^
This quotation from Farrow confirms the overlap and confusion that exists in
establishing whether a director has by his act or omission breached his fiduciary
duty or his duty of care. Perhaps it can be explained partly by the gradual move
by the courts in the direction of accepting the objective test in Charterbridge in
establishing breaches of fiduciary duty in a group Context.214 It has been
recognised by the case law that the test for a director's breach of his duty of 9 1 S
care is also objective. The significance of this is that, as in the case of
fiduciary duties, an enterprise approach will probably also be followed in the
case of a breach of duty of care, should it ever come before the courts.
208 (1997) 24 A C S R 369. 209 Ibid 373-374. If there was a reasonable prospect of detriment, the court had to weigh this up
against the likely benefit to the company to decide the negligence issue. 210 The fiduciary duty relevant here is to act in the interests of the company. 211 (1997) 26 A C S R 544. 2X2 Ibid 5m. 213 (1997) 26 A C S R 544. 214 See para 4.2 above. 215 See paras 4.4.1 and 4.4.2 above respectively.
133
4.4.4 Overlap with insolvent trading provisions
It is interesting to consider the relationship between the duty of care and the 91 f\
insolvent trading provisions of the Corporations Act. Directors have to
comply with the common-law duty of care as discussed in paragraph 4.4.1
above. In addition, the Corporations Act requires directors to exercise the
degree of care and diligence that a reasonable person would exercise in similar
circumstances.217 Despite this, there have been relatively few cases dealing with
directors' duty of care as such. However, between 1980 and 1993 creditors have
used the insolvent trading provisions extensively and the courts have developed
directors' duties of care and diligence, including the monitoring of the financial
position of their companies, in this context.218 It m a y be argued that the duty of
care in Australia has developed through consideration of the insolvent trading
provisions by the courts rather than the common-law or the statutory duty of
219
care.
O n the introduction of s 588G(1), relating to the liability of directors for
insolvent trading, its relationship with the statutory duty of care was explained.
At the time the statutory duty of care was contained in s 232(4) of the
Corporations Law. A director involved in insolvent trading had to comply with
the same standard of care and diligence laid down in the then s 232(4).220 This
means that the interpretation of the standard of care requirements in Daniels v 991
Anderson m a y be used to guide directors w h o wish to ensure that they do not
contravene the insolvent trading provisions of the Corporations Act?22 The
The insolvent trading provisions are discussed in more detail in Chh 6 and 7. See further Comerford and Law, above n 184. 217 See currently s 180(1) of the Corporations Act. 18 See A Herzberg, 'Why are there so few insolvent trading cases?' (1998) 6 Insol Law Jnl 11, who points out that the voluntary administration regime introduced in 1993 has had the effect of decreasing the number of actions instituted under s 588G of the Corporations Act.
I Ramsay, Transcript of Symposium held at C onnecticut in 1998, published in (1999) 13 Conn J Int 7 L 397 at 433-4. 220
Butterworths Australian Corporation Law, Principles and Practice (loose-leaf), Vol 1, para 3.2.0645. 221 (1995) 13 ACLC 614. Til
B Mescher, 'Personal liability of company directors for company debts' (1996) 70 AU 837 at 839.
134
statutory business judgment rule will, however, not be developed in the same
way. It has been made clear that the business judgment rule does not operate in
the realm of the insolvent trading provisions.223
The recent decision in Sheahan v Verco224 serves as an illustration of the
interesting overlap between the duty of care and the statutory duty to prevent
insolvent trading. It should be noted that the alleged breach of duty of care took
place prior to 23 June 1993, when there were no provisions in the Corporations
Law that made directors liable to a company for insolvent trading, like s 588G
of the Corporations Act does at present. At the time, there was liability to
creditors for insolvent trading pursuant to s 592 of the Corporations Law. In 99_c
Sheahan v Verco the liquidator's claim was not that the directors were liable
for debts incurred in trading when the company was insolvent. Rather, the
liquidator claimed that the directors had a duty of care to the company pursuant
to s 232(4) of the Corporations Law226 and at c o m m o n law to cause the
company to cease trading when it was insolvent and trading at a loss.
4.5 Evaluation of position of group creditors
4.5.1 Fiduciary duty to act in interests of company
With the advent of companies operating in groups consisting of holding
companies and subsidiaries rather than carrying on business as single entities, it
is not surprising that the question of whether directors m a y take into account
the interests of other companies in the group without breaching their fiduciary
227
duty towards their o w n company anses m increasing measure.
223 See para 4.4.2 above. See further Law, above n 192; R Langford, 'The new statutory business j udgment rule: should it apply to the duty to prevent insolvent trading?' (1998) 1 6
C&SU 533. 224 (2001) 79 SASR 109. 225 Ibid. 226 See now s 180(1) of the Corporations Act. 221 For the results of an empirical study of the group structures in Australia's top 500 listed companies in 1997, see I Ramsay and G Stapledon, Corporate Groups in Australia (1998). This
study revealed that 89 percent of the sample companies had at least one controlled entity. It
135
The English decision of Charterbridge2 laid down an objective formulation of
directors' duty to act in the interests of their company. Also referred to as the
'enterprise' approach, it entails that directors do not need to consider the
interests of their particular company directly, as long as they act in the interests
of the group and as long as reasonable directors would have concluded that
such action would be in the interests of their particular company if it had been
considered. The High Court in Walker v Wimborne229 took a different view to
that in Charterbridge?30 Walker v Wimborne231 adhered to a subjective
formulation of directors' duty to act in the interests of their company by
affirming that, as each company forming part of a corporate group was a
separate legal entity, directors were required to consider specifically the interest
of their particular company. This formulation is also known as the 'entity'
approach.
An analysis of more recent case law reveals that the objective approach
followed in Charterbridge232 has become increasingly popular in practice in
Australia. This general relaxation in the context of groups of companies
indicates that the objective test is favoured over and above the traditional
subjective test in ascertaining whether directors have complied with their
fiduciary duties in terms of the general law. If an objective test is accepted, a
director of a group company would not be in breach of his general law fiduciary
duty by failing to take into consideration the interests of his company, instead
taking into account the interests of the group of companies as a whole. The
particular director would not be in breach of this duty, provided that an
intelligent and honest director could reasonably have believed that his actions
defined control as 'the capacity of an entity to dominate decision-making, directly or indirectly, in relation to the financial and operating policies of another entity so as to enable that other entity to operate with it in pursuing the objectives of the controlled entity'. Cf Ch 2 para 2.2. 228 [1970] 1 Ch 62. 229 (1976) 137 CLR 1. 230 [1970] lCh62. 231 (1976) 137 CLR 1. 232 [1970] lCh62.
136
would benefit his particular company. This can be seen as a move in the
direction of enterprise liability.
Farrow?32 decided by the Supreme Court of Victoria, was the first decision
definitely attempting to relieve directors from their strict duty to consider the
interests of 'their company alone' and the first Australian decision after Walker
v Wimborne to adopt expressly an objective approach in a group context. The
N e w South Wales Court of Appeal also followed this objective formulation of
directors' duties in Linton?35 None of the subsequent decisions can, however,
override the decision by Mason J in the High Court in Walker v Wimborne?26
As will be seen in Chapter 5, however, the legislature has endorsed enterprise
liability, at least in respect of wholly-owned subsidiaries.237
4.5.2 Nominee directors
The case law in Australia remains unresolved on the formulation of nominee
directors' duties. What is clear, however, is that the approach in Walker v
Wimborne has not been strictly adhered to. The notion of a so-called 'dual
loyalty' seems to have become more popular in this regard, at least where the
constitution or a shareholders' agreement provides for this. Nominee directors
may therefore take into account the interests of their appointer, the holding
company, as long as their act is also bona fide in the interests of their own
company, the subsidiary. Japan Abrasive Materials, in which the
Charterbridge test has expressly been applied, serves as corroboration that the
courts have already started moving in an enterprise direction and away from an
233 (1997) 26 ACSR 544. 234 (1976) 137 CLR 1. 235 (1999) 30 ACSR 465. 236 (1976) 137 CLR 1. The decision in Pascoe v Lucas (1998) 27 ACSR 737, discussed in Ch 5 para 5.5.3, was distinguished from Walker v Wimborne on the basis that the shareholders unanimously required the company to act in a particular way. 237 See para 5.4.2. 238 (1976) 137 CLR 1. 239 (1998) 16 ACLC 1172.
137
entity approach in order to make more business sense in the context of nominee
directors.
4.5.3 Duty of care, skill and diligence
In the context of groups the courts have been willing to move in the direction of
accepting the objective Charterbridge test in so far as breaches of fiduciary
duties are concerned. Although the fiduciary duty to act in the interests of the
company has an objective limitation to it, the formulation of this duty is
predominantly subjective.240 A fortiori the courts should be willing to accept the
Charterbridge test in cases of breaches of duty of care where an objective
standard has traditionally been required, n o w strengthened by the recognition of
a higher standard placed on directors than before.
Where a group company faces insolvency an objective test to establish a breach
of the duty of care implies taking into account the fact that the company forms
part of a group. It also implies taking into account the company's dire financial
position and the financial position of the group as a whole. The court will focus
not simply on the director's position in the company but also the predicament of
the company itself. In this regard s 180(l)(a) of the Corporations Act refers to
the degree of care and diligence that a reasonable person would exercise if he or
she were a director or officer of the corporation in the corporation's
circumstances. 41 The 'corporation's circumstances' that need to be considered
when determining whether a director acted with the degree of care and
diligence of 'a reasonable person' in these circumstances would include the fact
that the company in question formed part of a group.
It is therefore submitted that, should a true case of breach of duty of care in a
corporate group situation come before the Australian courts, the same route that
has been followed in respect of directors' breach of fiduciary duties will in all
See the discussion in para 4.2 above. 241 See also Friedrich (1991) 9 A C L C 946.
138
likelihood be followed. Thus, the courts will most probably move away from
the strict test in Walker v Wimborne242 in determining whether directors have
complied with their duty of care in a group context and instead apply an
objective test, similar to the one laid down in Charterbridge?42 The overlap and
confusion that exist between directors' breach of fiduciary duties and breach of
their duty of care in corporate group situations when they fail to consider the
interests of a particular company in the group provide even more support for
this view.
(1976) 137 CLR 1. [1970] lCh62.
5
5.1
5.2
5.2.1
5.2.2
5.2.3
5.3
5.3.1
5.3.2
5.3.3
5.3.4
5.3.5
5.4
5.4.1
5.4.2
5.5
DIRECTORS' DUTIES: CAPITA SELECTA
Background
Particular difficulties in intra-group transactions
Downstream, lateral and upstream transactions
Restructuring a group
Uncommercial transactions
Duty to take into account interests of creditors
Extension of duty
Insolvency as condition established
Concept of 'insolvency' delineated
Duty to future creditors
N o direct duty to creditors
Statutory duty to act in interests of company
Interests of the company and proper purpose
Specific provision for corporate groups
Evaluation of position of group creditors
139
139
139
142
146
153
153
155
157
159
162
164
164
167
173
5 DIRECTORS' DUTIES: CAPITA SELECTA
5.1 Background
Despite its strict application of the rule that each company is a separate legal
entity, the High Court in Walker v Wimborne1 recognised the manner of
operation of corporate groups, even though to a limited extent.2 The High Court
held that the directors of the lending company had breached their fiduciary
duties because the company advancing the funds did not receive any so-called
'commercial benefit' from the transaction.3 It was not sufficient that the loans
could have been for the overall benefit of the group - it also had to be for the
commercial benefit of their particular company. In this chapter particular
difficulties encountered in the context of intra-group transactions, closely
associated with the notion of 'commercial benefit', are discussed. Thereafter the
fact that directors' duties to their company entail taking into account creditors'
interests, pivotal to this thesis, is considered.4 Finally, the statutory duty of
directors to act in the interests of their company, that complements the similar
general law duty dealt with in Chapter 4, is discussed. In this regard particular
emphasis is placed on the provision specifically regulating the position in
wholly-owned corporate groups as a form of protection for creditors.
5.2 Particular difficulties in intra-group transactions
5.2.1 Downstream, lateral and upstream transactions
On the strength of what was said regarding 'commercial benefit' in Walker v
Wimborne,5 one m a y argue that the granting of a loan or guarantee by a holding
company in respect of a subsidiary (downstream transaction) would generally
'(1976) 137 CLR 1. 2 Ibid 6. 3 On corporate benefit generally, see J O'Sullivan, 'Group corporate benefit revisited' (1993) 4 JBFLP 290; G D Cooper and D B Robertson, 'Subsidiary company guarantees - their continued existence' (1990) 1 JBFLP 284. 4 The general principles relating to directors' duties in corporate groups are discussed in Ch 4. 5 (1976) 137 C L R 1.
140
be permitted.6 It can be justified by saying that such a downstream transaction
is in the interests of the holding company and not in breach of directors' duties.
This is the case because the better the financial position of the subsidiary, the
greater the chances of the holding company sharing in bigger dividends
declared by the subsidiary. In the same way, other intra-group financial
transactions are allowed if the holding company obtains a direct or derivative
commercial benefit from the transaction.
The situation is more contentious where the subsidiary provides a loan or
guarantee for the benefit of a sibling company (lateral transaction) or the
holding company (upstream transaction).8 Provided they are for the commercial
benefit of the company giving the loan or guarantee,9 there is no reason in
principle w h y lateral and upstream transactions in corporate groups should not
be allowed.10 It will, however, generally be difficult to show that there has been
commercial benefit for the particular subsidiary in the case of a lateral or
upstream intra-group transaction, even though the group m a y be better off as a
whole. As soon as there is no real commercial benefit, the directors are in
breach of their fiduciary duty.1'
A 'downstream' transaction is a transaction 'involving a parent company passing of a financial benefit to a company that it controls' (see C A S A C Corporate Groups Final Report, M a y 2000 (Final Report)) at 44.
It is interesting to note that the potential for future financial benefit is not taken into account in the similar context of wife guarantors: Garcia v National Australia Bank Ltd (1998) 72 ALIR 1243.
While an 'upstream' transaction is a transaction 'involving a controlled company passing a financial benefit to its parent company' (see C A S A C , Final Report, above n 6, 44), a 'lateral' transaction 'involves benefits passing between controlled companies within the same corporate group' (see C A S A C , Final Report, above n 6,45). 9 See the discussion of Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] 1 C h 62 in Ch 4 para 4.2.1. See further Nicholas v Soundcraft Electronics [1993] B C L C 360, where it was held to be legitimate for the directors of the partly-owned subsidiary to take into account the interests of the group and not just its own. However, it would be necessary to prove that sacrificing the interests of the subsidiary in the short term was for its benefit in the longer term.
Internally generated funds transferred by way of inter-corporate loans, to name an example, may provide a more secure and less costly means of financing for group subsidiaries than could be obtained from external sources. The use of inter-corporate financing techniques is not in any way improper or illegal. It may, however, pose additional risks for unsecured creditors to the extent that it reduces the assets available to meet claims by allowing related companies to claim alongside unsecured creditors on the winding up of a subsidiary. 11 It should be pointed out that s 187 of the Corporations Act 2001 (Cth) (Corporations Act)
overrides directors' fiduciary duty to act bona fide in the best interests of their company - this duty will apply only where the provisions of s 187 are not satisfied. See para 5.4.2 below for a discussion of s 187 of the Corporations Act.
141
The difficulties generally encountered in proving commercial benefit in a lateral
transaction m a y be illustrated by the decision in Rolled Steel Products
(Holdings) Ltd v British Steel Corporation}2 In return for money advanced,
Rolled Steel Products (Holdings) Ltd (Rolled Steel) had to provide a guarantee
for the existing liability of an associated company to the same lender. Although
Rolled Steel received a benefit in the sense that the advance enabled it to
discharge an existing liability to the associated company, the court held that the
directors providing the intra-group security breached their fiduciary duty to act
in good faith for the benefit of their company.13 The Court of Appeal found that
the company received no real commercial benefit from the transaction, since its
directors knew at the time of providing the security that the guarantee would be
called up. Although the decision was based mainly on the fact that the
execution of the guarantee and charge by the company was not referable to its
objects, it is clear that the fact that the transactions would only benefit the
associated company weighed heavily in the mind of the court.15
An excellent illustration of the difficulties faced in an upstream transaction,
where a subsidiary provided security for the indebtedness of its holding
company, is ANZ Executors and Trustee Co Ltd v Qintex Australia Ltd. A
holding company covenanted with a financier to procure guarantees from its
wholly-owned subsidiaries for its indebtedness under three trust deeds. O n
default by the holding company of its obligations the financier applied for
specific performance of the covenant. The evidence showed that all the relevant
12 [1986] 1 Ch 246 (Rolled Steel). Xi Ibid 29%. 14 The transactions were held to be beyond the authority of the directors and in breach of their fiduciary d uty, s ince t hey were ' not e ffected for t he p urposes o f t he c ompany': Rolled Steel
[1986] 1 Ch 246 at 292 (Slade LJ). 15 J Lambrick, 'Corporate benefit in financial transactions: a policy perspective' (1997) 8 JBFLP 212 at 218-225. 16 (1990) 2 A C S R 307 (Byrne J); appeal case reported at [1991] 2 Qd R 360 (McPherson J). (Lee and MacKenzie JJ agreed with the reasons and the order made). The appeal case is referred to as 'ANZ v Qintex'. See also Sydlow Pty Ltd (in liq) v Melwren Pty Ltd (in liq) (1994)
13 ACSR 144. 17 ANZ v Qintex [1991] 2 Qd R 360 at 362.
142
subsidiaries were insolvent.18 The directors of the subsidiaries argued that the
giving of a guarantee in circumstances of insolvency would be a breach of their
fiduciary duty to consider the interests of the subsidiaries' creditors.19 The
financier, however, maintained that the holding company could cause a
guarantee to be given by resolution of the general meeting of each subsidiary.
The question that arose was whether an insolvent company could validly make
a voluntary disposition of assets that served no corporate purpose whatsoever,
prejudicing the interests of creditors. The Queensland Full Court refused to
order specific performance, holding that it is an essential principle of company
law that the powers and the funds of the company m a y be used only for
corporate purposes.20 The court cannot infringe this principle by ordering a
shareholder (the holding company) to require a company (the subsidiary) to
execute a guarantee.21 For a trading company on the brink of insolvency to
place its assets at risk by granting a guarantee without any consideration in
derogation of its creditors' interests, is not for its benefit but for a non-corporate 99
purpose. In other words, the giving of a guarantee by a subsidiary in casu • 9T
would involve a misuse of corporate power.
5.2.2 Restructuring a group
Commercial benefit was also in issue in the waterfront dispute between Patrick
Stevedores and the Maritime Union of Australia ( M U A ) during the first half of
1998, culminating in the High Court decision in Patrick Stevedores Operations
See para 5.3 below for a discussion of the duty to take into account creditors' interests. 20 ANZ v Qintex [1991] 2 Q d R 360 at 371. A n old illustration of this principle is Hutton v West Cork Railway Co (1883) 23 Ch D 654.
In casu the subsidiary's power to guarantee a corporate loan was to be exercised for the benefit of the holding company and not the subsidiary. 22 ANZ v Qintex [1991] 2 Q d R 360 at 371.
Ibid. The character of such a use of power is not altered because the guarantee is given or promised on behalf of the company by its sole or controlling shareholder. Shareholders possess
no general authority to bind the company to a result that is not for its benefit. The guarantee would b e u nenforceable whether t he b oard o f d hectors o r t he s hareholders o f t he s ubsidiary
resolved that the guarantee should be given. See further F Dawson, 'Commercial benefit' (1991) 10710? 202 at 203.
143
No 2 Pty Ltd v Maritime Union of Australia. The companies within the
Patrick Stevedoring Group (Patricks) which owned the stevedoring businesses
and assets also employed the unionised labour force. A restructuring of the
group took place. This involved dividing the functions of employing the
workforce and owning the stevedoring business into separate companies, which
was effected by selling the business and assets of the employer companies to
Patrick Stevedores Operations N o 2 Pty Ltd, one of the group companies.25 The
interest of Patrick Stevedore Operations N o 2 in the assets and business supply
agreements was subsequently transferred to another company in the group,
namely, Patrick Stevedoring Operations Ltd.
The employer companies used part of the proceeds of the sale to buy back their
own shares and to repay their debts. They furthermore entered into labour
supply agreements with the stevedoring company, which provided their only
source of income. The effect of the restructuring was that the bulk of the capital
of the employer companies was returned to the shareholders, which were
wholly-owned companies in the Patrick Group. W h e n the employees
subsequently engaged in industrial action, the stevedoring company terminated 9ft
the labour supply agreements, as it was entitled to do under those agreements.
Since the only significant assets of the employer companies after the restructure
- the labour supply agreements - were then lost, they were placed into
administration on grounds of insolvency.
Counsel for the ultimate holding company in the Patricks group suggested that
the restructuring had been undertaken for the commercial benefit of the group.
It was argued that the commercial benefit lay in the fact that the business could
24 (1998) 27 A C S R 521; affirmed by (1998) 27 A C S R 535 (Patrick's case). The decision of North J i n the Federal Court, at first instance, is reported as Maritime Union of Australia v Patrick Stevedores No 1 Pty Ltd (1998) 27 A C S R 497. Although it was predominantly an industrial law matter, the issue of directors' fiduciary duty to act in the interests of the company arose. 25 The new structure, dividing the functions of employing workers and owning the business between two companies, made it easier to dismiss the whole workforce. 26 The employees submitted that the decision toe ommence with the restructuring was taken
because they were members of the Maritime Union of Australia and that these steps altered their position to their detriment.
144
be streamlined and placed on a more m o d e m footing. Selling the business of
each of the employer companies and returning the capital to the shareholders
while leaving the employer companies with only liabilities could indeed be in
the interests of some group companies. Such restructuring would, however,
clearly be detrimental to other companies in the group. One should bear in mind
that the current law in Australia is that directors have to take into account the
interests of their company separately and that it is not sufficient if they consider
9R
the interests of the group as a whole.
Clearly the directors in question had not considered the interests of the creditors
or the employees. While the employer companies in the Patricks Group showed
substantial profits before the restructuring, there were less than sufficient funds
on which the creditors or the employees could lay their hands afterwards.
Neither the creditors nor the employees could hold the shareholders of the
employer companies liable, due to the rule that each company was a separate
legal entity. If the M U A had opted for a corporate law remedy by attempting to
hold other Patrick group companies liable, they would have had to prove that
the circumstances warranted a lifting of the corporate veil, something which
Australian courts are reluctant to do.29
The decision by the employer companies to dismiss their entire workforce was
based on insolvency considerations. Under s 170CG of the Workplace Relations
Act 1996 (Cth), the insolvency of the employer would be a 'valid reason' for
termination of employment. A finding that the terminations of employment as
a result of the reorganisation contravened sections 298K and 298L of the
Workplace Relations Act 1966 (Cth) would involve lifting the corporate veil
Although each group company was being managed as if it were part of a single enterprise and the employer companies all had the same director, the decision of each of the employer companies to participate in the restructuring was, presumably, autonomous. 28 See Walker v Wimborne (1976) 137 C L R 1. See also R Baxt and T Lane, 'Developments in
relation to corporate groups and the responsibilities of directors - some insights and new directions' (1998) 16 C&SLJ 628 at 652-3; T Taylor, 'Wharf Warfare: Voluntary
Administration under spotlight', paper presented to the Western Australia Division of the Insolvency Practitioners Association of Australia, Perth, 16 July 1998, at 16. 29 See the discussion of the lifting of the corporate veil in Ch 3.
145
and looking at the motives of directors of other companies in the group.30 The
M U A chose to avoid this issue and instead claimed a conspiracy between the
employer companies and other Patrick Group companies and directors.31
Since the issue of the loss of employee entitlements upon the insolvency of the
employer first became prominent in Australia during the waterfront dispute in "̂9
Patrick's case, Australia has witnessed a series of high-profile corporate
insolvencies. Employees have been unable to recover significant amounts in
unpaid wages and other entitlements owed to them following their employer's
insolvency. Corporate groups have been a particular feature of these cases,
since the fact that each group company enjoys limited liability makes it possible
to manipulate the group structure in an attempt to transfer assets among several
companies, ensuring that they fall outside the reach of employees. In response
to this the Commonwealth Parliament enacted changes to the Corporations
Act, contained in the Corporations Law Amendment (Employee Entitlements)
Act 2000 (Cth).35 In a nutshell, these changes were designed to address the issue
of t he 1 oss o f employee e ntitlements o n t he i nsolvency o f e mployers, a nd t o
extend directors' liability for insolvent trading.
In particular, a new offence was introduced that targets agreements and
transactions entered into for the purpose of avoiding the payment of employee
entitlements upon an employer's insolvency.36 Part 5.8A of the Corporations
D Kingsford Smith, L Riley and L Aitken, 'Unveiling the waterfront corporate veil, directors' duties and voluntary administration' (1998) 10 Butt Corp LB 7 at 8-9. 31 For a detailed analysis of the waterfront particulars, see M Lee, 'On the waterfront' (1998) 23 The Alternative Law Journal 107-111. See further D Noakes, 'Dogs on the wharves: corporate groups and the waterfront dispute' (1999) 11 AustJnl of Corp Law 27. 32 (1998) 27 A C S R 521; affirmed by (1998) 27 A C S R 535. 33 These include Cobar Mines Pty Ltd, Oakdale Collieries Pty Ltd and National Textiles
Limited. 34 For a discussion of the amendments and their likely impact, see D Noakes 'The recovery of employee entitlements in insolvency' in I Ramsay (ed), Company Directors' Liability for Insolvent Trading (2000) 129. See fiirther M Broderick, 'Extending the liability for insolvent trading' (2001) 19 C&SLJ 58 at 61; HAJ Ford, RP Austin and IM Ramsay, Ford's Principles of
Corporations Law (2001) at 897. 35 This Act commenced on 30 June 2000. For criticism of the amendments, see D Noakes, 'Corporate groups and the duties of directors: protecting the employee or the insolvent
employer?' (2001) 29 A Bus L Rev 124 at 124-125.
146
Act now prohibits persons from deliberately entering into an agreement or a
transaction with the intention or part intention of preventing the recovery of
entitlements of employees of a company or significantly reducing the amount of
entitlements that can be recovered.37 A person is liable to pay compensation if
such person contravenes the prohibition on agreements or transactions to avoid
employee entitlements, the company is being wound up, and the employees
suffer loss or damage because of the contravention.38 It is arguable that this
offence would be more effective if effect, and not intention, were the test to be
applied.39
5.2.3 Uncommercial transactions
The effect of the developments discussed in paragraph 5.2.2 above was a
widening of the scope for the prosecution of directors w h o breach the
prohibition on insolvent trading. In keeping with this, s 588G of the
Corporations Act has been amended recently to extend the existing duty on
directors not to engage in insolvent trading to include an 'uncommercial
transaction'40 entered into by the company.41 Thus, the engagement of a
director in an 'uncommercial transaction' is deemed to be an incurring of debt.
The amendment was designed to address the fact that there was no duty on
directors to refrain from engaging in a non-debt uncommercial transaction
where the company was or became insolvent.42
See s 596AB(1) of the Corporations Act. 38 See s 596AC(1) of the Corporations Act.
See further D Noakes, 'Corporate groups and the duties of directors: protecting the employee or the insolvent employer?', above n 35; C Hammond, 'Voluntary administrators: their role, powers and liability with respect to employee wages' (1999) 7 Insol Law Jnl 40. 40 Many of the transfer of debt arrangements in the case law, eg, in Walker v Wimborne (1976)
137 C L R 1 would probably meet the statutory definition of 'uncommercial transaction', thereby triggering the operation of the insolvent trading provisions. O n uncommercial transactions generally, see A Keay, 'Liquidators' avoidance of uncommercial transactions' (1996) 70 ALI 390. For the history of s 588B of the Corporations Act, see A Keay, Avoidance Provisions in Insolvency Law (1997) 208.
Section 588G(1A), Item 7 of the Corporations Act. See further the discussion on insolvent trading under s 588G of the Corporations Act in Ch 6.
Directors in breach of this duty are liable to pay compensation under the civil penalty provisions of the Corporations Act. Directors may also be subject to criminal prosecution where the failure to prevent the company incurring the debt was dishonest.
147
Part 5.7B of the Corporations Act confers the power on liquidators to recover
property disposed by a company in an uncommercial transaction. An
uncommercial transaction is not necessarily invalid. It is only voidable under s
588FF of the Corporations Act if it is also an 'insolvent transaction'.43 The
clearest case of an insolvent transaction as defined under s 588FC of the
Corporations Act is a transaction entered into when the company is insolvent. A
transaction may also be an insolvent transaction, however, when an act giving
effect to it is performed when the company is insolvent. The onus is on the
liquidator to prove that an uncommercial transaction is an insolvent
transaction. The test of solvency under s 95A of the Corporations Act is the
ability of the company to pay its debts as and when they become due and
payable. The liquidator is assisted by rebuttable presumptions authorised by s
588E of the Corporations Act to prove insolvency, which operate only for the
purposes of recovery proceedings.46
In the absence of proof to the contrary47 there are two presumptions of
insolvency48 that operate in a civil recovery proceeding.49 The first presumption
allows the court to assume, if the company is being wound up, and it is proved
to be insolvent, or it is presumed to be insolvent50 at a particular time during the
43 Section 9 of the Corporations Act states that 'insolvent transaction' has the meaning given by s 588FC, which reads as follows: 'A transaction of a company is an insolvent transaction of the company if, and only if, it is an unfair preference given by the company, or an uncommercial transaction of the company, and: (a) any of the following happens at a time when the company is insolvent: (i) the transaction is entered into; or (ii) an act is done, or an omission is made, for the purpose of giving effect to the transaction; or (b) the company becomes insolvent because of, or because of matters including: (i) entering into the transaction; or (ii) a person doing an act, or making an omission, for the purpose of giving effect to the transaction.' 44 It is curious that the legislature has imposed this additional burden of proving insolvency on the liquidator since s 588FB of the Corporations Act is intended to provide redress for the conduct of corporate debtors. 45 The meaning of'insolvent' is discussed further in C h 7 para 7.3.1.2. 46 The other presumptions of insolvency authorised by s 459C of the Corporations Act do not apply for the purposes of recovery proceedings. 4 Section 588E(9) of the Corporations Act. 48 Sections 588E(3) and 588E(4) of the Corporations Act. 49 These presumptions also operate in a civil proceeding for compensation for loss that result from t he i nsolvent t rading o f a s ubsidiary o r o ther c ompany i n t he c ontext ofs 5 8 8 V a n d s 588G of the Corporations Act respectively, namely ss 5 8 8 W and 588M of the Corporations
Act. See further C h 7 para 7.3.1.2 on the meaning of 'insolvent'. 50 It m a y be presumed to be insolvent because it failed to keep adequate accounting records
pursuant to s 588E(4) or it was proved to be insolvent pursuant to a 588E(8) of the
Corporations Act in other recovery proceedings.
148
twelve months ending on the 'relation-back day', that the insolvent company
was insolvent throughout that period beginning at that time and ending on that
day.52 In practical terms, the 'relation-back day' means the date on which the
successful winding-up application was filed. The second presumption allows
the court to assume, if the company has failed to keep or retain for seven years
accounting records that correctly record and explain its transactions and
financial position in accordance with the statutory standard,53 that the company
was insolvent for the period to which the inadequacy or absence of the records
relates.54 Accounting records in this context do not only mean financial
statements, but includes documents such as invoices, receipts, and vouchers.
Pursuant to s 588FB of the Corporations Act a transaction will be deemed
'uncommercial' if a reasonable person in the company's circumstances would
not have entered into the transaction having regard to:56
(i) the benefits (if any) to the company of entering into the transaction; and
(ii) the detriment to the company of entering into the transaction; and
51 Section 9 of the Corporations Act defines 'relation-back day' and, in relation to a winding-up of a company or Part 5.7 body, means: '(a) if, because of Division IA of Part 5.6, the winding-up is taken to have begun on the day when an order that the company or body be wound up was made - the day on which the application for the order was filed; or (b) otherwise - the day on which the winding-up is taken because of Division IA of Part 5.6 to have begun.' 52 Section 588E(3) of the Corporations Act. 53 Section 286(1) and (2) of the Corporations Act set out the obligation to keep financial records. 54 Section 588E(4) of the Corporations A ct. This second presumption does not apply where
there are minor or technical breaches. It also does not apply to the extent that it would prejudice a right or interest of a person where the accounting records were destroyed, concealed or
removed and the person was not knowingly or recklessly involved in such action: s 588E(5) and (6) of the Corporations Act.
Section 9 of the Corporations Act defines 'financial records' to include '(a) invoices, receipts, orders for the payment of money, bills of exchange, cheques, promissory notes and vouchers; (b) documents of prime entry; and (c) working papers and other documents needed to explain (i) the methods by which financial statements are made up; and (ii) adjustments to be made in preparing financial statements.' See in this regard Van Reesema v Flavel (1992) 7 A C S R 225, which was followed in Love v ASC (2000) 36 A C S R 363. See also ASIC v ABC Fund Managers Ltd (2001) 39 A C S R 443.
S ee J O 'Donovan,' Corporate b enefit i n r elation t o guarantees a nd t hird p arty mortgages' (1996) 24 A Bus L Rev 126 at 138-139 for a corporate benefit checklist to assist in ascertaining whether a transaction might be uncommercial. O n the uncertainties that may arise regarding the application of 'uncommercial transactions' in s 588FB of the Corporations Act to cross-guarantees, see J Hill, 'Corporate groups, creditor protection and cross guarantees: Australian perspectives' (1995) 24 Can Bus LJ321 at 351. Cross-guarantees are further discussed in Ch 8 para 8.2.
149
(iii) the respective benefits to other parties to the transaction as a result of
entering into it; and
(iv) any other relevant matter.57
The meaning of 'uncommercial transaction' in s 588FB of the Corporations Act
was considered in a number of recent decisions in the context of corporate
groups. In R ivarolo Holdings Pty Ltd v Casa Tua (Sales) PtyL td5* Rivarolo
Holdings Pty Ltd (Rivarolo) sold and transferred its assets as w ell as certain
liabilities to Casa Tua (Sales) Pty Ltd (Casa Tua), a related company. The
companies shared two c o m m o n directors and c o m m o n shareholders. The
liquidator of Rivarolo alleged that there was no evidence that the transferred
liabilities were legitimate debts of the company. H e brought action to set aside
this transaction on the basis that:59
• it was entered into when Rivarolo was insolvent or it became insolvent as a
result of it;
• it was entered into within a period of six months prior to the relation back
day (the date that the winding up of the company commenced); and
• it was an uncommercial transaction.
The court found that there was no sensible explanation for the transaction in
question.60 It found that what really happened was that the assets of Rivarolo
were taken over by Casa Tua and it was not proved that Rivarolo gained any
Although an uncommercial transaction is usually a transaction where the other party has not provided full value for a contribution by the company, the fact that a transaction is for value does not preclude it from being an uncommercial transaction: Tosich Constructions Pty Ltd v Tosich (1997) 23 A C S R 466 (Tosich) at 474. See further the Australian Law Reform Commission (ALRC), General Insolvency Inquiry Report No 45 (1988) (AGPS, Canberra),
(Harmer Report), vol 1 para 679. 58 (1997) 24 A C S R 105 (Rivarolo v Casa Tua). 59 Sub-s 588FE(3) of the Corporations Act provides that a transaction is voidable if it is both an
insolvent transaction and an uncommercial transaction of the company, and it was entered into, or an act was done for the purpose of giving effect to it, during the two years ending on the relation-back day. Sub-s 588FE(4) of the Corporations Act provides that a transaction is
voidable if it is an insolvent transaction and a related entity of the company is a party to it, and
it was entered into, or an act was done for the purpose of giving effect to it, during the four
years ending on the relation-back day. 60 Rivarolo v Casa Tua (1997) 24 A C S R 105 at 107.
150
benefit.61 The court held that the transaction was caught by s 588FB of the
Corporations Law as being uncommercial. It m a y be said, therefore, on the
strength of this decision, that the interests of the individual company rather than
the interests of the group enjoy preference in these circumstances. A (lateral)
transaction pursuant to which the individual company receives something at an
undervalue can thus not be protected on the basis that it creates benefits to other
companies in the group.62
The issue of whether the hypothetical reasonable person in the company's
circumstances s hould c onsider t he i nterests o f t he i ndividual c ompany o r t he
interests of the 'group' in this context also arose in Kitay v Strathfield Holdings
Pty Ltd.62 Allstate Machinery Hire and Sales Pty Ltd (in liq) (Allstate)
transferred certain property to Strathfield Holdings Pty Ltd (Strathfield).
Allstate and Scotsville Pty Ltd (Scotsville) had c o m m o n directors and
shareholders. Allstate became insolvent and the liquidator claimed that the
disposition to Strathfield was voidable and that a re-transfer should take place.
H e claimed that the property had been transferred at a considerable undervalue,
and relied on s 588FB of the Corporations Act to the effect that it was an
uncommercial transaction, since a reasonable person in Allstate's circumstances
would not have entered into the transaction. It was argued on behalf of
Strathfield that the disposition of the property by Allstate to Strathfield was
legitimate as it conferred a benefit on Scotsville, the alleged holding
company.64
In finding that there was prima facie an uncommercial transaction pursuant to s
588FB of the Corporations Act, Parker J emphasised the need to consider the
benefit to the particular insolvent company rather than the benefit to the group
61 Ibid.
This is in line with the legal position on 'lateral' transactions: see the discussion in para 5.2.1 above. 63 (1998) 27 A C S R 716 (Kitay).
Ibid 720. It was argued that a transaction by a subsidiary to confer a benefit upon a holding
company is legitimate on the basis that the subsidiary m a y obtain a derivative benefit. However,
in this case there was no evidence that the companies involved had a holding company/subsidiary relationship as defined in s 46 of the Corporations Law.
151
as a whole. His Honour rejected the argument on behalf of Strathfield that, by
benefiting Scotsville, the transaction also conferred a benefit on Allstate. Parker
J found that the argument failed to appreciate the independent legal character of
each company. There was a lack of evidence that Allstate and Scotsville had a
holding company/subsidiary relationship. But even where a true group exists,
the directors of each company, when deciding what transactions their company
should enter into, should consider the interests of their individual company
rather than the interests of the group as a whole.66 In this regard, his Honour
stated:67
[T]he 'group' argument provides no justification for the transfer of the property from Allstate at less than true value. Allstate does not hold shares in Scotsville and does not have any claim to benefit if Scotsville succeeds commercially. Furthermore, in deciding which transactions a company should enter into, the directors of the company must take into account the interests of the creditors of the c ompany. T he c reditor o f a c ompany, whether o r n ot it b e a member o f a 'group' of companies must look to that company for payment.
More recently the meaning of 'uncommercial transaction' was considered in
Lewis v Cook. The directors of a wholly-owned subsidiary resolved to forgive
the debt owed by its holding company.69 The subsidiary and holding company
had the same directors. Shortly after the directors' resolution both companies
proceeded with a voluntary winding up. Separate liquidators were appointed for
the two companies. The liquidator for the subsidiary challenged the forgiveness
of the debt by the directors of the subsidiary, arguing that, inter alia, the
transaction was voidable under s 588FE(3) of the Corporations Law. As stated
above, for an uncommercial transaction to be voidable it has to be an insolvent
transaction as w ell.70 T h e c ourt found that the subsidiary was insolvent. The
only remaining question for decision was whether the purported forgiveness fell
55 Kitay (1998) 27 A C S R 716 at 720. 66 Parker J in Kitay (1998) 27 A C S R 716 at 720 relied on Walker v Wimborne (1976) 137 C L R
1 at 6. 67 Kitay (1998) 27 A C S R 716 at 720. 68 (2000) 18 A C L C 490 (Lewis). See also Sparks v Berry (2001) 1 9 A C L C 1430 where the forgiving of a debt was likewise held to be an uncommercial transaction for purposes of s
588FB of the Corporations Law. 69 This may be described as an 'upstream' transaction: see the discussion in para 5.2.1 above. 70 See n 58 above, quoting the provisions of sub-s 588FE(3) of the Corporations Law.
152
within the definition of 'uncommercial transaction' in s 588FB(1) of the
Corporations Law.
The liquidator for the holding company argued that the transaction was not
uncommercial, on the basis that the holding company experienced such
financial difficulties that its shares had no value and there was little prospect of
direct recovery of the debt. H e argued that not only did the holding company
not obtain any benefit from the transaction, but the subsidiary company - to the
knowledge of the latter's directors - had not suffered any detriment by
forgiving the debt because the holding company was unable to repay the debt.
In dealing with this issue, Austin J referred to Demondrille Nominees Pty Ltd v
Shirlaw?2 In that case the Full Federal Court said that the object of the section
is to prevent a depletion of the assets of a company which is being wound up by
certain 'transactions at an undervalue' entered into within a specified time limit
before the winding up.73 Austin J also referred to the Full Federal Court
decision in Tosich?4 dealing with the meaning of 'uncommercial transaction',
though not in the context of a corporate group,75 and stated that:76
The section was intended to emphasise the objective nature of the inquiry - not an inquiry into what the particular company might have done, but rather into whether a reasonable person would not have entered into the transaction. However, although the inquiry is objective, the Court must have regard to the 'the company's circumstances' - which includes the state of knowledge of the company when it enters into the transaction.
71 Lewis (2000) 18 A C L C 490 at 496-497. 72 (1997) 15 A C L C 1,716. 73 Ibid 1,727. Young J in McDonald v Hanselmann (1998) 28 A C S R 49 at 53 also referred to Demondrille Nominees Pty Ltd v Shirlaw (1997) 15 A C L C 1,716 and para 1044 of the Explanatory Memorandum to the Corporate Law Reform Bill 1992 (which introduced Pt 5.7B of the Corporations Act) and found that, at least where there is a sale at an undervalue, the test
is whether there was 'a bargain of such magnitude that it could not be explained by normal commercial practice'. 74 (1997) 23 A C S R 466.
In Tosich (1997) 23 A C S R 466 a company's application of its funds in paying off a debt owed by the daughter of one of the directors of the company was held not to be an
uncommercial transaction. This was because the payment operated as a partial discharge of a larger debt that the company owed to the director, and the discharge of this debt conferred an
objective benefit on the company. See further KJ Bennetts, 'Reviewing the nexus between uncommercial and insolvent transactions' (1994) 6 AIB 36. 76 Lewis (2000) 18 A C L C 490 at 497.
153
The court considered that a reasonable person in the position of the subsidiary
would have been influenced by certain matters to decline to forgive the debt.
These matters included the possibility that the holding company m a y enjoy a
windfall gain or realise a contingent asset, allowing it to pay part of the debt. It
also included the possibility that, if the holding company were to be wound up
in insolvency, a liquidator would pursue rights under Part 5.7B of the
Corporations Act against directors or other parties to recover assets. The court
rejected the argument by the liquidator for the holding company and held that
the purported forgiveness by the subsidiary of a debt owed to it by the holding
company was in the circumstances an uncommercial transaction.77
5.3 Duty to take into account interests of creditors
5.3.1 Extension of duty
The uncommercial transaction regime has a general law counterpart in the duty
of directors to act bona fide in the interests of their company. Romer J in Re — 78
City Equitable Fire Insurance Company reiterated the principle that directors
owe fiduciary duties to their company as a whole and that these duties are owed 7Q
to the company alone and not to others. This principle can be seen as a
corollary to the separate entity doctrine set out in Salomon v Salomon & Co Qf\
Ltd. It was therefore assumed that directors owed no fiduciary duties to the o -I
company's creditors. Subsequently, however, certain common-law countries,
including Australia, N e w Zealand and the United Kingdom have been prepared
to find that, in particular circumstances, directors m a y be obliged to take into 89
account the interests of creditors to fulfill their fiduciary duties. The debate
" Ibid 499. 78 [1925] Ch 407. 79 Directors also do not owe their fiduciary duties to individual members: Percival v Wright
[1902] 2 Ch 421. 80 [1897] A C 22 (Salomon v Salomon). 81 Percival v Wright [1902] 2 Ch421, which wasreliedonby the Report in the U K of the
Jenkins Committee, Cmnd 1749 (1962), para 89 at 31. 82 In addition to their fiduciary duties, directors' duty of care has been extended to include the interests of creditors. See, eg, Hilton International Ltd v Hilton [1989] 1 N Z L R 442 at 475. See further JH Farrar, "The responsibility of directors and shareholders for a company's debts'
154
about whether a director owes fiduciary duties to creditors of the company was
sparked by the following comments of Mason J in Walker v Wimborne:*3
[T]he directors of a company in discharging their duty to the company must take account of the interest of its shareholders and its creditors. Any failure by the directors to take into account the interests of the creditors will have adverse
consequences for the company as well as for them.
This was the first real attempt to establish that directors, in discharging their
fiduciary duty towards their company, must take into consideration not only the
interests of the shareholders of the particular company, but also the interests of
its creditors.84 After the decision in Walker v Wimborne*5 had been handed
down, uncertainty existed as to whether creditors' interests should be taken into
account not only when the company was insolvent, but also when it was
solvent.86 The company in Walker v Wimborne*1 was insolvent when the
impugned transactions took place. Apart from this fact, there was nothing in the
judgment of Mason J to suggest that insolvency provided the trigger that gave
rise to the duty to take into account creditors' interests.
(1989) 4 Canterbury L Rev 12 at 13. See also Ch 4 para 4.4.3 for a discussion of the overlap between directors' fiduciary duties and their duty of care. 83 (1976) 1 3 7 C L R 1 at7.Before Walker v Wimborne the case law rejected the notion that
creditors' interests may be taken into account: Re Wincham Shipbuilding Boiler & Salt Co (1878) 9 Ch D 322; Re Dronfield Silkstone Coal Co (1881) 17 Ch D 76; Salomon v Salomon [1897] A C 22. Like Walker v Wimborne (1976) 137 C L R 1, the ruling by the English Court of Appeal in In Re Horsley & Weight Ltd [1982] 3 W L R 431 suggested that under certain circumstances the discharge of this duty to the corporation could be influenced by a consideration of creditor interests. Cf the statement of Templeman LJ (as he then was) suggesting that directors could owe a duty directly to creditors where a company is insolvent or close to insolvency (at 443).
For the distinction between a fiduciary duty owed to creditors, and a duty to consider the interests of creditors, see C Riley, 'Directors' duties and the interests of creditors' (1989) 10 Co Dir 87 at 91; R Sappideen, 'Fiduciary obligations to corporate creditors' [1991] JBL 365 at 391; R Baxt, 'Do directors owe duties to creditors - some doubts raised by the Victorian Court of Appeal' (1997) 15 C&SU 373 at 374. 85 (1976) 137 C L R 1.
See, in general, A Keay, 'The director's duty to take into account the interests of company creditors: when is it triggered?' (2001) 25 MULR 315. 87 (1976) 137 C L R 1.
The issue of the extent to which directors have a duty to consider the interests of creditors has been analysed by many commentators over the years. See, eg, D A Wishart, 'Models and theories of directors' duties to creditors' (1991) 14 NZULR 323; JS Ziegel, 'Creditors as corporate stakeholders: the quiet revolution - an Anglo-Canadian perspective' (1993) 43 Univ of Toronto LI 511; SL Schwarcz, 'Rethinking a corporation's obligations to creditors' (1996) 17 Cardozo L Rev 647. More recent discussions include M R Pasban, 'A review of directors' liabilities of an insolvent company in the U S and England' [2001] JBL 33 and Keay, 'The
directors' duty to take into account the interests of company creditors: when is it triggered?', above n 86.
155
5.3.2 Insolvency as condition established
In 1985 the New Zealand Court of Appeal in Nicholson v Permakraft (NZ) Ltd QQ
(in liq) delivered a landmark decision relating to the fiduciary duty of
directors to act in the interests of their company. This case went a long way
towards establishing insolvency as a necessary condition for directors to take
into account the interests of creditors. As part of a restructuring scheme a new
company was created with the same shareholders as the original company. The
new company purchased the principal asset of the original company, whereafter
the proceeds of the sale were distributed to the shareholders by way of a
substantial capital dividend. This reduced the fund ultimately available to
creditors. For a while the business was profitable, but later on insolvency
supervened.90 The liquidator was unsuccessful in bringing a misfeasance action
against the directors.
Cooke J stated that directors are required to consider the interests of creditors
where the company is 'insolvent or near insolvent, or of doubtful solvency, or if
a contemplated payment or other course of action would jeopardise its
solvency.'91 Therefore, even though strictly speaking directors owe their duties
to the company, they are required to consider the interests of its creditors where
the company is insolvent or on the brink of insolvency. Under these
circumstances it is the creditors and not the shareholders w h o have a substantial 09
interest in the assets of the company. Somers J agreed with Cooke J on this
aspect, stating that directors of a company that is only marginally solvent can
be seen to be acting to the detriment of creditors rather than shareholders when
93
entenng into certain transactions.
89 [1985] 1 N Z L R 242 (Nicholson). 90 LS Sealy, 'Directors' 'wider' responsibilities - problems conceptual, practical and procedural' (1987) 13 Mon ULR 164 at 171-2. 91 Nicholson [1985] 1 N Z L R 242 at 249. 92 Ibid. n Ibid 255.
156
Cooke J did not exclude the possibility of an action by a creditor against the
directors or the company for breach of duty of care based on ordinary principles
of negligence.94 B y making this obiter statement Cooke J seemed to have
contemplated a duty of care owed directly to creditors by directors. However,
most other judicial pronouncements in N e w Zealand, Australia and the United
Kingdom have stopped short of suggesting a duty owed by directors to creditors
directly.
The New South Wales Court of Appeal in Kinsela v Russell Kinsela Pty Ltd (in
liq)95 was the first to endorse the judgment of Cooke J in Nicholson96 regarding
the duty of directors to take into account creditors' interests in the shadow of
the company's insolvency. In this case the directors leased property from their
company at a rental substantially below the market rate when the company was
experiencing severe financial difficulties. All the shareholders in general
meeting agreed to this arrangement. O n the facts it was clear that the purpose of
the lease was to keep company assets out of reach of creditors.
The court unanimously held that the liquidator could set aside the lease because
it was clear that the company was insolvent and the prejudice to the creditors
was the direct and calculated result of the lease. Entering into the lease
agreement was a breach of duty towards the company because it indirectly
prejudiced the creditors. Therefore it was voidable. Since the company was
plainly insolvent at the time the lease transaction was effected, it was
unnecessary for the court to formulate a test determining the degree of financial
instability before directors were required to consider the interests of creditors.
Street CJ did not have to draw upon Nicholson91 as authority for any more than
the proposition that 'the duty arises when a company is insolvent in as much as
Ibid 250. (1986) 4 N S W L R 722 (Kinsela). [1985] 1 NZLR 242.
157
it is the creditors' money which is at risk in contrast to the shareholders' go
proprietary interests .
Significant i n t he j udgment d elivered i n K insela i s t he issue o f r atification.
The court relied on Nicholson100 for stating that directors' duty to a company as
a whole extends in an insolvency context to not prejudicing the interests of
creditors, and held that it followed that shareholders were unable to ratify such
a breach of duty by directors.101 Street CJ held that this breach of fiduciary duty
could not be validated even by the unanimous approval of the shareholders.102
Although it is acceptable to recognise that shareholders can generally authorise
or ratify a breach of duty by directors, they cannot do so any longer when
creditors' interests are at stake, as the case would be when insolvency
supervenes. Because the giving of the lease was in disregard of the interests of
creditors, it could not be said to be in the interests of the company.103
5.3.3 Concept of 'insolvency' delineated
After the judgments in Nicholson104 and Kinsela105 it was clear that, at least in
situations of insolvency or near insolvency, it was an integral part of directors'
duties towards their company to take into account creditors' interests.10 It was,
98 (1986) 4 NSWLR 722 at 733. See also West Mercia Safetywear Ltd (in liq) v Dodd [1988] BCLC 250 at 252-253; Lyford v Commonwealth Bank of Australia (1995) 130 ALR 267 at 283-
284. 99 (1986) 4 NSWLR 722. 100 (1985) 3 ACLC 453. 101 Kinsela (1986) 4 N S W L R 722 at 732. 102 CfID Heydon, 'Directors' duties and the company's interests' in PD Finn (ed), Equity and
Commercial Relationships, (1987) 120. 103 Similarly, the court ANZ v Qintex [1991] 2 Qd R 360 held that there could be no benefit to a subsidiary in providing a guarantee for zero consideration while the subsidiary was insolvent. In deciding what was for the company's benefit, the creditors' interests had to be taken into account. It was not possible for either the board of the subsidiary or the shareholders to give the guarantee. See further R Grantham, 'Ultra vires: Gone but not forgotten' (1993) 10 Aust B Rev 233. Since the judgment in Kinsela (1986) 4 NSWLR 722, liquidators have been given power under Pt 5.7B of the Corporations Act to recover property that a company disposed of in an uncommercial transaction: s 588FB of the Corporations Act, discussed in para 5.2.3 above. 104 [1985] 1 NZLR 242. 105 (1986) 4 N S W L R 722. 106 Cf the position in Delaware, where the Delaware Court of Chancery held in Geyer v Ingersoll Publications Co 621 A.2d 784 (1992) that a director of a Delaware corporation owed
a fiduciary duty to the corporation's creditors as soon as its liabilities exceeded the fair market
158
however, still uncertain exactly when a company would be regarded as
insolvent or sufficiently close to insolvency for this duty to arise. The
respective justices in Nicholson101 differed on this point. Richardson and
Somers JJ were of the view that 'insolvency' meant an excess of liabilities over
assets.108 Cooke J, however, favoured a wider view that insolvency meant a
lack of liquidity and stated that directors should also take into account 'their
company's practical ability to discharge promptly debts owed to current and
likely continuing trade creditors'.109 In Kinsela110 it was not necessary to decide
this issue. The court hesitated to lay down a general test of the degree of
financial instability that would impose on directors an obligation to take into
account the interests of creditors, as this might be different, depending on the
particular company involved. '
In Grove v Flavel}12 however, the facts were such that the court had to
delineate the degree of insolvency required before the duty to take into account
creditors' interests would arise. The question that had to be decided was
whether a director had breached his duty not to make improper use of certain
information, namely, that a particular company was experiencing liquidity
problems. Acting on this information, the director granted a preference in
favour of himself and other companies of which he was a director. In doing so
they were safe from the consequences of liquidation of the financially troubled
company.113 The court held that the director had acted improperly. The duty to
creditors did not arise only when it was known that the company was insolvent,
but also where the director had 'knowledge of a real risk of insolvency'.114
value of its assets. See further SR McDonnell, 'Geyer v Ingersoll Publications Co: Insolvency shifts directors' burden from shareholders to creditors' (1994) 19 Delaware J Corp L 177. 107 [1985] 1 NZLR 242. 108 Ibid 254 (Richardson J) and 255 (Somers J). }9 Ibid 249. This was also the definition adhered to in Grove v Flavel (1986) 43 SASR 410 at 421 and Jeffree v NCSC [ 1990] W A R 183 (Jeffree) at 194. 110 (1986) 4 NSWLR 722. 111 See further Sealy, above n 90, 179. 1,2 (1986) 43 SASR 410 (Grove). 1 11
The director effected a so-called 'round robin' of cheques among the parties concerned. 114 Grove (1986) 43 SASR 410 at 421.
159
The decision in Grove115 caused an extension of the duty of directors to take
into account creditors' interests. Arguably, on the strength of this decision, a
liquidator would be able to institute an action against a director w h o entered
into a transaction on behalf of his company when he realised that the company
was experiencing financial problems and the transaction caused detriment to a
creditor.116 What was not clear, however, was whether this duty also entailed
taking into account the interests of future creditors.
5.3.4 Duty to future creditors
The question whether directors' duties should be extended to include taking
into account the interests of future creditors came before the House of Lords in
Winkworth v Edward Baron Development Co Ltd}11 Lord Templeman118
included prospective creditors in the class of persons to be protected. He
stated:119
[A] company owes a duty to its creditors, present and future .. .the company owes a duty to its creditors to keep its property inviolate and available for the repayment of its debts. The conscience of the company, as well as its management, is confided to its directors. A duty is owed by the directors to the company and to the creditors of the company to ensure that the affairs of the company are properly administered and that its property is not dissipated or exploited for the benefit of the directors themselves to the prejudice of the
creditors.
115 (1986) 43 S A S R 410. 116 See J Dabner, 'Directors' duties - the schizoid company' (1988) C&SLJ 105 at 107. See also Re Welfab Engineers Ltd [1990] B C C 600, where it was held that, while creditors should not be exploited, directors are not under an obligation to manage the company primarily for their benefit. In contrast to the duties of a liquidator, directors only need to avoid action that would cause a loss to creditors. See further R Grantham, 'Directors' duties and insolvent companies'
(1991) 54 MLR 576. 117 [1987] 1 All E R 114 (Winkworth). 118 Lords Keith of Kinkel, Griffiths, Mackay of Clashfem and Ackner agreed with the judgment
delivered by Lord Templeman. 119 Winkworth [1987] 1 All E R 114 at 118. 120 The nature of this duty to creditors was clarified subsequently in the decision of the Privy Council, Lord Templeman concurring, in Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1990] 3 All E R 404. It was held that directors are not liable as such to creditors
of the company - a fiduciary relationship does not generally exist between directors and
creditors.
160
191
This dictum of Lord Templeman in Winkworth has, however, not been
followed by subsequent cases in England. The bulk of English case law, and 1 99
certainly the more recent English decisions, still favour the view that the duty
to take into account creditors' interests would only arise if the company were
insolvent or on the verge of insolvency. This view is similar to that of Cooke J
in Nicholson.123 O n this view it would be much harder to make out a duty to
future creditors as opposed to current and continuing trade creditors.124
19^ 19/̂
Although a number of Australian cases, for example, Kinsela and Grove,
require insolvency or financial instability before creditors' interests are required
to be taken into account, it seems as though the courts in Australia are prepared
to go further than their British counterparts in extending the duty to future 1 97
creditors. Mason J in Walker v Wimborne did not suggest that directors
should only take into account creditors' interests in case of insolvency of a
company.12 Rather, it is submitted that Mason J suggested that the interests of
creditors should always be taken into account because it is possible that a
company m a y in the future become insolvent as a result of a particular
transaction.
In Ring v Sutton, decided in the context of a claim against a director for
misfeasance under the then s 367B of the Companies Act 1961 ( N S W ) , this
sentiment was confirmed. In this case the N e w South Wales Court of Appeal
held that the interests of creditors should be taken into account where the
company was clearly solvent at the time when the parties entered into the
121 [1987] 1 AUER114. 122 With the exception of Winkworth [1987] 1 All ER 114, the English courts have been conservative on this aspect. Generally the requirement of insolvency or near insolvency is seen as essential before the interests of creditors would be taken into account: see West Mercia Safetywear Ltd v Dodd [1988] BCLC 250; Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd [1983] Ch 258; Brady v Brady [1988] BCLC 20 at 40. See further Re Joshua Shaw (1989) 5 BCC 188; Re Produce Marketing Consortium (in liq) (1989) 5 BCC 569. 123 (1985) 3 ACLC 453 at 459. 124 Ibid. 125 (1986) 4 NSWLR 722. 126 (1986) 43 SASR 410. 127 (1976) 137 CLR 1. 128 See also the view of Jacobs J in Grove (1986) 43 SASR 410 at 420.
161
transaction.130 The principal shareholder and director of the company borrowed
money from the company at less than market rate. Despite the fact that the
company was solvent when the loan was made, the court held that the directors
breached their fiduciary duty by disregarding the interests of the company's
creditors.
In the subsequent case of Jeffree131 Wallace J in the Supreme Court of Western
Australia approved of Lord Templeman's approach in Winkworth132 to hold that
directors' duties in this regard involve taking into account the interests of both
present and future creditors of the company.133 Brinsden and Pidgeon JJ agreed
with Wallace J that the duty of directors to take into account creditors' interests
also extends to prospective creditors.134 In other words, the duty to take into
account creditors' interests is present irrespective of the question of solvency.
This view should be contrasted with Nicholson}35 where Cooke J found that the
question of solvency was relevant to the existence of such a duty.
However, in New Zealand the courts have also started moving away from the
conservative approach adhered to in English case law generally on the topic of
directors' duties vis-a-vis creditors. W h e n the matter came before the court in
High Court of N e w Zealand in Hilton International Ltd v Hilton}36 Tipping J
held that, when directors declared a dividend, they owed a duty not only to the
company but also to its creditors, both present and future. In the course of his
judgment, Tipping J considered previous authorities, including Winkworth13*
and Nicholson}39 His Honour concluded with a list of propositions in respect of
,29(1980)5ACLR546. 130 Sealy, above n 90, 171-2 is of the view that the decision in Ring v Sutton (1980) 5 ACLR 546 is probably wrong on its reported facts. 131 [1990] W A R 183. 132 [1987] 1A11ER114. 133 [1990] W A R 183 at 187-188. 134 Ibid 194 (Brinsden J) and 196 (Pidgeon). 135 [1985] 1 NZLR 242. 136 [1989] 1 NZLR 442 (Hilton). 137 Ibid 415. 138 [1987] 1 All ER 114. 139 (1985) 3 ACLC 453.
162
the legal responsibilities regarding the declaration of dividends. The list
included the following propositions:l40
N o dividend may be paid, whether out of capital or income profits, if the company i s i n a st ate o f d oubtful t rading orb alance sheet s olvency u nless the
directors can demonstrate, if later challenged, that they believed in good faith and on reasonable grounds that the payment of the dividend would not jeopardise the company's ability promptly to satisfy its creditors present and future and whether secured or unsecured [and] [t]he directors of a company, when declaring a dividend, owe a duty not only to the company but also to its creditors, of all kinds
likely to be affected.
5.3.5 No direct duty to creditors
The High Court of Australia has recently confirmed in Spies v The Queen
that directors owe no duty directly to creditors. This issue arose in the context
of the High Court deliberating whether the Court of Criminal Appeal ( N S W )
erred in using its powers under the Criminal Appeal Act 1912 ( N S W ) to
convict the appellant of an offence against the former s 229(4) of the
Companies (New South Wales) Code}42 The High Court considered this issue
after deciding that a conviction for an offence under s 176A of the Crimes Act
1900 ( N S W ) should be quashed.
M r Spies (Spies) and M r McPherson (McPherson) were the directors of Sterling
Nicholas Duty Free Pty Ltd (Sterling Nicholas). Sterling Nicholas sold duty
free items from different outlets to overseas travellers. Spies, who held 33,750
of the 50,000 issued shares in Sterling Nicholas, owed substantial amounts of
money to the company. Spies and McPherson were also directors of Sterling
Nicholas Holdings Pty Ltd (Holdings), in which Spies held 9,999 out o f the
10,000 issued shares and McPherson held the remaining share. Holdings had
very little trading activities.
140 Hilton [1989] 1 N Z L R 442 at 475. 141 (2000) 18 A C L C 727 (Spies v The Queen). See further, eg, I Ramsay, 'High Court confirms
directors owe no duty to creditors', (2000) Keeping Good Companies 523; J Duns, 'The High
Court on duty to creditors' (2001) 9 Insol Law Jnl 40; M Berkahn, 'Directors' duties to 'the company' and to creditors' (2001) 6 Deakin LR 360 at 261-365. 142 Section 7(2) of the Criminal Appeal Act 1912 (NSW).
163
Sterling Nicholas experienced financial difficulties to such an extent that, at all
material times, it was operating at a loss. Spies and McPherson, as directors of
Sterling Nicholas, resolved that this company purchase all Spies' and
McPherson's shares in Holdings for $500,000. Since Sterling Nicholas did not
have the financial resources to pay for these shares, it was also resolved that an
equitable charge be granted over all the assets of Sterling Nicholas in favour of
Spies until the latter was repaid. Spies' loan account with Sterling Nicholas
was credited with $500,000, being the purchase price of all the shares in
Holdings. A s a result, Spies had sold shares in an apparently worthless
company for $500,000 and had gone from a substantial debtor of Sterling
Nicholas to a secured creditor.
The court stated obiter that there are statements in the authorities, which
would suggest that because of the insolvency of Sterling Nicholas, Spies, as a
director, owed it a duty to consider the interests of its creditors and potential
creditors in entering into transactions on behalf of the company.145 The court
referred to commentators w h o have stated that it is extremely doubtful whether
Mason Jin Walker v Wimborne146 intended to suggest that directors owe an
independent duty directly to creditors.147 To give some unsecured creditors
remedies in an insolvency that are denied to other creditors, would undermine
the basic principle of pari passu participation by creditors. In this regard the
N o w s 182 of the Corporations Act. 144 These statements commenced with that of Mason J in Walker v Wimborne (1976) 137 CLR
1 at 6-7. 145 Spies v The Queen (2000) 18 A C L C 727 at 730-1. 146 (1976) 137 C L R 1. 147 Spies v The Queen (2000) 18 A C L C 727 at 731. It is interesting to note that Hayne J in the
maj ority j udgment a ppeared t o a cknowledge t hat a d uty to t ake i nto a ccount t he i nterests o f creditors existed: at 731. Previously his Honour made certain ambiguous remarks concerning the existence of such a duty in Fitzroy Football Club Ltd v Bondborough Pty Ltd (1997) 15 A C L C 638 at 643, which were criticised by Baxt 'Do directors owe duties to creditors - some doubts raised by the Victorian Court of Appeal', above n 84, 374-5. Cf the Company Law Review Steering Group, U K Department of Trade and Industry, Modern Company Law for a Competitive Economy: Developing the Framework (2000) 43, which stated that it would not recommend that a director's duty to take into account the interests of creditors should be
included in the principles laid down by it to govern directors' functions. See further Keay 'The director's duty to take into account the interests of company creditors: when is it triggered?',
above n 86, 320. 148 Spies v The Queen (2000) 18 A C L C 727 at 731.
164
majority of the High Court quoted with approval from the judgment of 150 G u m m o w J in Re New World Alliance Pty Ltd; Sycotex Pty Ltd v Baseler as
follows:151
It is clear that the duty to take into account the interests of creditors is merely a restriction on the right of shareholders to ratify breaches of the duty owed to the company. The restriction is similar to that found in cases involving fraud on the minority. Where a company is insolvent or nearing insolvency, the creditors are to be seen as having a direct interest in the company and that interest cannot be overridden by the shareholders. This restriction does not, in the absence of any conferral of such a right by statute, confer upon creditors any general law right against former directors of the company to recover losses suffered by those creditors ... The result is that there is a duty of imperfect obligation owed to creditors, one which the creditors cannot enforce save to the extent that the company acts on its own motion or through a liquidator.
The majority of the High Court also stated obiter that, in so far as the remarks
in Grove152 and Nicholson152 suggest that directors owe an independent duty to,
and enforceable by, creditors of the company by reason of their position as
creditors, these cases are 'contrary to principle and later authority and do not
correctly state the law'.154
5.4 Statutory duty to act in interests of company
5.4.1 Interests of the company and proper purpose
The fiduciary duty of directors to act in the interests of their company and for a
proper purpose as expounded in the case law has been supplemented by a
similar duty incorporated into the legislation.155 This duty is currently contained
Gaudron, McHugh, G u m m o w and Hayne JJ. Callinan J delivered a separate judgment. 150 (1994) 122 A L R 531 (New World Alliance) at 550. 151 Spies v The Queen (2000) 18 A C L C 727 at 731. For a discussion of the term 'imperfect obligation' as it applies to company law to describe the nature of directors' duties to creditors, see Heydon, above n 102, 131. 152 (1986) 43 S A S R 410. 153 [1985] 1 N Z L R 242. 154 Spies v The Queen (2000) 18 A C L C 727 at 731. This is in line with the recent English case of Yukong Line Ltd v Rendsburg Investments [1998] 2 B C L C 485, which denied that directors owed any direct duty to an individual creditor. See further Pasban, above n 88, 40. Cf Winkworth [1987] 1 All E R 114. 1SS
Section 185 of the Corporations Act. For authorities on the different schools of thought that exist as to whether the duty to act bona fide and for a proper purpose is one or two duties, see
Ch4n4.
165
in s 181(1) of the Corporations Act, which was enacted on 13 March 2000.156
Section 181(1) of the Corporations Act provides as follows:
A director or other officer of a corporation must exercise their powers and discharge their duties: (a) in good faith in the best interests of the corporation; and (b) for a proper purpose.
The paucity of case law as a result of the fact that this section has only been in
operation for a relatively short time makes it useful to consider its predecessors
for purposes of interpretation. The immediate predecessor of s 181 was s 232(3)
of the Corporations Law, which imposed a duty on officers (including
directors) t o a ct h onestly at a 111 imes i n t he e xercise oft heir p owers a nd t he
discharge of the duties of their office. The predecessors of s 232(3) of the
Corporations Law also contained the concept of acting honestly. The Australian
courts had to pronounce on the meaning of the term 'act honestly' in the
predecessors of s 232(2) of the Corporations Law a number of times.
In Marchesi v Barnes151 the Supreme Court of Victoria held that 'honestly' in
this context meant bona fide in the best interests of the company. O n this view
it seems as though directors who honestly believe that they are acting in the
best interests of the company do not breach the section, even if they have acted
for an improper purpose.158 Cases such as Southern Resources v Residue
Treatments^59 and Fitzsimmons v R160 have followed this approach. However, in
Australian Growth Resources Corporation Pty Ltd v van Reesema161 the
Supreme Court of South Australia held that the statutory duty to act honestly
encompassed not only the duty to act in the interests of the company but also
the duty to act for a proper purpose.
156 See, generally, W Heath, 'The Corporations Law, section 181: A two-edged sword' (2000) 18 C&SLJ 311. 157 [1970] V R 434 at 438. 158 See also Ford, Austin and Ramsay, above n 34, para 8.065. 159 (1991) 3 A C S R 207 at 227. 160 (1997) 23 A C S R 355 at 365. 161 (1988) 6 A C L C 529 (Van Reesema) at 539.
166
1 A9
One should bear in mind that Marchesi v Barnes was decided before the
Corporate Law Reform Act 1993 decriminalised s 232 of the Corporations
Law. Previously courts were very reluctant to find that directors had breached
their duty of honesty because that meant that they would be liable to criminal
sanctions. Generally, there had to be evidence of so-called 'conscious
wrongdoing' b y t he d irectors b efore t he court w ould find t hat t hey breached
their statutory duty to act honestly. Such a restrictive interpretation of this
section as in Marchesi v Barnes163 was not necessary after legislative
amendments to the effect that contravention of s 232 of the Corporations Law
was no longer a criminal offence unless the prescribed intent was present.
The proposals by the Simplification Task Force in its report in October 1995
corroborated the view in Van Reesema.164 The Simplification Task Force
recommended that s 232(2) of the Corporations Law should be amended to
state expressly that the duty of good faith included the notion of exercising
powers and discharging duties for a 'proper purpose'. As part of the Corporate
Law Economic Reform Program (CLERP), the Department of Treasury
incorporated this recommendation in the Corporate Law Economic Reform Bill
1998. It has subsequently been enacted as s 181(1) of the Corporations Act.
Although there is no relevant case law on s 181 of the Corporations Act, the
fact that the requirement of 'proper purpose' has been added to this provision
may be said to be indicative of an objective approach. While the predecessors
of s 181 of the Corporations Act followed the more subjective wording, the
wording of s 181 of the Corporations Act - especially as seen against the
,w [1970] V R 434.
Incorporations Law Simplification Program (Task Force): Officers and Related Party
Transactions - Proposals for Simplification, October 1995 at 4. The Task Force has thus followed the approach in Van Reesema (1988) 6 A C L C 529 where the director was found to have breached the duty to act honestly because he had acted for an improper purpose, even if there was no evidence of conscious wrongdoing.
167
development of the proper purpose requirement in the case law - gravitates
more towards an objective approach.165
5.4.2 Specific provision for corporate groups
Subsequent amendments to the Corporations Act indicate that the legislature
has recognised the necessity to move away from the strict entity approach of
Walker v Wimborne}66 In particular, as far as wholly owned subsidiaries are
concerned, the legislature has endorsed an enterprise approach in the context of
directors' duties in corporate groups. In 1989 the Companies and Securities
Law Review Committee recommended that legislation should be adopted
expressly recognising that directors of a solvent company would not be in
breach of their fiduciary duty merely because they took into consideration
something other than the benefit of their company as a whole.167 It was
recommended that this should be the case in three instances, namely:
• where all the members have agreed beforehand to the particular exercise of
power;
• where a shareholders' agreement authorised the nominee directors to take
into account the interest of one or more of the m embers in the particular
exercise of power; or
• where the company was a wholly-owned subsidiary and the directors took
into consideration the interests of the holding company.
This recommendation has never been adopted in Australia. Subsequently,
however, the legislature passed legislation, this time as part of C L E R P ,
recognising that directors of a subsidiary may in certain circumstances take into
165 See further H A J Ford, R P Austin and IM Ramsay, An Introduction to the CLERP Act 1999 -Australia's New Company Law (2000) who point out (at 17) that the new s 184(1) of the Corporations Act imposes criminal sanctions for breach of the duty to act in good faith in the
best interests of the corporation and for a proper purpose only if the director or other officer was 'intentionally dishonest' or reckless. Because the requirements specified in Marchesi v Barnes
[1970] V R 434 can lead to the imposition of criminal sanctions, s 181(1) of the Corporations Act clearly applies where a director exercises powers for a purpose which in his or her opinion
is proper but which the court finds to be improper. 166 (1976) 137 CLR 1.
168
account the interests of the holding company. This culminated in the enactment
of s 187 of the Corporations Law (now: Corporations Act), that makes
provision for the position where wholly-owned subsidiaries are concerned.
Section 187 reads as follows:168
A director of a corporation that is a wholly owned subsidiary of a body corporate is to be taken to act in good faith in the best interests of the subsidiary if:
(a) the c onstitution o f t he su bsidiary e xpressly a uthorises t he d irector t o
act in the best interests of the holding company; and (b) the director acts in good faith in the best interests of the holding
company; and (c) the subsidiary is not insolvent at the time the director acts and does not
become insolvent because of the director's act.
The phrase 'does not become insolvent because of the director's act' was
inserted to avoid directors dissipating the assets of the subsidiary gradually
while they m a y be acting in the interests of the holding company, which could
lead to the eventual - although not the immediate - insolvency of the
subsidiary. It differs from the predecessor provision in the C L E R P Draft Bill:
New Directors' Duties and Corporate Governance Provisions (1998) that
referred to the subsidiary not being insolvent 'at the time, or immediately after,
the director acts'.169
Section 187 of the Corporations Act does not remove the uncertainty that exists
in the case law - in particular where groups of companies are involved - as to
whether the formulation of directors' fiduciary duty to act bona fide in the
interests of their company should be subjective or objective.170 In practical
terms, the wording of s 187 of the Corporations Act does not make it clear as to
who m a y take the interests of the holding company into account and when. If,
on the one hand, it is for the directors of the subsidiary themselves to determine
whether their act is in good faith in the interests of the holding company when
Nominee Directors and Alternate Directors, Report N o 8 (1989) at 3.
Section 187 excludes directors' fiduciary duties in these circumstances. Since s 187 defines the content of directors' fiduciary duties in this context, there can be no breach of fiduciary duty in the circumstances outlined by this section. 169 Sees 8(1) of the Draft Bill.
169
they are faced with the original decision leading to their impugned actions, the
test is subjective. If, on the other hand, it is for the court to determine at the
time of the hearing whether the directors of the subsidiary have breached their
duties, the test is objective. In such a case the directors will only satisfy this test
if they have acted reasonably.
The wording of s 131(2) of the Companies Act 1993 (NZ), on which s 187 of
the Corporations Act is modelled, states that directors must act in good faith
and in what they believe is in the best interests of the holding company.171 This
is clearly a subjective formulation of their fiduciary duty. In N e w Zealand it is
thus sufficient for directors of a group company to comply with their duty to act
bona fide in the interests of their company if they subjectively believe that they
are doing so. The fact that the wording of s 187 of the Corporations Act does
not expressly indicate that the genuine belief of the director plays a role points
to a definite departure from the equivalent N e w Zealand provision. One can
therefore only assume that the test in s 187 of the Corporations Act is objective.
Even t hough s 1 87 d oes n ot h ave a p roper p urpose r equirement s uch a s t hat
contained in s 181(1) of the Corporations Act, it is submitted that s 187 of the
Corporations Act implies an objective approach and m a y be regarded as a
statutory exception to the entity approach. This view is corroborated by the 1 7^
fact that both Van Reesema and s 181(1) of the Corporations Act also favour
an objective formulation.
It is important to note that s 187 of the Corporations Act in its current form
only applies to wholly-owned subsidiaries or their related companies.174 In the
case of partly-owned subsidiaries there is no statutory provision to the effect
that directors are taken to have acted in good faith in the best interests of their
170 As will be recalled, the formulation of the duty to act bona fide in the interests of the company as a whole in the case law is predominantly subjective although it has an objective
limitation to it, namely, the act has to be reasonable. See Ch 4 para 4.2. 171 Sub-ss 131(2) and (3) of the Companies Act 1993 (NZ). 172 There is no predecessor for s 187 of the Corporations Act in Australia and there is no
relevant case law on this section yet. 173 (1988) 6 A C L C 529.
170
subsidiary in certain circumstances where they have acted in good faith in the
best interests of the holding company.175 Like s 131(3) of the Companies Act
1993 (NZ), the original CLERP Draft Bill (1998) also contained a provision on 1 7fi
partly-owned subsidiaries, providing as follows:
A director of a corporation that is a subsidiary, but not a wholly-owned subsidiary, of a body corporate is to be taken to act in good faith in the best interests of the subsidiary
if: (a) the constitution of the subsidiary expressly authorises the director to act in the best
interests of the holding company; and (b) a resolution passed at a general meeting of the subsidiary authorises the director to
act in the best interests of the holding company (no votes being cast in favour of the resolution by the holding company or an associate);177 and
(c) the director acts in good faith in the best interests of the holding company; and (d) the subsidiary is not insolvent at the time, or immediately after, the director
acts.178
The p ro vision o n p artly-owned s ubsidiaries c ontained i n t he o riginal C L E R P
Draft Bill was, however, subsequently omitted for further review by the
Companies and Securities Advisory Committee (CASAC).1 7 9 C A S A C
subsequently recommended that the Corporations Act should allow the
directors of a solvent, partly-owned group company to act 'in good faith and in
the interests of the parent company where the minority shareholders of the
former company pass an ordinary resolution, in accordance with its
constitution, that approves the directors so acting.'180
See, in general, R Baxt, "The corporate group and the duties of directors - two steps backward, no steps forward!' (1999) 17 C&SLJ 126.
The position relating to partly-owned subsidiaries still has to be investigated. In the case of a partly-owned subsidiary, s 131(3) of the Companies Act 1993 (NZ) sets out an additional requirement that has to be satisfied, namely, that the directors have to obtain the prior consent of the shareholders (excluding the holding company). 6 There was a provision for 'other subsidiaries' than 'wholly-owned subsidiaries' in s 8 of Sch
1 Ch 2 D Pt 2D.1 of the Draft Legislative Provisions of C L E R P entitled 'New Directors' duties and corporate governance provisions'. 177 This was previously s 8(2) of the draft C L E R P legislation, which was never enacted. ^ January 1998 C L E R P Draft Bill, cl 8 of Chapter 2 D (p 107 of the draft).
For a discussion of the provision on partly-owned subsidiaries, see C A S A C Final Report, above n 6, paras 2.36-2.38. 180
C A S A C Final Report, above n 6, Recommendation 3. As part of this Recommendation, C A S A C has set out a list of directions with which such a provision should comply.
171
A recent decision, Pascoe Ltd (in liq) v Lucas}*1 provided similar relief to that
contemplated by s 187 of the Corporations Act. Pascoe Ltd was incorporated
under the provisions of the International Companies Act 1981-82 of the Cook
Islands. B y order of the Supreme Court of South Australia, Pascoe Ltd was
liquidated pursuant to the then Part 5.7 of the Corporations Law. The liquidator
claimed damages from one of its directors, Lucas, on the basis that, by being a
party to a series of intricate loan transactions, he had breached his fiduciary and
statutory duties to the company.182 Pascoe Ltd was incorporated for the sole
purpose of these transactions. The liquidator argued that, by taking into account
the interests of the holding company, Lucas had failed to act in the interests of
Pascoe Ltd. The court dismissed the liquidator's claim. In the court of first
instance Debelle J held that the director was not liable for breach of duty as
director of the relevant company. This decision was taken on appeal to the Full
Court of the South Australian Supreme Court, which unanimously c onfirmed
Debelle J's decision.
At first instance, Debelle J found that Lucas was not liable because he acted on
the instructions and with the full knowledge of its only shareholder at a time
when the company was solvent. Both the director and the shareholder acted
intra vires and there was no evidence to prove that they had acted in bad
faith.] 85 In t he c ourse o f h is j udgment D ebelle J p ointed o ut t hat h e h ad n ot
overlooked the statement of Mason J (as he then was) in Walker v Wimborne
that in a group of companies directors must consider only the interests of the
181 (1998) 27 A C S R 737 (Pascoe). XS2 Ibid 164. 183 Pascoe Ltd (in liq) v Lucas (1999) 33 A C S R 357 (Lander J). 184 Pascoe (1998) 27 A C S R 737 at 766. 185 Ibid 769-770. Like the court at first instance, the Court of Appeal in Pascoe Ltd (in liq) v Lucas (1999) 33 A C S R 357 at 389 also ruled that it would have invoked the Cook Islands equivalent of s 1318 of the Corporations Law (s 214(1) of the International Companies Act 1981-82) if that had become necessary. Pursuant to s 1318 of the Corporations Law the court could relieve a director from liability for a breach of duty where the director had acted honestly and ought fairly to be excused in all the circumstances. Section 214(1) of the International Companies Act 1981-82 was not in exactly the same terms as s 1318 of the Corporations Law as the former section required the applicant for relief from liability to establish not only that he
or she had acted honestly but also reasonably. 186 (1976) 137 C L R 1.
172
particular company that they direct.187 Although Debelle J recognised that
Walker v Wimborne1** was still good law, his Honour was of the view that it
did not apply where shareholders unanimously required the company to act in a
particular way.189 This would be the case unless the actions of the directors
were so reckless so as to amount to fraud.
Furthermore, Debelle J said that the statement of Mason J in Walker v
Wimbornem that directors also had to look at the interests of creditors in
discharging their fiduciary duties, needed to be qualified.192 Although creditors'
interests needed to be considered where the company was insolvent or near
insolvent, the circumstances could be such that it was difficult to make out a
duty to future creditors.193 This was said to be a difficulty, but it is submitted
that this should not be so. There is no doubt that the cognate duty is owed to
present and future shareholders. There is no reason w h y the same should not
apply for creditors.194 In Pascoe195 the court did not find it necessary to
determine to what extent the directors and shareholders of Pascoe Ltd had to
consider the interests of its (current) creditors, since the company was solvent at
all material times.196
187 In this case that company would have been Pascoe Ltd. The judgment in Pascoe (1998) 27 ACSR 737 emphasised that, in the absence of legislative changes, the strict approach in Walker v Wimborne (1976) 137 CLR 1 will continue to be applied. See further by R Baxt, 'Lost opportunity' (September 1998) Charter 58 at 58. 188 (1976) 137 CLR 1. 1 RQ _
Pascoe (1998) 27 ACSR 737 at 770. The director in question in Pascoe was held not to be liable for breach of fiduciary duty because he acted on the instructions and with the full knowledge of the only shareholder of the company at a time when it was solvent. 190 Pascoe (1998) 27 ACSR 737 at 767-769. 191 (1976) 137 CLR 1. 192 (1998) 27 ACSR 737 at 769. 193 Ibid 769-770. 194 See Winkworth [1987] 1 All ER 114 and Jeffree [1990] W A R 183. 195 (1998) 27 ACSR 737. 196/ta/769.
173
5.5 Evaluation of position of group creditors
5.5.1 Particular difficulties in intra-group transactions
A recurrent theme that runs through the p articular difficulties experienced in
intra-group transactions, is the notion of 'commercial benefit'. Intra-corporate
transactions are allowed, provided they are for the 'commercial benefit' of the
company advancing the funds. Relying on the judgment in Walker v
Wimborne}91 it could be said that a downstream transaction entered into by
directors of a holding company would generally be allowed, since it would not
be in breach of their fiduciary duty towards the holding company. It would be
relatively easy to prove that the holding company received 'commercial benefit'
from such a transaction. Although it would not be impossible to do so, the case
law indicates that the existence of 'commercial benefit' would be much harder
198
to prove in the case of a lateral or upstream transaction.
'Commercial benefit' played an important role in the waterfront dispute,
eventually leading to the enactment of the Corporations Law Amendment
(Employee Entitlements) Act 2000 (Cth).199 In turn, this led to the extension of
the duty of directors not to be involved in insolvent trading to include an
'uncommercial transaction' entered into by the company pursuant to s 588FB of
the Corporations Act?00 Apart from the doubts expressed above about the
effectiveness of the offence created in the new Part 5.8A of the Corporations
Act, it should be borne in mind that the new provisions were introduced for the
protection of employees. The only additional protection for other unsecured
creditors as a result of the legislative amendments brought about by the
Corporations Law Amendment (Employee Entitlements) Act 2000 (Cth) is the
(1976) 137 C L R 1. See para 5.2.1 above. See para 5.2.3 above. See Ch 6 for a discussion of insolvent trading under s 588G of the Corporations Act.
174
fact that entering into an 'uncommercial transaction' is n o w regarded as
incurring a debt for purposes of the insolvent trading provisions.201
In the context of corporate groups it seems that the courts will generally not
regard an argument that the transaction was to the benefit of other companies in
the group as convincing in an attempt to prove that a transfer at an undervalue
was not 'uncommercial'. What is interesting, however, is that none of the
reported cases in the context of uncommercial transactions concerned the
position where a downstream transaction had occurred. The question has
been p osed w hether i t m eans t hat a t ransfer a t a n u ndervalue m ay n ot b e a n
uncommercial transaction, as long as a clear benefit to another group company 70^
in which the insolvent company holds shares could be proved. In other
words, could a transaction escape being classified as an 'uncommercial
transaction' for purposes of s 588FB of the Corporations Act where it is a
downstream transaction and the holding company, which m a y potentially share
in future dividends of its subsidiary, is insolvent?204 Commentators have
speculated that, to a degree at least, the answer would depend on the size of the
shareholding.205 Where an insolvent (holding) company holds only 1 0 % of the
shares in the (subsidiary) beneficiary, for example, a transfer at undervalue may
be uncommercial, whereas it may be commercial and therefore justifiable
where the holding company holds 9 0 % of the shares.206
5.5.2 Duty to take into account interests of creditors
To comply with their duties towards the company, the general law counterpart
of the uncommercial transaction regime, directors must in certain circumstances
take into account the interests of creditors and even future creditors. There can
See further Ch 7 para 7.3.1.1 on the incurring of a debt under the insolvent trading provisions.
See further para 5.2 above on downstream, lateral and upstream transactions. D Morrison and C Anderson, 'Uncommercial transactions - developments in the new
regime '(1999)7 Insolv Law Jnl 184 at 192.
As stated in para 5.2.1 above, it will generally be difficult to prove that there has been commercial benefit for a subsidiary company in the event of a lateral or upstream transaction.
Morrison and Anderson, above n 203, 192.
175
be little doubt that, for unsecured creditors to enjoy sufficient protection in
jurisdictions that had abolished the ultra vires doctrine, protective measures had
to be developed. The aim of these measures was to prevent directors and
shareholders of insolvent and near insolvent companies from entering into
transactions that were not for the company's commercial benefit and were
clearly prejudicial to unsecured creditors.207 The previous spate of cases on
directors owing fiduciary duties to their companies to take into account the
interests of creditors when their companies were in an insolvent or near
insolvent position m a y partly be explained as an attempt to develop such
protective measures.
It appears that, generally speaking, the position under English and Australian
law, as under New Zealand law, is that directors do not owe a direct duty to
creditors.208 However, it is arguable that the statements in Spies v The Queen209
to the effect that directors owe no direct duty to creditors may be considered as 710
obiter only. It so, the possibility would then remain that the High Court m a y
in future confirm that an independent duty to creditors does in fact exist. The
main reasons stated for this view include:
• the gradual expansion of directors' duties towards creditors in a number of 711
State Supreme Court decisions, in particular Grove;
• the abolition of the rule in Foss v Harbottle212 in Australia in 2000, one of
the main hurdles in the way of recognition by the courts of an independent
fiduciary duty directly enforceable by creditors against directors;213 and
207 See further JJ Mannolini, 'Creditors' interests in the corporate contract: a case for the reform of our insolvent trading provisions' (1996) 6 Aust Jnl of Corp Law 14 and the discussion of
insolvent trading in Chh 6 and 7. 208 See further D Thomson 'Directors, creditors and insolvency: a fiduciary duty or a duty not to
oppress?' (2000) 58 UTFaculty LR 31 at 43. 209 (2000) 18 A C L C 727. 210 J McConvill, 'Directors' duties to creditors in Australia after Spies v The Queen' (2002) 20
C&SU4 at 16-17. 211 See also Ring v Sutton (1980) 5 A C L R 546; Kinsela (1986) 4 N S W L R 722; Jeffree [1990]
W A R 183, discussed in paras 5.3.2-5.3.4 above. 212 (1843) 2 Hare 461. The rule in Foss v Harbottle entails that, in proceedings instituted for
wrongs done to a company (which may have an adverse impact on the creditors' rights and
interests), the proper plaintiff is the company. Wrongs against the company include breaches of
directors' duties.
176
• the recent trend in Australian company law of adopting American principles
and doctrines in an effort to ensure the most equitable and practicable
corporate governance framework possible which m a y influence the High
Court to extend the duties of directors to the extent that they owe a direct
duty to creditors, something which is not presently part of the Australian
It is submitted that the judgment in Spies v The Queen215 is not revolutionary.
Stating that directors have a duty to take into account the interests of creditors
is rhetoric. It goes n o further than confirming that directors have a fiduciary
duty towards their company. In this regard it is submitted that G u m m o w J in
New World Alliance216 was correct when he said that the duty to take into
account the interests of creditors is 'merely a restriction on the right of
shareholders to ratify breaches of the duty owed to the company'.
The question that remains unanswered, however, is what is the meaning of the
'company'? Uncertainty exists about whether the 'company' is the legal entity
itself o r t he s hareholders a s a whole (or t he m ajority o f t he s hareholders) o r
whether it includes other stakeholders such as creditors, employees or even the
community (as far as social conscience obligations are concerned). For the
High Court in Spies v The Queen21* to say that there is no direct duty as far as
creditors a re c oncerned does n ot a ssist t he d ebate a ny further. It i s r ather a n
unimaginative way of stating that the duty should be extended to include
creditors. If the 'company' in respect of which the duty exists is not defined
Part 2F.1A of the Corporations Act introduced a new statutory derivative action, with s 236(3) abolishing the rule in Foss v Harbottle. See, in general, P Prince, 'Australia's statutory
derivative action: using the N e w Zealand experience' (2000) 18 C&SLJ 493; J McConvill, 'Ensuring b alance in corporate governance: Parts 2F.1 and 2F.1A of the Corporations Law* (2001) 12 AustJnl of Corp Law 293. 214 See, eg, J Cassidy, 'Standards of conduct and standards of review: divergence of the duty of care in the United States and Australia' (2002) 28 A Bus L Rev 180. This article points out the similarity between s 4.01 of the Principles of Corporate Governance of the American Law Institute and the recently enacted s 180(1) (duty of care and diligence) and s 180(2) (business judgment rule) of the Corporations Act. 215 (2000) 18 A C L C 727. 216 (1994) 122 A L R 531. 1X1 Ibid 55Q. 218 (2000) 18 A C L C 727.
177
more exactly one m a y decline into a regime where directors face an almost
unlimited liability for company debts.
— 710
Even if the statements in Spies v The Queen to the effect that directors owe
no direct duty to creditors are considered as obiter, the question of whether an
independent duty to creditors does in fact exist m a y never come before the
courts. The number of cases on directors owing fiduciary duties to their
companies to take into account the interests of creditors when their companies
were in an insolvent or near insolvent position has rapidly declined in recent
years. The reason for this is probably the wealth of statutory remedies that
exists for the protection of creditors today.220 Most of the instances of irregular
conduct by directors that occurred in the case law, such as wrongful trading,
preferences and undervalued transactions, could have been dealt with under the
current legislative provisions if they had been in force at the relevant time. The
statutory protection for creditors in the Corporations Act, specifically designed
for the corporate group situation, is discussed in Chapter 7.
5.5.3 Statutory duty to act in interests of company
The general law duty of directors to act in the best interests of their company is
supplemented by s 181(1) of the Corporations Act. The effect of s 181(1) is that
directors m a y be found to have breached their statutory duty to act in good faith
because they have not acted for a proper purpose, even though they have acted
bona fide in the interests of the company.221 The amendment by the legislature,
stating the duty as acting in the best interests of the corporation as well as for a
220 See A Muscat, The Liability of the Holding Company for the Debts of its Insolvent
Subsidiary (1996)246-249. 221 It is interesting to note that para (a) of the then proposed s 181(1) of the Corporate Law Economic Reform Program Bill 1998 read as follows: '(a) in good faith in what they believe to be in the best interests of the corporation' (emphasis added). The words emphasised have been
omitted in the final version that became law on 13 March 2000. It was said that the amendment,
accepted b y a 11 p arties, was d esigned t o t ake a s ubjective t est a nd make i t o bjective: S enate
Hansard, 13 October 1999 at 9234. This may be compared with the position in N e w Zealand where directors' statutory duty to act in the interests of their company is clearly subjective: see s 131(1) of the Companies Act 1993 (NZ), which provides as follows: 'Subject to this section, a
178
proper purpose, places an objective restriction on the predominantly subjective
duty of directors to act in the interests of their company. This is in line with the
general law duty of directors to act bona fide in the interests of the company
that also contains the objective limitation that directors m a y not exercise their
222
discretion for a collateral or improper purpose.
By enacting s 187 of the Corporations Law?23 which came into operation on 13
March 2000, the legislature recognised that the strict entity approach of Walker
v Wimborne?24 where a subjective formulation of directors' fiduciary duties is
favoured, m a y not be appropriate in a corporate group situation. The legislature
acknowledged that directors of a subsidiary might in certain circumstances take
into account the interests of the holding company without breaching their
fiduciary duty towards the subsidiary. Section 187 of the Corporations Act is
based on s 131(2) of the Companies Act 1993 (NZ),225 which incorporates the
liberal approach adopted in Levin v Clark?26 Re Broadcasting Station 2GB22
and Berlei Hestia v Fernyhough?2* discussed in Chapter 4.229
Section 131(2) of the Companies Act 1993 (NZ) provides that the directors of a
wholly-owned subsidiary m a y act in what they believe is in the best interests of
the holding company. They m a y act in this way even though their action may
not be in the best interests of the subsidiary, provided that the constitution of
the subsidiary makes express provision for this. The N e w Zealand provision
goes further than the Australian one by specifically stating that the nominee
director m a y act in the interests of his appointer, the holding company, even if
director of a company, when exercising powers or performing duties, must act in good faith and in what the director believes to be the best interests of the company.' 222 See the discussion in Ch 4 para 4.2.
This provision is now contained in s 187 of the Corporations Act. 224 (1976) 137 CLR 1. 22S
This is acknowledged in the Explanatory Memorandum to the Bill, para 6.94. For the differences between s 187 and the equivalent provision in New Zealand, as well as a criticism of the then proposed Australian provision, see J Kluver, 'CLERP: Reform or Revolution -Directors of Group Companies: The CLERP implications' AICD/BLS/Law Society Seminar, Perth, 26 August 1998 at 3-13. See also Baxt and Lane, above n 28, 643. 226 [1962] N S W R 686. 227 [1964-5] N S W R 1648. 228 [1980] 2 NZLR 150. 229 See Ch 4 para 4.3.2.
179
this is not in the best interests of the subsidiary. Arguably this is also the idea
behind the Australian provision, but it does not state it so clearly.
The effect of s 187 of the Corporations Act is that directors will not be found to
have breached their statutory duty to act in the interests of their subsidiary if
they acted in good faith in the best interests of the holding company. This is the
case, provided the constitution of the subsidiary authorised this and the
solvency of the subsidiary was not an issue. The fact that directors will comply
with their fiduciary duty to act in the interests of a subsidiary company if they
act in the interests of another company in the group, namely the holding
company, indicates the acceptance of an objective approach and is an
endorsement of enterprise liability.
Although Pascoe allows directors of a wholly owned subsidiary to do exactly
what s 187 of the Corporations Act authorises them to do where the constitution
of the company expressly provides for this, it is submitted that it was indeed 7^0
necessary to enact this section. While authority exists that shareholders m a y
ratify a breach of directors' common-law duty to the company,231 doubt exists
as to whether they m a y validly ratify a breach of directors' statutory duty to the
company.232 O n appeal Lander J held that it was possible for a sole shareholder
to authorise a transaction that gave rise to a breach of fiduciary duty on the part
of a director.233 However, there is nothing in his Honour's judgment to suggest
that it would also be possible to excuse a director from a possible breach of
statutory duty.234 B y contrast, Debelle J in Pascoe235 was of the view that
230 Cf R Baxt, 'The South Australian Full Court confirms the ability of directors of wholly
owned subsidiaries to act in the interests of their holding company - do we need section 187 of the Corporations LowT (2000) 18 C&SLJ 223; Baxt and Lane, above n 28, 639-40. 231 See, eg, Hogg v Cramphorn Ltd [1967] Ch 254; Bamford v Bamford [1970] Ch 212;
Winthrop Investments Ltd v Winns Ltd [1975] 2 N S W L R 666. 232 Baxt, 'The South Australian Full Court confirms the ability of directors of wholly owned subsidiaries to act in the interests of their holding company - do we need section 187 of the
Corporations LawT, above n 230, 224. 233 Pascoe Ltd (in liq) v Lucas (1999) 33 A C S R 357 at 386. 234 This issue was not considered by the Full Court. 235 (1998) 27 A C S R 737.
180
shareholders m a y indeed excuse a breach of statutory duty where he stated
obiter?36
There is, however, a nice question whether shareholders can relieve a director from a breach of his statutory duties. But, as the statutory duties reflect the duties of a director at common law and in equity, I do not think that there is any
237 impediment to the shareholders excusing a breach of a statutory duty.
Kluver, however, points out that it is possible to argue that the opposite is
true.238 W h e n something becomes a commercial norm through legislation, it is 7^G
not possible to contract out of or to exclude the norm. In other words, one
may make out a case for saying that the shareholders are incapable of ratifying
the directors' actions if to do so would be condoning a contravention of the
Corporations Act. It is submitted that this is the correct view.240 Thus directors
who w ould n ot b e i n b reach o f t heir fiduciary d uties i n t erms o f t he g eneral
law241 m a y still be held liable for breach of their fiduciary duties - but then
only pursuant to the statute. A simple majority of shareholders should not be
allowed to override policy in the statute that has been placed there for the
benefit of all the shareholders and, arguably, creditors. Even a unanimous
resolution by shareholders to ratify directors' actions that contravene the
Corporations Act should not be regarded as valid, because in this way neither
236 Ibid 772. 237 qrthe statement by Santow J in Miller v Miller (1995) 16 A C S R 73 at 89, approved by Young J in Gray Eisdell Timms Pty Ltd v Combined Auctions Pty Ltd (1995) 17 A C S R 303 at 312. See further R A Zakrzewski,' The law relating to single director and single shareholder companies' (1999) 1 C&SLJ 156. 238 Kluver, above n 225, 5. In Miller v Miller (1995) 16 A C S R 73 at 89 Santow J stated that ratification could not rectify a breach of statutory duty, more particularly one that imposed criminal liability. See further Lambrick, above n 15, 236 and C A S A C Final Report, above n 4, paras 2.3 and 2.35.
In the context of s 52 of the Trade Practices Act 1974, see, eg, Petera Pty Ltd v EAJ Pty Ltd (1985) A T P R para 40-605 at p 48,334; Collins Marrickville Pty Ltd v Henjo Investments Pty
Ltd (1987) A T P R para 40-783 at pp 48,539-48-540; McMahon v Pomeroy Pty Ltd (1991) A T P R para 41-125 at p 52,860. See further C Lockhart, The Law of Misleading or Deceptive Conduct (1998) paras 10.17-10.18.
See also Ford, Austin and Ramsay Ford's Principles of Corporations Law, above n 34, para 8.385; Baxt and Lane, above n 28, 639-640.
They would not be in breach because of unanimous shareholder ratification.
181
the interests of future shareholders nor those of creditors are being taken into 242
account.
It is conceded that s 187 of the Corporations Act, as it currently reads, does not
completely rid us of the constraints of Walker v Wimborne?42 The principle laid
down in Pascoe implies that, where shareholders do not unanimously require
the company to act in a specific way, the principle in Walker v Wimborne244
still applies in the absence of legislative change. At the moment s 187 of the
Corporations Act only applies to wholly-owned subsidiaries. If, however, the
legislature were to adopt the recommendation by C A S A C that s 187 of the
Corporations Act should be extended to partly-owned subsidiaries, it would be
going further than was contemplated by Pascoe?45 An extension of s 187 of the
Corporations Act as envisaged by CASAC would mean that, to ratify a breach
of directors' duty in this context, unanimous shareholder consent would not be
required, but an ordinary resolution by minority shareholders would be
sufficient.246
In the same way as one cannot contract out of s 52 of the Trade Practices Act 1974 (Cth), one should not be able to contract out of the statutory provisions dealing with directors' duties (currently ss 180-184 of the Corporations Act). For the position in respect of the Trade Practices Act see, eg, N C Seddon and M P Ellinghaus, Cheshire & Fifoot's Law of Contract (1997) at 466-467 (and the authorities cited there). It is a norm of public policy. Furthermore, the proposition that shareholders should be able to approve directors' breach of statutory duty where such duty is merely a reflection of their obligations under general law also appears to nullify the operation of s 1324 of the Corporations Act. 243 Baxt, 'Lost opportunity', above n 187, 58. 244 (1976) 137 C L R 1. 245 (1998) 27 A C S R 737. 246 A number of other differences exist between the decision in Pascoe and s 187 of the Corporations Act. A n example of such a difference is that s 187 of the Corporations Act requires that the power of directors to act in the interests of the holding company should be expressly stated in the company's constitution, while this is not stated as a requirement in Pascoe. It is submitted, however, that these differences will have little effect in practice and are
therefore not discussed further. See, in this regard, Kluver, above n 225, 3-13; Baxt and Lane, above n 28, 639-640. See also G W Hone 'Pascoe's case and the business judgment rule -
commentary on paper by Richard England', paper delivered at the Corporations Law Workshop, Business L a w Section of the Law Council of Australia, 27-29 August 1999, Fairmont Resort, Leura, N S W 23 at 26-27.
INSOLVENT TRADING: HOLDING COMPANY AS SHADOW DIRECTOR
6.1 Background 182
6.2 Addressing the problem 188
6.2.1 Position in the United Kingdom 18 8
6.2.2 Position in Australia 192
6.2.3 Position in New Zealand 196
6.3 Liability of holding company 199
6.4 Evaluation of position of group creditors 218
6.4.1 Meaning of 'directors of the body' 218
6.4.2 Meaning of 'accustomed to act' 221
6.4.3 Meaning of 'directions or instructions'
6 INSOLVENT TRADING: HOLDING
COMPANY AS SHADOW DIRECTOR
6.1 Background
The only major general law principles to curb manipulation and abuse in the
group context apart from lifting of the corporate veil are directors' duties,
which are the focus of Chapters 4 and 5.1 It is clear from the discussion in these
chapters that, under certain circumstances directors m a y be held liable
personally for losses or for equitable compensation on the ground that they
have b reached o ne o r m ore o f t heir d uties t owards t he c ompany, w hich m ay
include taking into account creditors' interests. In the context of corporate
groups, the effect of this development is that creditors of a subsidiary m a y have
a claim against the holding company where the holding company qualifies as a
director of the subsidiary and breaches the duty that it owes to its subsidiary in
this capacity.2
In addition to the general law the Corporations Act 2001 (Cth)3 also provides
for the protection of group creditors in order to alleviate their plight. The most
important safeguards in this regard are the insolvent trading provisions that set
out the circumstances under which a holding company m a y be held liable for
the debts of its insolvent subsidiary.4 These include the provisions in terms of
which a holding company m a y be held liable for the debts of its subsidiary on
the basis that it is regarded as a director of its subsidiary, which forms the
subject of this chapter. The provisions in terms of which a holding company
may be held liable for the debts of its subsidiary as shareholder and not in its
capacity as director are discussed in Chapter 7.
1 Piercing the corporate veil is discussed in C h 3. 2 It should be noted that it is the liquidator of the company and not the creditor itself that must
institute the claim. 3 (Corporations Act). 4 For a discussion of the other specific areas of statutory veil-piercing in the context of corporate g roups, n amely t he c onsolidation o f g roup a ccounts, r elated p arty t ransactions a nd
cross shareholdings, see C h 2 para 2.2.
183
Although a body corporate cannot be appointed as a director, it is not
precluded from being held to be a "de facto director' or a 'shadow director' by
virtue of s 9 of the Corporations Act.6 A de facto is defined in s 9 as a person
who is not validly appointed as a director if he or she acts in the position of a
director.7 A shadow director, by contrast, is defined in s 9 as a person w h o is
not validly appointed as a director if the directors of the company or body are
accustomed to act in accordance with the person's instructions or wishes.8 In
the context of a corporate group, a holding company m a y therefore be held
liable for the debts of its insolvent subsidiary pursuant to s 588G of the
Corporations Act in circumstances where it is regarded as a de facto or shadow
director of its subsidiary. This does not necessarily make the directors of the
holding company liable as de facto9 or shadow directors of the subsidiary.10
In Re Hydrodann Millett J distinguished between the different types of
director. His Lordship stated that a dejure director has validly been appointed
to office, while a de facto director has not validly been appointed to his or her
position but is held out as a director by the company and purports to be a
director. B y e ontrast, a 5 hadow director is not held out by the company as a
director and does not claim or purport to act as a director. In fact, he or she
claims not to be a director and 'lurks in the shadows', hiding behind others who
he or she claims are directors.12 The Federal Court in Beach Petroleum NL v
Section 201B(1) of the Corporations Act states that '[o]nly an individual who is at least 18 may be appointed as a director of a company' (own emphasis). For judicial recognition of the statement that, by their very nature, shadow directors are not
'appointed' to the position of director, see Standard Chartered Bank of Australia Ltd v Antico (1995) 38 N S W L R 290 (Antico). Further support may be found in Re a Company (No 005009 of 1987); Ex parte Copp [1989] B C L C 13; Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 A C 187 (Kuwait); Re Hydrodan (Corby) Ltd [1994] B C C 161 (Re Hydrodan) and Dairy Containers Ltd v NZI Bank Ltd [1995] 2 N Z L R 30 (Dairy Containers). See para (b)(i) of the definition of 'director' in s 9 of the Corporations Act.
8 See para (b)(ii) of the definition of 'director' in s 9 of the Corporations Act. 9 Secretary of State for Trade and Industry v Laing [1996] 2 B C L C 324. 0 Re Hydrodan [1994] B C C 161, discussed in more detail in para 6.3 below. "[1994] B C C 161. 12 Ibid 163. Cf Secretary of State v Deverell [2000] 2 B C L C 133, where Morritt LJ in the
English Court of Appeal said that controlling shareholders may be shadow directors notwithstanding the fact that they take no steps to hide the part they play in the affairs of the company concerned.
184
1 "\
Johnson also considered the meaning of a de facto director.14 V o n Doussa J
was of the view that there were two limbs to be analysed. The first limb is
where a p erson occupies an o ffice and discharges functions attaching to that
office of the kind normally performed by a director. The second limb is where a
person acts in the position of a director.
At least one commentator is of the view that, while it will depend on all the
relevant circumstances, it is unlikely that a holding company will occupy or act
in the position of a director.15 It is argued that, because of its corporate form, a
holding company cannot act in common with properly appointed directors or
hold i tself o ut a s a d irector.16 W hatever t he p osition m ight b e, a s a p ractical
matter it is more likely for a holding company to be held liable as a shadow
director, as borne out by the case law discussed in paragraph 6.3 below. This
chapter therefore concentrates on the liability of the holding company for the
debts of its subsidiary in its capacity as shadow, rather than de facto, director.17
Since 1931 Australian corporate law has contained a provision imposing
personal liability on directors and other persons responsible for managing the
affairs of a company recklessly or with the intent to defraud the creditors of the 1 R
company. " This was derived from a similar provision in the United Kingdom
introduced in 1929.19 Other Commonwealth countries, including New Zealand,
13 (1993) 11 ACSR 103. 14 See, generally, on the meaning of a de facto director, S Griffin, 'The characteristics and identification of a de facto director' (2000) Com Fin & Insolv LR 126. 15 D Murphy, 'Holding company liability for debts of its subsidiaries: corporate governance implications' (1998) 10 BondLRev 214 at 260-261. 16 Ibid. 17 See further on de facto directors, M Markovic, 'To be or not to be a de facto director', 1997 Australian Law Teachers' Conference Papers 98; M Stoney, 'Borrower companies approaching insolvency - the potential liability of the lender as a de facto director' (2000) 8 Insol Law Jnl
192. 18 In 1931 the Queensland Companies Act became the first Australian legislation to contain a fraudulent trading provision by virtue of s 284. The other States followed: South Australia (1934) s 290, Victoria (1938) s 275, N e w South Wales (1936) s 307, Western Australia (1943) s 281, and Tasmania (1959) s 237. Currently s 592(6) of the Corporations Act regulates
fraudulent trading. 19 Section 275 of the Companies Act 1929 (UK). In the U K the offence of fraudulent trading has
also been retained and it applies whether or not a company goes into insolvent liquidation: s 213 of the Insolvency Act 1986 (UK) and s 458 of the Companies Act 1985 (UK).
185
have followed suit. If such a person was found guilty of reckless or
fraudulent trading he or she could be ordered by the court to contribute to the
assets of the company in circumstances where the company went into insolvent
liquidation.
The shortcomings of the requirement that the person in question should have
acted recklessly or dishonestly are well known.21 First, although the • 99
presumption of fraudulent intent was raised in some cases, the courts
generally interpreted proof of fraud as requiring dishonesty.23 Negligence, that
is, trading in circumstances where those who were responsible for managing the
company's affairs should have known that the company was unable to pay its
debts, was not sufficient to give rise to liability in these circumstances.24 In
other words, unreasonable conduct alone was insufficient to establish liability,
since the test of liability was subjective. Furthermore, it was difficult to prove
as a matter of practice that the person in question took part in managing the
affairs of the company.
The above-mentioned shortcomings are perhaps best illustrated by Re Augustus
Barnett & Son Ltd?5 decided in the context of the then s 332 of the Companies
Act 1948 (UK). Augustus Bamett and Son Ltd (Augustus Bamett), a subsidiary
company, had been trading at a loss for some time. Its creditors were unwilling
to extend further credit unless the holding company, Rumasa S A (Rumasa),
could give assurances of continued financial support to the subsidiary. Rumasa
gave these assurances, injected capital into Augustus Bamett and provided
Section 380 of the Companies Act 1993 (NZ). 21 Report of the U K Company Law Committee, London, 1962 (Cmnd 1749) (also known as the Jenkins Report) para 497; United Kingdom: Report of the UK Review Committee on Insolvency
Law and Practice, chaired by Sir Kenneth Cork, Cmnd 8558, (1982) (Cork Report) para 1776. 12 Freeman v Pope (1870) L R 5 C h A p p 538. This interpretation is n o w widely accepted in Australia: see Noakes v J Harvey Holmes & Sons (1979) 37 FLR 5; Official Trustee v Marchiori (1983) 69 FLR 290; Pt Garuda Indonesia Ltd v Grellman (1992) 107 A L R 199. See further P Carruthers, 'Bringing the high flyers back to earth? Sections 120 and 121 of the Bankruptcy Acf (1995) 25 UWALR 88 at 98. 13 It was held in Re Patrick and Lyon Limited [1933] Ch786 that 'defraud' and 'fraudulent purpose' connote 'actual dishonesty involving ... real moral blame'.
'A See R v Grantham (1984) 1 B C C 99,075, discussed further later in this paragraph, and the cases mentioned there.
186
letters of comfort, which were noted in the accounts. One of these letters stated
that Rumasa would provide Augustus Bamett with the capital required for
carrying on business for at least another year. Despite warnings that Augustus
Bamett was in dire financial straits and the risk involved as far as fraudulent
trading was concerned, the directors of Augustus Bamett continued to carry on
the company's business.
Shortly thereafter Augustus Bamett went into voluntary liquidation and its
creditors attempted to rely on the letters of comfort in order to hold Rumasa
liable for the subsidiary's debts. Hoffmann J rejected the liquidator's claim to
hold Rumasa liable pursuant to s 332 of the Companies Act 1948 (UK). His
Lordship stated that, before a successful action could be brought under this
provision, it had to be proved that the persons w h o actually continued carrying
on the activities of the company were guilty of fraudulent trading.26 This meant
that a holding company could only be held liable for fraudulent trading
pursuant to s 332 Companies Act 1948 (UK) as a party to fraudulent trading if it
could be proved that the directors of the subsidiary themselves had been guilty
of fraudulent t rading. H offrnan J f ound t hat t here w as n o 1 iability u nder t his
section, as there was no evidence of fraudulent intent on the side of the persons
responsible for carrying on the business, namely, the directors of Augustus
Bamett.27 They were genuinely of the opinion that Augustus Bamett could
continue paying its debts on the strength of Rumasa's undertaking in the letter
of comfort.
A holding company could also be held liable for the debts of its subsidiary
pursuant to s 332 Companies Act 1948 (UK) if it could be proved that the
holding company itself carried on the activities of the subsidiary with the 9R
intention to prejudice its creditors. In Re Augustus Bamett, however, the facts
were such that this possibility did not arise. There was no allegation by the
25 [1986] BCLC 170 (Re Augustus Bamett). 26 Ibid 173. 21 Ibid. 28 [1986] B C L C 170.
187
liquidator that Rumasa actually c arried on the activities of Augustus B arnett.
Even if the liquidator had contended this and the judge accepted it, the
liquidator would have had to prove the fraudulent intent of Rumasa. It is 29
doubtful whether he would have been able to do so.
The decision of the Court of Criminal Appeal in R v Grantham has made it
easier to prove a contravention of the fraudulent trading provisions in the
United Kingdom. The court found that an intention to defraud could be inferred
in certain circumstances. This would be the case where a person taking part in
the management of the company's business obtains credit for the company
when he knows that there is no good reason for thinking that funds will become
available to pay the debt when it becomes due or shortly afterwards.31 The Lord
Chief Justice disapproved of certain statements by Buckley J in In re White and
Osmond (Parkstone) Ltd32 to the effect that there would be no fraud if the
directors genuinely believed that 'the clouds [would] roll away and the sunshine
or prosperity [would] shine upon them again'.33 This so-called 'sunshine
doctrine' was a huge hurdle when invoking the fraudulent trading provisions, as
a director could invariably claim that in his view matters would improve, and
that it was for this reason that he had continued to carry on the business.34
Despite the decision in Grantham, however, creditors are still insufficiently
protected against improper use of the corporate form under the fraudulent
trading provisions, due to the fact that negligence is not covered. In Australia
proof of dishonesty is required before an intention to defraud will be found to
See also D Milman, 'Letters of comfort and fraudulent trading' (1986) 7 Co Law 245 at 245-246; D D Prentice, 'A survey of the law relating to corporate groups in the United Kingdom' in E Wymeersch (ed) Groups of Companies in the EEC - A Survey Report to the European Commission on the Law relating to Corporate Groups in various Member States (1993) 279 at 312; A Muscat, The liability of the holding company for the debts of its insolvent subsidiaries (1996) at 209-210. 30 (1984) 1 B C C 99,075 (Grantham). 31 Ibid 99,078. 32 Unreported judgment delivered on 30 June 1960. 33 Grantham (1984) 1 B C C 99,075 at 99,079, quoting from In re White and Osmond (Parkstone) Ltd, unreported judgment delivered on 30 June 1960. 34 Grantham (1984) 1 B C C 99,075 at 99,079. See also R C Williams, 'Fraudulent trading' (1986)3Cc£5ZJ14at25.
188
exist. In other words, there has to be actual dishonesty involving real moral
blame. A similar position exists in N e w Zealand.37 Incompetence cannot be
equated with fraud and strong policy reasons exist for ensuring that directors do
not c ontinue t rading i n circumstances w here a r easonably c ompetent d irector
would realise that the company could not trade profitably any longer.38
6.2 Addressing the problem
6.2.1 Position in the United Kingdom
The decision in Re Augustus Bamett clearly indicates how easy it is to avoid
being caught by the fraudulent trading provisions.40 To overcome some of the
aforementioned defects in the then s 332 of the Companies Act 1948 (UK), as
highlighted by this decision, the Cork Committee made certain
recommendations in its Report submitted to the Government in 1982. As a
result the legislature enacted the wrongful trading provisions now contained in s
214 of the Insolvency Act 1986 (UK).41 Section 214 is arguably the most
important statutory exception to the separate entity doctrine in the United
Kingdom today.42 The provisions of s 214 of the Insolvency Act 1986 (UK)
need to be briefly considered as this section was the forerunner of the insolvent
trading provisions in Australia and many of the cases interpreting it continue to
3i (1984) 1 B C C 99,075. 36 Hardie v Hanson (1959-1960) 33 ALJR 455; Flavel v Semmens (1987) 5 A C L C 868. 37 Re Day-Nite Carriers Ltd (in liq) [1975] 1 N Z L R 172; Re Southmall Hardware Ltd (in liq) (1984) 2 N Z C L C 99,102. The provision on fraudulent trading has largely fallen into disuse following the introduction of the wrongful trading provisions in the U K , and the insolvent
trading provisions in Australia and N e w Zealand. 38 D Prentice, 'Insolvency and the group' in R M Goode (ed), Group Trading and the Lending
Banker (1988) 75 at 75-8. 39 [1986] B C L C 170. 40 Although this case was decided in the context of a corporate group, the same problem also
arises outside the realm of corporate groups. 41 The wrongful trading provision is significantly different from the recommendation by the Cork Report, above n 21. See further J Dabner, 'Insolvent trading: an international comparison'
(1994) 7 Corp & Bus U 49 at 61-2. 42 PL Davies, Gower's Principles of Modern Company Law (1997) at 151; D D Prentice
'Creditors' interests anddirectors' duties' (1990) 10 OJLS265 at 277. See further A Hicks,
'Wrongful trading - has it been a failure?' (1993) 8 Ins L&P 134.
189
have relevance in Australia today. The provisions o f subsections (l)-(4) o f s
214 of the Insolvency Act 1986 (UK) read as follows:
(1) Subject to subsection (3) below, if in the course of the winding up of a company it appears that subsection (2) of this section applies in relation to a person who is or has been a director of the company, the court, on the application of the liquidator, may declare that that person is to be liable to make such contribution (if any) to the company's assets as the court thinks proper.
(2) This subsection applies in relation to a person if-(a) the company has gone into insolvent liquidation, (b) at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, and (c) that person was a director of the company at that time; but the court shall not make a declaration under this section in any case where the time mentioned in paragraph (b) above was before 28th April 1986.
(3) The court shall not make a declaration under this section with respect to any person if it is satisfied that after the condition specified in subsection (2)(b) was first satisfied in relation to him that person took every step with a view to minimising the potential loss to the company's creditors as (assuming him to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation) he ought to have taken.
(4) For the purposes of subsections (2) and (3), the facts which a director of a company ought to know or ascertain, the conclusions which he ought to reach and the steps which he ought to take are those which would be known or ascertained, or reached or taken, by a reasonably diligent person having both -(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and (b) the general knowledge, skill and experience that that director has.
In summary it may be said that s 214 of the Insolvency Act 1986 (UK) imposes
a civil remedy against directors who fail to minimise potential losses to the
company after becoming aware of an impending insolvency.43 It empowers the
court, on application by the liquidator, to order that directors be made liable for
the debts of a company that has gone into insolvent liquidation.44 For this
section to apply the court has to find that, at some time before the
commencement of the winding up, the directors knew or ought to have
43 See V Breskovski, 'Directors' duty of care in Eastern Europe' (1995) 29 Int'l Law 11 at 87-88 for a discussion of the wrongful trading provisions.
Only the liquidator, not creditors, can apply for a wrongful trading order.
190
concluded that there was 'no reasonable prospect' that the company would
avoid going into insolvent liquidation.45
To decide this question a director is deemed to have the 'general knowledge,
skill and experience that m a y reasonably be expected of a person carrying out
the same functions as are carried out by that director in relation to the
company'.46 This reflects the common-law standard of the duty of care of
directors.47 A n objective standard of competence to determine liability has thus
been imported into the section.48 This objective standard is the minimum
standard of skill, knowledge and experience required, but it m a y be increased
by taking into account an individual director's subjective attributes.49 The test is
therefore both objective and subjective and accordingly higher than expected
traditionally under the c o m m o n law.50 Section 214 provides a defence where
the court is satisfied that the director took every step with a view to minimising
the potential loss to the company's creditors after he became, or should have
become, aware that the company could not have avoided insolvent
liquidation.51
Shortly after the enactment of s 214 English company lawyers anxiously waited
to see how the section would in practice be applied to groups of companies. It
does not seem, however, that this section has made life much easier for
45 Section 214(2) of the Insolvency Act 1986 (UK). See also T E Cooke and A Hicks, 'Wrongful trading - predicting insolvency' (1993) JBL 338, where the authors discuss methods used by the courts to determine when a director should have concluded that insolvent liquidation was
inevitable. 46 Section 214(4)(a) of the Insolvency Act 1986 (UK). 47 Re D 'Jan of London Ltd [1994] 1 B C L C 561. 48 G P Stapledon, "The A WA case: non-executive directors, auditors, and corporate governance issues in court' in D D Prentice and PPJ Holland (eds) Contemporary Issues in Corporate Governance (1993) 187 at 112-113; F Oditah, 'Wrongful trading' [1990] LMCLQ 205 at 212. 49 R e Produce Marketing Consortium Ltd (No 2) (1989) B C L C 5 20 a 15 50. S ee further M R Pasban, 'A review of directors' liabilities of an insolvent company in the U S and England' (2001) JBL 33 at 46; S Wheeler, 'Swelling the assets for distribution in corporate insolvency'
(1993) JBL 256 at 264. 50 For the traditional test under the common law, see Re City Equitable Fire Insurance Co Ltd
[1925] Ch 407 discussed in Ch 4 para 4.4.1. 51 Section 214(3) read with s 214(4) of the Insolvency Act 1986 (UK). This is the only defence. 52 See, eg, Milman, above n 29, 246; Prentice, 'A survey of the law relating to corporate groups
in the United Kingdom', above n 29, 314 fh 51.
191
liquidators seeking to hold the holding company liable for the debts of its
subsidiary. Gower in the 5th edition of his book Principles of Modern Company
Law wrote that it should generally be easier for a liquidator to prove that a
holding company (as opposed to an individual) was a shadow director and that
it knew or ought to have known about the impending insolvency.5 This is
because the holding company is likely to require its subsidiaries to afford it
monthly or quarterly financial statements, and is true even in the most loosely
organised or decentralised group. Also, the accounts of the holding company
and those of its subsidiaries generally have to be consolidated annually. Gower
concluded:54
Hence a parent company will either have to allow the board of a subsidiary to act independently in the sole interest of the subsidiary, free from directions or instructions from above, or face the possibility that it will have to contribute to the payment of the subsidiary's creditors if it allows the subsidiary into insolvent liquidation. This is a considerable step in the direction of rationalising the legal
position of groups.
In the 6th edition of Principles of Modern Company Law, edited by Davies, this
initial enthusiasm is slightly restrained. Davies has omitted the above passage
and replaced it with the following passage, which holds back on the importance
of s 214 for liability in corporate groups:55
In relation to parent companies, such a degree of cession of autonomy by the subsidiary may be more easily found, but much will still depend upon how exactly intra-group relationships are established. The degree of control exercised by parent companies may vary from detailed day-to-day control to virtual independence, with many variations in between. It would seem that the establishment of business guidelines within which the subsidiary had to operate would not make the parent inevitably a shadow director of the subsidiary. Thus, whether the courts will take the opportunity afforded by the wrongful trading provisions to rationalize the legal position of groups of companies remains to be seen.
Looking at Re Augustus Bamett, it is not certain what the outcome would
have been if s 214 had been in place when the case was decided. It would not
L C B Gower, Gower's Principles of Modern Company Law (1992). 54 Ibid 113. 55 Davies, above n 42, 154. 56 [1986] B C L C 170.
192
have b een n ecessary t o show that Rumasa was a party to the carrying on of
Augustus Barnett's business under the wrongful trading provisions. The degree
of control under s 214 is merely that of shadow director. The definition of
shadow director in s 251 of the Insolvency Act 1986 (UK) would probably
impose a much lower degree of control exercised by a holding company over its
subsidiary.57 The decision itself does not provide an answer, because it was
unnecessary for the judge to decide to what extent Rumasa interfered with the
policy of its subsidiary. It has been pointed out, however, that the fact that
Rumasa provided capital to Augustus Bamett would not have been sufficient to CO
make it a shadow director under this section. It would only be regarded as a
shadow director if it played an active role in the management of the company
and interfered with its running by way of instructions that the board followed.5
It seems, therefore, as though the result would have been the same as under s
332 of the Companies Act and that it would not have been possible to hold
Rumasa liable for wrongful trading as a shadow director under s 214 of the
Insolvency Act 1986 (UK).
6.2.2 Position in Australia
As stated above, the original insolvent trading provisions contained in the
Corporations Act were based on the United Kingdom model of wrongful
trading. In 1 988, however, the Australian Law Reform Commission ( A L R C )
recommended, in the Harmer Report, that the insolvent trading provisions of
the then Companies Code should be restructured.60 Its most important
recommendation in this context was that directors should be placed under a
57 A Wilkinson, 'Piercing the corporate veil and the Insolvency Act 1986' (1987) 8 Co Law 124 at 127. See also D Prentice, 'Corporate personality, limited liability and the protection of creditors' in R Grantham and C Rickett (eds) Corporate Personality in the 20th Century (1998)
99 at 111-125. 58 See D D Prentice, 'Fraudulent trading: parent company's liability for the debts of its subsidiary' (1987) 103 LQR 11; Muscat, above n 29, 214 fh 2; M L Lennarts, Concernaansprakelijkheid - Rechtsvergelijkende en internationaal privaatrechtelijke
beschouwingen (1999) at 140. 59 See E Bailey, H Groves and C Smith, Corporate Insolvency, Law and Practice (1992) para
16.23 at 420.
193
duty to prevent their company from trading in insolvent circumstances. The
subsequently enacted Corporate Law Reform Act 1992 (Cth) amended the
provisions relating to insolvent trading to implement the Harmer Report
reforms.61 As far as directors are concerned, the current s 588G of the
Corporations Act is of overriding importance in this context. It is probably
fair to say that s 588G of the Corporations Act has since its enactment become
the most consistently applied statutory exception to the rule in Salomon v
Salomon & Co Ltof3 in Australia. The provisions of s 588G(1) and (2) of the
Corporations Act read as follows:
(1) This section applies if: (a) a person is a director of a company at the time when the company incurs a debt; and (b) the company is insolvent at the time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and (c) at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be; and (d) that time is at or after the commencement of this Part.64
(2) By failing to prevent the company from incurring the debt, the person contravenes this section if: (a) the person is aware at that time that there are such grounds for so suspecting; or
(b) a reasonable person in a like position in a company in the company's circumstances would be so aware.
In short, s 588G of the Corporations Act provides that a director of a company
may be held personally liable for the debts of the company in certain defined
circumstances. The section applies if a person is a director of the company
0 A L R C , General Insolvency Inquiry Report No 45 (1988) (AGPS, Canberra), (Harmer Report). 61 See also the Corporate Law Reform Bill 1992, Explanatory Memorandum, paras 1,076-1,134. It should be noted that s 588G of the Corporations Act applies to debts incurred on or after 23
June 1993 and s 592 to debts incurred before this date.
[1897] A C 22. See R Baxt and T Lane, 'Developments in relation to corporate groups and the responsibility of directors - some insights and new directions' (1998) 16 C&SLJ 628 at 631. Cf A Herzberg, 'Why are there so few insolvent trading cases?' 1998 (6) Insol LawJnl 11. 64 Part 5.7B of the Corporations Act commenced on 23 June 1993.
To institute proceedings under s 588G of the Corporations Act a creditor must first obtain the consent of the liquidator (s 588R(1)), or be granted leave by the court after providing written notice of the proceedings to the liquidator (s 588T(2)).
194
when it incurs a debt and the company is insolvent, or it becomes insolvent
as a result of such debt.68 A further requirement is that at the time reasonable
grounds must exist for suspecting that the company is insolvent or would
become insolvent by incurring the debt. The section is contravened if the person
fails to prevent the company from incurring the debt and that person was aware
at the time the debt was incurred that there were grounds for suspecting the
company was or could become insolvent because of that debt.69 The section is
also contravened if a reasonable person in a like position in the company, in the
same circumstances, would have been so aware.70 The provisions of s 588G of
the Corporations Act in effect establish that directors owe a limited duty of care
to their insolvent company not to act contrary to the interests of its creditors.71
The defences are contained in s 588H of the Corporations Act. It is a defence if
it is proved that, at the time when the debt was incurred, the person had
reasonable grounds to expect, and indeed expected, that the company was
solvent. In order for this defence to be successful, it should also be proved
that, at that time the person had reasonable grounds to expect, and did expect,
that the company would remain solvent if it incurred that debt and any other
66 A 'debt' within the meaning of s 588G(1A) of the Corporations Act must be incurred before the operation of the provisions will be triggered. Despite the recent extension of s 588(1A) to cover 'uncommercial transactions', the meaning of 'debt' remains narrow. For a discussion of
uncommercial transactions, see Ch 5 para 5.2.4. 67 See the discussion in C h 7 para 7.3.1.2 for a discussion of the meaning of 'solvent'. 68 Section 588G(1) of the Corporations Act. 69 Section 588G(2) of the Corporations Act. 70 A WA Ltd v Daniels (trading as Deloitte Haskins & Sells) (1992) 10 A C L C 933. See further I Trethowan, 'Directors' personal liability for insolvent trading: at last, a degree of consensus'
(1993) C&SLI 102 at 114. 71 See also A Herzberg, 'Insolvent Trading 'Down Under" in J Ziegel (ed; Current Developments in International and Comparative Corporate Insolvency Law, (1994) 501 at 501-2. In the N e w Zealand case of Hilton International Ltd v Hilton [1989] N Z L R 442 Tipping J decided that, even in the absence of specific legislation, directors of an insolvent company owed a duty of care to creditors (at 475). See further on this case C h 5 para 5.3.4. 72 Section 588H(2) of the Corporations Act. Thus, while proof of reasonable grounds for suspecting insolvency may implicate a director, exculpation requires proof of reasonable grounds for expecting solvency. The liability provision creating the duty (s 588G) requires the
lower hurdle of 'suspicion' to be mounted in making out a case for breach of the statutory duty. This should be contrasted with s 588H(2) that requires the director to mount the higher hurdle of 'expectation' of solvency in making out a defence. In the context of corporate groups, a subsidiary m a y put up as a defence the fact that there was a reasonable expectation that the
holding company would inject more share capital into it.
195
debts that it incurred at that time. It is also a defence if it is proved that, when
the debt was incurred, the person had reasonable grounds to believe and indeed
believed that a competent and reliable person was fulfilling the responsibility of
providing adequate information about the company's solvency.74 Furthermore,
it should be proved that such person expected, on the basis of such information,
that the company was solvent and would remain so if it incurred that debt and
any other debts that it incurred at that time. It would constitute a defence for a
director if he/she can prove that, because of illness or some other good reason,
he/she did not partake in the management of the business at that time.75 Finally,
it is a defence if it is proved that the person took all reasonable steps to prevent
the company from incurring the debt.76
If directors are not successful in pleading any of these four alternative defences
available, they are obliged to compensate the company. Such compensation
would be equal to the loss or damage77 suffered by the unsecured creditors of
the company as a result of the insolvency of the company.78 The court may,
however, relieve a director from liability where proceedings are brought against
the director to pay compensation as a result of a breach of s 588G of the
Corporations Act. The court m a y do so if it appears to the court that the director
has or may have contravened s 588G of the Corporations Act but that the
director acted honestly and, taking into account all the surrounding
This defence is similar to that found in the legislation before 1992. The main difference between the two is as follows. The previous provision required the directors to prove that they did not have reasonable cause to expect that the company was insolvent. The current position requires proof that the directors indeed had reasonable grounds to expect that the company was solvent at the time the debt was incurred. See the Corporate Law Reform Bill 1992, Explanatory Memorandum, para 1093. 74 Section 588H(3) of the Corporations Act.
Section 588H(4) of the Corporations Act. Note the recent decision in Southern Cross Interiors Pty Ltd (in liq) v Deputy Commissioner of Taxation (2001) 39 A C S R 305, where Palmer J held that 'some other good reason' included deception of a wife by her husband, a co-director. This case is discussed further in Ch 7 para 7.3.2.3. 76 Section 588H(5) of the Corporations Act.
For the meaning of the phrase 'loss or damage' in this context, see Powell & Duncan v Fryer & Perry (2001) 37 A C S R 589 which is discussed in C h 7 para 7.2.
Sections 588J, 588K and 588M of the Corporations Act. While a creditor must be able to establish loss or damage in order to recover compensation for loss resulting from insolvent trading, this is not a requirement as far as a breach of fiduciary duty is concerned.
196
circumstances, the director ought fairly to be excused.79 In addition to an order
for compensation, a civil penalty order m a y be obtained against the directors or
they m a y be prosecuted criminally.80
6.2.3 Position in N e w Zealand
N e w Zealand has similar provisions relating to insolvent trading. The N e w
Zealand provisions, however, are much wider and go even further that those in
the United Kingdom or Australia, exposing directors to the debts of the
company to a far greater extent.81 These provisions are currently contained in
sections 135 and 136 of the Companies Act 1993 (NZ).82 Section 135 deals with
reckless trading and provides as follows:
See ss 1318 and 1317S of the Corporations Act. Section 1317S of the Corporations Act was introduced by the Corporate Law Economic Reform Program Act 1999 (CLERP Act) that came into operation on 13 March 2000 to address conflicting judicial interpretations as to whether s 1318 of the Corporations A ct (then: Corporations Law) was available to directors as far as breaches of the insolvent trading provisions were concerned. See further J Schultz, 'Liability of directors for corporate insolvency- the new reforms' (1993) 5 Bond L Rev 191 at 201; S M Pollard, 'Fear and loathing in the boardroom: directors confront new insolvent trading provisions' (1994) 22 A Bus L Rev 392 at 408-410; M Hyland, 'Insolvent trading - does section 1318 apply?' (1996) LSI 44; L Powers, 'Can the court excuse insolvent trading?' (1996) 7
JBFLP 160 at 160-161. 80 See Pt 9.4B of the Corporations A ct for the civil consequences of contravening the civil penalty provisions. The CLERP Act removed the criminal consequences of breaching s 588G previously contained in s 1317FA of Pt 9.4B of the Corporations Law. The criminal consequences of breaching s 5 88G are currently contained in s 588G(3) of the Corporations Act. Pursuant to s 588G(3) a director commits an offence if he or she suspected that the company was insolvent and dishonestly failed to prevent the company from incurring the debt. For the meaning of the term 'dishonestly' in a criminal context, see R v Brow [1981] V R 783, R v Harvey [1993] 2 Q d R 389, R v Bonollo [1981] V R 633, R v Love [1989] 17 N S W L R 608 and R v Ghosh [1982] 2 All E R 689. Cf also the different approaches taken by the various Justices of t he H igh C ourt i n P eters v /? (1998) 192 C L R 4 93 t o t he c oncept o f d ishonesty. S ection 1308A of the Corporations Act provides that, subject to the Corporations Act, Chapter 2 of the Criminal Code applies to all offences against such Act. Pursuant to the Criminal Code Amendment (Application) Act 2000, the federal Criminal Code, which is a schedule to the Criminal Code Act 1995 (Cth), applies to all offences against the laws of the Commonwealth on
or after 15 December 2001. 81 These provisions do not allow directors to be entrepreneurs, but only to look at the situation
from the creditors' point of view. 82 By virtue of s 301 of the Companies Act 1993 (NZ) a liquidator or creditor of a company in
liquidation may take action in respect of a breach of s 135 or s 136 of this Act.
197
Reckless trading
A director of a company must not -(a) agree to the business of the company being carried on in a manner likely to create
a substantial risk of serious loss to the company's creditors; or (b) cause or allow the business of the company to be carried on in a manner likely to
create a substantial risk of serious loss to the company's creditors.
Section 136 in turn states that directors must not agree that the company incurs
an obligation unless at that time they reasonably believe that the company will
be able to comply with such obligation when required.83 Section 136 of the
Companies Act 1993 (NZ) reads as follows:
Duty in relation to obligations
A director of a company must not agree to the company incurring an obligation unless that director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.
Some commentators are of the view that it is too easy to hold directors liable
under this provision.84 Goddard, for one, is of the opinion that the New Zealand
provisions on wrongful trading go too far. He argues that there is no rationale
for director liability where a creditor is aware of the risk and prepared to take it
and that the ability to recover from directors should be more limited in these or
circumstances. Telfer is also critical of the current provisions on wrongful
trading in New Zealand and agrees with Goddard's view.
The main criticism of s 135 of the Companies Act 1993 (NZ) is that it does not
make allowance for normal business risk, thereby stifling entrepreneurial
See also J Farrar,' The responsibility of directors and shareholders for a company's debts under N e w Zealand law' in J Ziegel (ed), Current Developments in International and Comparative Corporate Insolvency Law (1994) 521 at 545-6, who is of the view that it is likely that s 135, which is supplemented by s 136, was influenced by Nicholson v Permakraft (NZ) Ltd (in liq) [1985] 1 N Z L R 242.
For the most important criticism, see Hon Justice Tompkins, 'Directing the directors: the duties of directors under the C ompanies A ct 1993' (1994) 2 Waikato L Rev 13; Hon Justice Elias, 'Company law after ten years of reform' (NZ Law Society, The Company Law Conference 1997) at 9; J Hodder, 'Whither the Companies Act 1993?' [1997] NZU91 at 99; D Goddard, 'Corporate personality: limited recourse and its limits' in R Grantham and C Rickett (eds) Corporate Personality in the 20th Century (1998) 11.
Goddard, 'Corporate personality: limited recourse and its limits', above n 84, 61-63. See also D Goddard, 'The 1993 Act comes into its own' (1997) 8 Butt Co & Sec L Bull 94 at 95. T G W Telfer,' Risk a nd i nsolvent t rading' i n R G rantham a nd C R ickett) (eds) Corporate
Personality in the 20th Century (1998) 127 at 140-146.
198
activity. Section 135 of the Companies Act 1993 (NZ) does not allow a director
to balance future gains against the risk of loss when making a business • • 87
decision. This has the effect that directors m a y be held liable in cases not
suited t o s uch 1 iability. 11 i s i n t he n ature o f a 1 imited 1 iability company t hat
there is some risk involved to creditors. Moreover, it is a feature of a number of
high-risk businesses that there is a substantial risk of serious loss to creditors.88
Under s 135 of the Companies Act 1993 (NZ), however, directors may
potentially be held liable for risks frequently encountered by businesses.89 This
section has on occasion been described as 'a virtual warranty of solvency'.90
The main criticism of s 136 of the Companies Act 1993 (NZ) is the use of the
phrase 'on reasonable grounds', which imposes an objective standard on
directors.9 Arguably this is too burdensome.93 Some commentators have even
described it as an 'onerous liability'.94 The objection that liability is imposed on
directors where the risk is acceptable to the creditor seems to apply more
strongly to s 136 than to s 135 of the Companies Act 1993 (NZ).95 A type of
business with a high failure rate will probably not be able to accept credit from
This interpretation of s 135 of the Companies Act 1993 (NZ) was recently supported judicially for the first time in Fatupaito v Bates (2001) 9 NZCLC,262,583 at 262,597 (O'Regan J), although the really contentious issue in the case was the manner of assessment of the amount that the court should order the defendant to contribute to the company's assets by way of compensation. See further on the assessment of the amount that a director should be ordered to pay, Nippon Express (NZ) Ltd v Woodward, Re Horticultural Handling Ltd (1998) 8 N Z C L C 261,765 a 12 61,778. S ee a lso B enchmark Building S upplies Ltd v Jackson (2001) 9 N Z C L C 262,612; Lawrence v Jacobson (2001) 9 N Z C L C 262,477. 88 R Deane, 'Besieged by duties: Will the Companies Act work for directors?' (The Company Law Conference, 1994, N Z Law Society) at 3; J Dabner 'Insolvent trading: Recent developments in Australia, N e w Zealand and South Africa' (1995) JBL 283 at 305. Cf Tompkins, above n 75, 27 and B Gould 'Directors' personal liability' [1996] NZLJ431 at 438. 89 The importance of risk-taking was also recognised by the N e w Zealand Law Commission, Company Law Reform and Restatement, Report N o 9 (Wellington, 1989) at 52 and 120. 90 H Rennie and P Watts Directors' Duties and Shareholders' Rights (New Zealand Law
Society Seminar, 1996) at 36. See also D DeMott, 'Directors' duty of care and the business judgment rule: American precedents and Australian choices' (1992) 4 Bond L Rev 133 at 141,
where she argues that, in similar fashion, the Australian provisions make directors contingent
guarantors of the company's business. 91 This section is the N e w Zealand equivalent of s 588G of the Corporations Act. 92 Re Petherick Exclusive Fashions Ltd (1987) 3 N Z C L C 99,946 at 99,958; Vinyl Processors
(New Zealand) Ltd v Cant [1991] 2 N Z L R 417. 93 Telfer, 'Risk and insolvent trading', above n 86, 140-146. 94 Rennie and Watts, above n 90, 39. 95 Goddard, 'Corporate personality: limited recourse and its limits', above n 84, 58-59.
199
lenders, as directors might be hard-pressed to prove that they believed on
reasonable grounds that the business would survive in the long run.
Unlike the position in the United Kingdom and Australia, there are no particular
defences available in N e w Zealand for the benefit of a person w h o contravenes
the insolvent trading provisions. As the relevant provisions are very broad, in
interpreting them the courts would probably take into account whether in fact
there was reasonable reliance or sufficient opportunity to prevent breach of the 07
sections imposing liability.
6.3 Liability of holding company
Where a company has carried on business while it was insolvent or on the verge
of insolvency, a person qualifying as a director can be held liable in his or her
personal capacity for the debts of such company pursuant to sections 588G-Q
of the Corporations Act. In this Chapter 6 only the requirement that a person
has to be a 'director' as defined in the Corporations Act to be held liable for the
company's insolvent trading under s 588G is dealt with. The other requirements
that have to be complied with before a person will be held liable for the
company's insolvent trading under s 588G of the Corporations Act are similar
to the requirements that have to be complied with under s 588V of the
Corporations Act, and are discussed in Chapter 7.
A ' director' i s d efined widely ins 9 o f t he Corporations A ct. S imilar t o t he
position in the United Kingdom where extending liability to shadow directors is
an important feature of s 214 of the Insolvency Act 1986 (UK), the definition of
96 Deane, above, n 88. 97 See, eg, Re Whiting Yacht (1984) (in liq) (1992) 6 N Z C L C 67,680, which was decided on the provisions of the Companies Act 1955 (NZ). See further V C S Yeo and JLS Lin, 'Insolvent trading - a comparative and economic approach' (1999) 10 Aust Jnl of Corp Law 216 at 219-225.
This is also consistent with s 301(5) of the Corporations Act, in terms of which directors are
obliged to state (in the directors' statement to the annual accounts) whether or not there are reasonable grounds to believe that the company will be able to pay its debts as and when they fall due.
200
'director' in s 9 of the Corporations Act includes a shadow director.99 A
comparable provision is also contained in the Companies Act 1993 (NZ).100 In
light of the paucity of case law on this subject in Australia and in light of the
similar provisions of the company legislation in the United Kingdom and N e w
Zealand, it is useful to consider the case law on shadow directors in these two
countries as well.
It is clear from the definition of 'director' in s 9 of the Corporations Act that a
shadow director is a person in accordance with whose instructions or wishes the
directors of the company or body are accustomed to act.101 It should be noted
that previously, when the cases discussed in this Chapter 6 were decided, the
relevant provision referred to 'directions and instructions' given by the person
in respect of w h o m it had to be decided whether a shadow directorship existed.
Currently s 9 of the Corporations Act refers to such person's 'instructions or
wishes'.102
Although the concept of a shadow director is entrenched in the company
legislation of a number of countries as stated above, it has not been the subject
of a detailed consideration by the courts in these countries until fairly •I A l
recently. The first reported decision of the English courts to consider the
definition of shadow director under s 251 of the Insolvency Act 1986 (UK) is Re
a Company (No 005009 of 1987; Ex parte Copp?04 In this case the company
was carrying on business profitably until it lost a major customer. Its
Section 214(7) of the Insolvency Act 1986 (UK) expressly extends liability to include shadow
directors. 100 See s 126(l)(d) of the Companies Act 1993 (NZ), which reads as follows: 'In this Act, 'director', in relation to a company, includes ... a person in accordance with whose directions or instructions a person referred to in paragraphs (a) to (c) of this subsection may be required or is accustomed to act in respect of his or her duties and powers as a director'. 101 See the definition of 'director' in s 9 of the Corporations Act, para (b)(ii). For the danger in the possible overlap between professional advice on the one hand and direction and instruction on the other hand, see the English decision of Tasbian Ltd (No 3), Re [1991] B C C 435 at 443. See further M Markovic, 'Corporate recovery accountants: beware of the long arm of section
60(l)(b) Corporations Law' (1997) 5 Insolv Law Jnl 112. 102 See further the discussion in para 6.4.3 below. 103 Since the Companies Act 1929 (UK) a similar definition of shadow directors has appeared in
every Companies Act in the U K . The company law legislation in N e w Zealand and each of the
Australian States have also contained a similar provision.
201
profitability subsequently decreased and it started having liquidity problems.
W h e n the company reached its overdraft limit, its bank became aware for the
first time that the company's financial position was deteriorating. Since the
bank initially had confidence in the financial standing of the company, it did
not take any security in respect of the overdraft.
When the bank learned of the financial problems experienced by the company,
it instructed its o w n financial services division to investigate the matter and
prepare a report. The bank also put pressure on the company for security in
respect of the overdraft. The company granted a debenture in favour of the bank
for the overdraft, but declined into insolvent liquidation within three months.
The company and its directors took various steps to carry out the
recommendations put forward in the bank's report. The liquidators of the
company claimed that, in so doing, the company acted according to the bank's
directions and instructions and the directors did not exercise their free will as
far as the affairs of the company were concerned.105 Furthermore, the liquidator
alleged that compliance by the company and its directors with the
recommendations in the report made the bank a shadow director of the
company. The reason proffered for this view was that the bank was aware at an
early stage that the company was insolvent and did not have a reasonable
prospect of avoiding insolvent liquidation.106
The question that arose was whether the claim by the liquidators was, on the
facts before the court, obviously unsustainable. Knox J held that the liquidator's
claim that the bank was a shadow director was not obviously unsustainable and
accordingly refused to strike out the claim that the bank was liable for wrongful • 107 —
trading. This case caused significant concern in the banking community,
resulting in calls for an amendment to the definition of 'shadow director' to
make it clear that it would not be applicable to financial institutions in these
[1989] BCLC 13 (Re a Company). Ibid 15. IbtdlS.
202
circumstances. Proponents of this amendment argued that, if banks were
regarded as shadow directors in these circumstances, it would hamper their
efforts to save a company in financial difficulty.108 W h e n the matter was
subsequently heard (reported as Re MC Bacon Ltd)}09 the liquidator dropped
the claim against the bank. Millett J, who presided, was of the view that the
claim was correctly abandoned.110 This suggests that Millett J was not
persuaded by the argument that the bank was indeed a shadow director.11
The issue of shadow directors in the context of a holding company/subsidiary
relationship came before the court in Kuwait Asia Bank EC v National Mutual
Life Nominees Ltd.U2 This was an appeal to the Privy Council from the N e w
Zealand Court of Appeal. The main issue before the court involved matters of
procedure relating to the service of a statement of claim outside of the
jurisdiction. The court did, however, also consider the definition of 'director'
under s 2 of the Companies Act 1955 (NZ), the then N e w Zealand equivalent of
s 9 of the Corporations Act. In this case the Privy Council seems to have
accepted that, where appropriate, s 2 of the Companies Act 1955 (NZ) could be
applied in a group situation. This section defined 'director' as 'a person in
accordance with whose directions or instructions the persons occupying the
position of director of a company are accustomed to act.'
Kuwait Asia Bank (KAB) held a beneficial interest in 40% of the shares in AIC
Securities Ltd (AICS). B y agreement with one of the other major shareholders,
Kumutoto Holdings Ltd (Kumutoto), it was entitled to appoint two of the
company's five directors. Kumutoto was entitled to appoint the other three
107 Ibid 21. Section 214 of the Insolvency Act 1986 (UK) prohibits wrongful trading and sub-s
214(7) of this Act expressly extends liability to include shadow directors. 108 JH Farrar and B Hannigan, Farrar's Company Law (1998) at 342. 109 [1990] B C L C 324. 110 Ibid 326. 111 See further the extra-curial comments by P Millett, 'Shadow directorships, a real or imagined threat to banks?' (1991) 1 Insolv Prac 14. See also M Markovic, 'Banks and shadow
directorships: not an 'almost entirely imaginary' risk in Australia' (1998) 9 JBFLP 184. 112 [1991] 1 A C 187. For comment see A Beck, 'Jurisdiction and responsibility for nominee
directors: the Privy Council speaks' [1990] NZLI 303. See also the decision of the Privy
Council in New Zealand Guardian Trust Co Ltd v Brooks [1995] 2 B C L C 242.
203
directors. K A B nominated two of its employees, House and August, as
directors of AICS. National Mutual Life Nominees Ltd (National Mutual) was
appointed as trustee for certain unsecured depositors of AICS. AICS
covenanted with National Mutual to provide monthly and quarterly financial
certificates on behalf of the directors. Subsequently AICS went into insolvent
liquidation. The unsecured depositors of AICS instituted action against
National Mutual for breach of trust on the ground that the latter failed to
perform its duties under the deed of trust diligently and competently.
National Mutual commenced proceedings as plaintiff, seeking contributions
from v arious d efendants. Initially i t i nstituted a c laim a gainst t he a uditors o f
AICS, and thereafter against the directors and company secretary of AICS. The
latter action was subsequently consolidated with the original proceedings.
National Mutual then sought leave to join K A B as a defendant in the
consolidated proceedings, which was granted. It was the subsequent service of
proceedings on the bank outside N e w Zealand that was the subject of the appeal
to the Privy Council.
National Mutual pleaded four causes of action against KAB.113 National Mutual
alleged, inter alia, that the employees House and August were persons
occupying a position of directors of AICS who were accustomed to act in
accordance with the directions of KAB. 1 1 4 The plaintiff argued that,
accordingly, K A B was a (shadow) director of AICS in terms of s 2(1) of the
Companies Act 1955 (NZ) and that it should therefore be held liable for any
losses that National Mutual incurred by the conduct of the two employees.115
Lord Lowry delivered the advice of the Judicial Committee/His Lordship was
of the view that the statement of claim did not disclose any cause of action
against K A B and that the bank could not be a shadow director under s 2(1) of
These were (1) that the bank was vicariously liable for the actions of its nominees; (2) that the two directors appointed by the bank were agents of the bank; (3) that the bank owed a duty of care; and (4) that the bank was a shadow director of AICS. 114 See further D Keenan, 'Banks as shadow directors' (1991) 17 Accountancy 41 at 41-42.
204
the Companies Act 1955 (NZ).116 Although it was in the interest of K A B to see
to it that the directors appointed by it duly performed their duties to AICS, the
bank was not under a duty to do so. In this regard Lord Lowry stated:' 1.117
In the present case House and August were two out of five directors, the other three being appointees of Kumutoto. And there is no allegation (and it is also inherently unlikely) that the directors in these circumstances were accustomed to act on the direction or instruction of the bank...The only rights and remedies of the plaintiff were against AICS for breach of contract and against the directors of AICS who owed a duty to the plaintiff ... House and August were directors but the bank was not a director. The bank never accepted or assumed any duty of care towards the plaintiff. In the absence of fraud or bad faith on the part of the bank, no liability attached to the bank in favour of the plaintiff for any instructions or advice given by the bank to House and August. Of course, it was in the interests of the bank to give good advice and to see that House and August conscientiously and competently performed their duties both under the trust deed and as directors of AICS.
These words by Lord Lowry have consistently been cited as authority that,
before a person could be regarded as a (shadow) director, all the directors of the
company had to be accustomed to act in accordance with the person's directions
or instructions.118 It has, however, with respect, correctly, been suggested that
this passage does not provide unequivocal guidance in this regard, but merely
confirms that exercising control over a minority of directors does not constitute
a shadow directorship.119 In this regard Hartman J in Re Unisoft Group Ltd (No
2) held that, for a third party to be a shadow director, the whole of the board,
or at least a governing majority of it, had to be accustomed to act on the
instructions of that third party.121 It was held to be insufficient that one of the
company's directors was accustomed to act in accordance with the third party's
instructions.122
115 Kuwait [1991] 1 A C 187 at 203. 1,6 Ibid 224. 1,7 Ibid 223-224. 118 M Markovic, 'The law of shadow directorships' (1996) 6 AustJnl of Corp Law 323 at 330. 119 M D Hobson, 'The law of shadow directorships' (1998) 10 BondL Rev 184 at 195. See further M Standen, 'Liabilities in the group context' (1998) 10 Austl Com Sec 444 at 446. 120 [1994] B C C 766. X2i Ibidll5. 122 Ibid.
205
In Re Hydrodan123 the application of the shadow director concept in the context
of a corporate group had to be considered once more. Although the scope of
liability of the directors of a holding company for the actions of its subsidiary
company in the context of wrongful trading was the main issue explored, Millet
J made certain obiter comments, relevant to the liability of a holding company
as a shadow director.124 In this case, Hydrodan (Corby) Ltd (Hydrodan), a
wholly-owned indirect subsidiary of Eagle Trust pic, went into insolvent
liquidation. The liquidator sought to hold two of the directors of Eagle Trust pic
liable for wrongful trading under s 214 of the Insolvency Act 1986 (UK),
claiming that they were shadow directors.125 Hydrodan only had two validly
appointed directors. The two directors of Eagle Trust pic had never been
appointed directors of Hydrodan.
Millett J held that if Eagle Trust pic had given directions to the board of
Hydrodan and the directors of the latter company were accustomed to act on
such instructions, Eagle Trust pic would have been a shadow director. It was
thus clear that, so far as wrongful trading under s 214 was concerned, it was
potentially possible for a holding company to be held liable for the debts of its
subsidiary where the holding company qualified as a shadow director of the
subsidiary. It did not necessarily follow, however, that because a
holding/subsidiary relationship existed, the holding company would incur
liability as a shadow director where the subsidiary slid into insolvent
liquidation. In other words, a holding company is not liable for the debts of its
subsidiary because of its status.
UJ [1994] B C C 161.
Although the wrongful trading provisions were not tailor-made for insolvent corporate groups, there is general consensus that they do apply to them. T Hadden, 'The regulation of corporate groups in Australia' (1992) 15 UNSWLJ 61 has also recognised the proposition that the defaulting officer provisions could apply in the corporate group context.
Millett J stressed that s 214 liability applied to dejure, de facto as well as shadow directors: Re Hydrodan [1994] B C C 161 at 162. 126 Re Hydrodan [1994] B C C 161 at 164. However, on the facts it was held differently.
206
Millett J rejected the contention that the directors of Eagle Trust pic themselves
would necessarily be shadow directors.127 If the directors of the holding
company acted collectively when they issued instructions to the subsidiary, they
would be regarded as agents of the holding company.128 In such an event only
the holding company could be held liable (as shadow director).129 Although
individual directors of a holding company could be potentially liable for
wrongful trading in the event of the subsidiary company's insolvency, a
sufficient nexus between individual directors of the holding company and the
trading activities of the subsidiary was necessary, in order to establish a shadow
directorship.130 This would be the case, for example, where directors of the
holding company issued instructions individually to the directors of the
subsidiary on a regular basis.131
Millett J stated obiter that the mere fact that Eagle Trust pic, in its capacity as
shareholder, approved of the disposal of the subsidiary's assets by its directors
was in any event not sufficient to constitute Eagle Trust pic a shadow director
of the subsidiary. In Millet J's view nothing in this case exposed the holding
company to liability for the decision or constituted it a shadow director
'[pjrovided that the decision is made by the directors of the subsidiary,
exercising their o w n independent discretion and judgement whether or not to
dispose of the assets in question, and that the parent company only approves or 1 "X"X
authorises t he d ecision'. M illett J p reviously s tated t hat t here h ad t o b e ' a
pattern of behaviour in which the board did not exercise any discretion or
judgment of its own, but acted in accordance with the directions of others'.134
127 Re Hydrodan [1994] B C C 161at 164. 128 They would be acting as an organ of the company in such an event. 129 Re Hydrodan [1994] B C C 161 atl64. 130 If this cannot be proved, it can perhaps be shown that the directors owed fiduciary duties
other than to the holding company. 131 Re Hydrodan [1994] B C C 161 atl64. 132 Ibid 165. 133 Ibid. 134 Ibid 163.
207
Some commentators are of the view that Millett J interpreted the statutory
definition of 'shadow director' in s 251 of the Insolvency Act 1986 (UK) too
narrowly.135 They argue that, on the strict interpretation of the judgment of
Millett J it becomes extremely difficult to hold a company liable as shadow
director. A less strict interpretation should rather be "followed, to the effect that
the requirement that the directors should be accustomed to act on the
instructions of the holding company would be complied with, even if the
subsidiary has retained some discretion of its o w n on a particular occasion.
Otherwise it would mean that if the board of directors has e xercised its own
judgment on one occasion on perhaps a small matter there could be no shadow
directors, even though on all other occasions the board has acted on instructions
from the holding company.136
Also indicating a reluctance to hold banks and other financiers liable as shadow
directors is the decision of Re PFTZM Ltd (in liquidation)}31 Humberclyde
Finance Group Ltd (Humberclyde) financed the activities of P F T Z M Ltd (the
company) by way of a loan. The directors subsequently informed Humberclyde
that the profits of the company were insufficient to cover the repayments.
Thereafter the managing director of the company and officers of Humberclyde
held weekly management meetings. At these meetings it was arranged that all
receipts of the company should be paid into an account in the name of
Humberclyde. Periodic transfers were made from this account to that of the
company. The company's financial position deteriorated before it eventually
went into liquidation.
N R Campbell, 'Liability as a shadow director' (1994) JBL 609 at 613; G K Morse, 'Shadow and de facto directors in the context of proceedings for disqualification on the grounds of unfitness and wrongful trading' in B A K Rider, The Corporate Dimension (1998) at 125; Lennarts, above n 58, 145. 136 Campbell, above n 135, 613; Morse, above n 135, 125. See further Lennarts, above n 58, 145, where she states that Eagle Trust could indeed be a shadow director of one of the other subsidiaries (a direct holding company of Hydrodan) if it was instrumental in the sale, but the liquidator has not put this case to the court. Lennarts states that it is to be hoped that liquidators would better motivate their claims in terms of s 214 of the Insolvency Act 1986 (UK). See also
G Bhattacharyya, lRe Hydrodan (Corby) Ltd - shadow directors and wrongful trading' (1994) 15 Co Law 151.
208
O n the issue whether the Humberclyde officers were shadow directors, Judge
Paul Baker Q C distinguished between the directions proffered by a shadow
director and the Humberclyde officers:138
This definition [of 'shadow director' in section 251 of the Insolvency Act 1986 (UK)] is directed to the case where the nominees are put up but in fact behind them strings are being pulled by some other persons who do not put themselves forward as appointed directors. In this case the involvement of the applicants here was thrust upon them by the insolvency of the company. They were not accustomed to give directions. The actions they took, as I see it, were simply directed to trying to rescue what they could out of the company using their undoubled rights as secured creditors.
The court held that, despite the participation by the bank officers in weekly
management meetings over a two-year period, the bank was not a shadow
director of the company. Judge Paul Baker Q C concluded that the officers of
the bank were not acting as directors of the company. The important point was
that the officers of Humberclyde were protecting Humberclyde's interests and
merely imposing terms in an effort to do so. It was not a case where the
directors of the company were accustomed to act in accordance with the
directions of others. It was rather a case where the creditor imposed terms for
the continuation of credit in the light of imminent default.139 The directors of
the company could choose to refuse or to accept these terms. In practice a very
fine line exists between these two situations.
It also appears from the New Zealand High Court decision in Dairy
Containers140 that a company may in principle be a shadow director, although
there was in this case insufficient evidence to support such a claim. Dairy
Containers Ltd was established as a wholly-owned subsidiary of the N e w
Zealand Dairy Board.141 Dairy Containers Ltd operated as a separate company,
although the N e w Zealand Dairy Board provided general guidelines regarding
its operation. Examples of these guidelines were that Dairy Containers Ltd had
137 [1995] 2 BCLC 354. 138 Ibid 367. 139 Ibid 368. 140 [1995] 2 NZLR 30. 141 The N e w Zealand Dairy Board treated it as a division and not a subsidiary.
209
to manufacture cans at the lowest price, Dairy Containers Ltd could not make a
profit, and Dairy Containers Ltd could invest surplus funds, but only in the New
Zealand Dairy Board. The directors of the subsidiary were all senior employees
of the holding company. The question arose whether the holding company was
responsible for the actions of its employees, who had failed to carry out their
duties properly. One of the questions that had to be determined was whether the
holding company was a shadow director in terms of the New Zealand
equivalent of s 9 of the Corporations Act.
In the course of his judgment Thomas J considered the decision of the Privy
Council in Kuwait and stated the following:143
Their Lordships' apparent reasoning that the words 'persons occupying the position of directors' applies to the directors as a whole, and not to individual directors, would not apply in this case. This is not a case where only a few of the directors were employee-directors; all directors of D C L were employed by N Z D B . But Their Lordships go on to say that the Companies Act cannot impose a duty on the employer which it has not assumed. With great respect, for the employer to fall within the definition of 'director' I do not think that the question whether he or she has assumed any duty of care is relevant. The question is one of fact: a re t he d hectors a ccustomed t o a ct o n the d irections o r i nstructions o f another person? If they are, that person is subject to the duties imposed on directors under the Act.
Thomas J found that the holding company in this case was not a shadow
director, because the holding company had not in fact issued identifiable
directions or instructions to the subsidiary's directors in respect of their duties
as directors.144 His Honour stated that it was important that a holding company
should not be held liable as a shadow director of its subsidiary where it merely
Section 2 of the Companies Act 1955 (NZ) (as amended) provides that the term 'director' includes 'a person in accordance with whose directions or instructions the persons occupying the position of directors of a company are accustomed to act'. Section 126 of the Companies Act 1993 (NZ) contains the same provision. O n the other question that arose in Dairy Containers [1995] 2 N Z L R 30, namely, whether an appointer may be held vicariously liable for its nominee directors' wrongdoing, the court seemed to favour the view that this was possible. See further R Baxt, 'Can nominating companies be vicariously liable for the negligence of their nominee directors?' (1995) 69 ALI 684; Justice E W Thomas, 'The role of nominee directors and the liability of their appointors' in I Ramsay Corporate Governance and the Duties of Company Directors (1997); J Pizer, 'Holding an appointor vicariously liable for its nominee
director's wrongdoing - an Australian roadmap' (1997) 15 C&SLJ SI. 143 Dairy Containers [1995] 2 N Z L R 30 at 90. 144 Ibid 91.
210
lays down broad policy guidelines for its group companies. The section on
shadow directors was not aimed at preventing general guidance of this nature
by the holding company. It should not, therefore, give rise to shadow director
status. In this regard Thomas J linked the issue of directions and instructions
to the capacity in which a person is acting at the time.146 His Honour
distinguished between the capacity of the two directors of Dairy Containers Ltd
as directors and their capacity as employees of NZDB.147 On this basis the
employees did not fall within the definition of 'shadow director':148
As employees of NZDB I do not doubt that they were accustomed to act in accordance with their employer's directions or instructions, but as directors of D C L they did not as a matter of fact receive directions or instructions from the parent company. They were, as directors of D C L , standing (or sitting) in the shoes of N Z D B at the board table, but they had not and did not receive directions or instructions from their employer. Even when a firm instruction from N Z D B was made, it was directed at the company and not at the directors.. .No fiction or artificiality is involved, however, in regarding the directors of D C L as employees of N Z D B acting in the course of their employment, for that is precisely what they were doing. But that does not mean that in carrying out their duties as directors of D C L they were acting on the directions or instructions of N Z D B as contemplated in the statutory definition. As its employees, N Z D B delegated the responsibility of running the company in its interests to them. But it did not give them identifiable directions or instructions as such.
Although the correct result was arguably achieved in Dairy Containers}49 the
approach of Millett J in Re Hydrodan is preferable. According to Millett J
shadow director status will arise only where the directors do not exercise any
discretion or judgment of their own in acting in accordance with the directions
of others.150 Despite the fact that the statute does not specifically provide for
this, it is a commercially sensible result and reflects the underlying policy of the
145 R Baxt, 'One ' A W A case' is not enough: the turning of the screws for directors' (1995) 13
C&SLI 414 at 430-433. 146 Dairy Containers [1995] 2 N Z L R 30 at 91. 147 Ibid. Former s 60(1 )(b) (or the current s 9 of the Corporations Act) does not state to w h o m the directions or instructions must be given. It appears that Thomas J in Dairy Containers [1995] 2 N Z L R 30 at 90 has accepted that the wording of the section requires that the directions or instructions should be issued to the board of directors. In finding that no shadow directorship had b een e stablished, h is H onour s tated t hat, e ven when a firm i nstruction from t he h olding company was made, it was directed at the company and not at the directors. For a discussion of the view t hat t his i nterpretation i s c ontrary t o the intention o f t he 1 egislation, s ee M arkovic,
'The law of shadow directorships', above n 118, 329 and Hobson, above n 119, 203-205. 148 Dairy Containers [1995] 2 N Z L R 30 at 91. 149 [1995] 2 N Z L R 30.
211
legislation. The approach of Millet J in Re Hydrodan can be applied to the
facts of Dairy Containers without changing the desired outcome and without
resorting to artificial distinctions.152 There is much to be said for not holding
the holding company liable for the debts of its subsidiary where the locus of
effective decision-making lies with the board of the subsidiary. This aspect is
taken up again in Chapter IO.153
In Antico154 the Supreme Court of New South Wales adopted the approach also
proposed by Baxt. This case, concerned with the liability of directors for
insolvent trading, was the first Australian case in which the courts considered
the extended definition of 'director'.155 Pioneer International Ltd (Pioneer)
indirectly owned 4 2 % of the shares of Giant Resources Ltd (Giant) and was the
most significant shareholder in Giant, with the next most significant
shareholder holding 1 0 % of the shares. The Chairman, Managing Director and
Deputy Managing Director of Pioneer were appointed as non-executive
directors of Giant. Standard Chartered Bank Australia Ltd (Standard) and Giant
entered into a bill discount and acceptance facility of $30 million. The facility
was given in connection with a proposed acquisition of shares in a third
company. Standard was given security over such shares but held no other
security. T w o other banks held security interests over the majority of Giant's
assets.
When Giant ran into financial difficulties Giant rolled over bills and
renegotiated the facility with Standard to extend it on several occasions.
Pioneer also provided funding to Giant in order to assist it with its cash flow
150 Re Hydrodan [1994] B C C Ch D 161 at 163. This approach was recently adopted in Re PFTZM Ltd (in liquidation) [ 1995] 2 B C L C 354. 151 [1994] B C C 161. 152 C/the proposed model in Ch lOpara 10.2.2, linking liability fordebt with the decision
making power responsible for it. 153 See Ch 10 para 10.2. 154 (1995) 38 N S W L R 290.
Although it would now be irrelevant to analyse in detail the operation of s 556 of the Companies Code (the predecessor of current insolvent trading provisions), as the insolvent
trading provisions have been substantially amended in 1993, the extended definition of 'director' under s 5 of the Companies Code is very similar to that of the Corporations Act.
212
problems. Pioneer took out a second ranking security interest over the majority
of Giant's assets in which the two banks, but not Standard, had security
interests. Pioneer's interest was in respect of moneys already provided as well
as funding to be provided to Giant in the future. O n the occasions when Giant's
facility with Standard was renegotiated, and bills under this facility rolled over,
Giant did not disclose the fact that it was already in default under a separate
finance arrangement with one of the other two banks. Giant also failed to
disclose that it had given security over most of its assets to Pioneer for
advances by Pioneer to Giant. Giant was required under the facility documents
of Standard to disclose both these matters to Standard.
Some time later Giant informed Standard that it could not meet its obligations
under bills that had been drawn and accepted by Standard that were maturing at
that time. Giant undertook to repay Standard when certain proposed asset sales
and restructures were finalised. Standard then made available to Giant an
overdraft facility in an amount equal to the face value of outstanding bills.
W h e n winding up proceedings were brought against Giant, Standard sought to
recover the moneys owing by Giant under the overdraft facility from Pioneer, a
finance subsidiary of Pioneer, and Pioneer's three nominee directors on Giant's
board. One of the bases relied on by Standard was the insolvent trading
provisions, then s 556 of the Companies Code}56 For Pioneer to be held liable,
it was necessary to establish that Pioneer was a shadow director of Giant.
Hodgson J was of the view that the fact that Pioneer held 42% of the shares in
Giant and had three nominee directors out of eight on its board alone were not
sufficient to make Pioneer either 'a director or a person w h o took part in the
management of Giant'.157 His Honour stated:158
156 Section 556 of the Companies Code was the predecessor of sections 592 and 588G of the
Corporations Act. 157 Antico (1995) 38 N S W L R 290 at 324. Hodgson J followed the decision of Kuwait [1991] 1
A C 187 in deciding that the mere fact that Pioneer had nominee directors on the board of Giant
was not enough to constitute Pioneer a shadow director of Giant. 158 Antico (1995) 38 N S W L R 290 at 324.
213
It is clear that the mere fact that Pioneer owned indirectly 4 2 % of the shares of
Giant, and had three nominees on its board, is insufficient to make Pioneer either a director or a person who took part in the management of Giant. Furthermore, in general, in the absence of evidence to the contrary, the Court would take it that actions performed by Antico, Quirk and Gardiner, as directors of Giant, were actions undertaken by them on behalf of Giant, and not as officers or agents of
Pioneer.
However, the Supreme Court of New South Wales took into account other
factors, s uch a s t he h igh d egree o f m anagement a nd c ontrol b y P ioneer o ver
Giant, to find that these factors taken together were sufficient to support a
finding that Pioneer in effect controlled Giant.159 A s a result it found that
Pioneer was a shadow director of Giant. First, although the fact that Pioneer
held 4 2 % of the shares in Giant was not on its o w n conclusive that Pioneer was
a shadow director, it gave Pioneer ' effective control', b ecause the next most
significant shareholder held 1 0 % of the shares. Moreover, Giant's annual report
admitted Pioneer's control.160 Second, Pioneer imposed financial reporting
requirements on Giant, such that it was required to report monthly to and
provide full access to all financial records.161 Third, there was evidence that
Pioneer's influence delayed a takeover and the sale of certain shares.162 Fourth,
on certain major strategic questions relating to the acquisition of Pioneer's
mineral assets by Giant and decided during the relevant period, Pioneer took the
effective decisions. Fifth, Pioneer exercised management and financial
control over Giant. Pioneer made the provision of finance conditional upon a
number of conditions. This included the instruction of particular outside
consultants, and the restructuring of Giant's board to give Pioneer three
directorships, one being the chair.164 Furthermore, Pioneer effectively made the
decision to fund Giant on the basis of security provided by Giant, a decision
simply accepted by Giant.165 In this regard Hodgson J stated:166
The case of Kuwait [1991] 1 A C 187 was distinguished on this point: Antico (1995) 3 8 N S W L R 290 at 323-324. See further Baxt, 'One ' A W A case' is not enough: the turning of the screws for directors', above n 145, 430-433; J Farrar 'Legal issues involving corporate groups'
(1998) 16 C & S L 7 184 at 188. 160 Antico (1995) 38 N S W L R 290 at 324. 161 Ibid. 162 Ibid. 163 Ibid 324-325. 164 Ibid 325-326. 165 Ibid 326.
214
I accept that a holding company is not a director of its subsidiaries, merely because it has control of how the boards of its subsidiaries are constituted, that, it is not uncommon for lenders to impose conditions on loans, including conditions as to the application of funds and disclosure of the borrower's affairs; and that it is even less uncommon for lenders to require security for a loan, and then to require the sale of property over which the security is given. Certainly, these factors on their o w n would not amount to assuming the position of a director, or taking part in the management of a borrower company. However, the circumstances in this case go far beyond these matters.
Hodgson J found on the evidence that they have carefully considered, in their
capacity as directors of Pioneer, these strategic decisions regarding the affairs
of Giant. His Honour found, however, that they did not give any separate
consideration to such decisions in their capacity as directors of Giant. The
directors of Giant merely accepted the decisions that had effectively been made
by Pioneer.167
On a different note, it is important to point out that Pioneer did not by any
stretch of the imagination fall into the definition of holding company of Giant
contained in the Corporations Act. This is important, because Giant was
insolvent and had substantial debts. If Pioneer were the holding company of
Giant, then Pioneer could be held liable for the debts of Giant on the strength of
s 588V of the Corporations Act, discussed in Chapter 7. But liability could not
on the facts of this case be attached to Pioneer under s 588V of the
Corporations Act. Therefore it was crucial whether Pioneer could be regarded
as the shadow director of Giant. Only then could it be held liable for the debts
of the latter.
The decision of ASC v AS Nominees Ltd16* in the Federal Court of Australia
casts further light on the shadow director concept, which at the time also
referred to a person in accordance with whose directions or instructions the
Ibid 321.
Ibid 32%. (1995) 18 A C S R 459 {AS Nominees).
215
directors were accustomed to act.169 M r Windsor (Windsor) was the founder of
the A S Group of companies. T w o of the companies, A S Nominees Ltd (ASN)
and Ample Funds Ltd (Ample), were trustees of various superannuation and
unit trusts with, for all p ractical purposes, common boards of directors. It is
important to note that Windsor was not a director of either of these two
companies. Windsor and one of the other group companies (of which he was
also a director) each held one share in a third company, A S Securities Ltd
(Securities). Windsor directly controlled Securities. Securities acted as manager
of A S N and Ample as well as the trusts under their control. Finn J described
Windsor's relationship with the group as a 'strategic presence'.170
The then Australian Securities Commission (ASC)171 brought an application to
wind up A S N , Ample and Securities under what was then s 461(k) of the
Corporations Law. The application was based on an alleged lack of propriety
and competence in the management and conduct of the affairs of the three
companies concerned. In support of its application the A S C argued that
Windsor was a (shadow) director of A S N and Ample by virtue of the then s 60
of t he Corporations L aw. T he A SC s ubmitted that W indsor w as a p erson i n
accordance with whose directions or instructions the directors of A S N and
Ample were accustomed to act, within the meaning of this section. If this
argument w ere s uccessful, i t w ould e nable t he c ourt t o find t hat t here was a
conflict of interest as far as the dealings between the companies were
concerned. Windsor argued that he was not a director of A S N or Ample, as his
advice to the directors of these two companies was given 'in the proper
performance of the functions attaching to ... [his] business relationship with the 1 79
directors' of each company.
Ibid 509. Previously, at the time of the case, the definition of 'director' was contained in s 60(1 )(b) of the Corporations Law. The wording was slightly different to what it is today but not in material respects. 170 AS Nominees (1995) 18 A C S R 459 at 462.
The A S C was the predecessor of ASIC, the Australian Securities and Investments Commission. 172 AS Nominees (1995) 18 A C S R 459 at 508. In other words, he argued that he was not a
shadow director by reason only that the directors acted on advice given by him in a professional capacity.
216
Finn J was not prepared to hold that Windsor, as manager of the relevant
companies, merely offered advice to their respective boards. Windsor could
therefore not successfully rely o n the ' business relationship exemption' i f he
was otherwise found to be a shadow director of the companies involved. In
considering whether Windsor was a director of A S N and Ample, his Honour
scrutinised the relationship that Windsor had had with the boards of these two
companies. Although Finn J did not specifically deal with the matter under the
different elements of the definition of 'director', it is convenient to distinguish
at least between the elements 'accustomed to act' and 'directions and
instructions'.
There was sufficient evidence that the directors were 'accustomed to act' on,
and willingly complied with, Windsor's instructions. In this regard Finn J found
that Windsor induced a series of transactions that either constituted or resulted
in breaches of trust. This brought Ample to the verge of financial ruin.
Furthermore, the directors of A S N and Ample entered into transactions
introduced by Windsor without due deliberation. In some cases, they even acted
recklessly. In addition, the directors of A S N and Ample entered into
transactions in a manner calculated to protect or advance the interests of
Windsor. As an example of Windsor's extraordinary control over the boards of
directors m a y be mentioned the occasion where he dismissed Ample's whole
board when a dispute arose. Although the management agreement did not
confer such power on Windsor, the directors did not question his power to
dismiss them.
As far as the element of 'directions and instructions' was concerned, Finn J
found that the directors did not always and for all purposes act completely as
puppets of Windsor, without exercising any discretion at all in matters relating
to the company.174 Moreover, the board did not act in a manner reminiscent of
AS Nominees (1995) 18 A C S R 459 at 508. Ibid 509.
217
errant nominee directors, unduly favouring the interests of their appointer.
Further, the 'directions and instructions' did not encompass all the decisions of
the board.176 However, Finn J held that none of these things detracted from his
view that Windsor was a shadow director. In particular, his Honour held that
the reference to shadow director 'does not ... require that there be directions or
instructions embracing all matters involving the board. Rather it only requires
that, as and when the directors are directed or instructed, they are accustomed to
act as the section requires.'
In the circumstances Finn J found that Windsor was a director of both ASN and
Ample by virtue of the then s 60 of the Corporations Law. His Honour held that
is was not necessary to have proof of formal directions or instructions for a
shadow directorship to arise. Finn J stated:178
This finding [that Windsor is a director of both A S Nominees and Ample as a result of s 60 of the Corporations Law] [now: Corporations Act] does not, in m y opinion, require it to be shown that formal directions or instructions were given in those matters in which he [Windsor] involved himself. The formal command is by no means always necessary to secure as of course compliance with what is sought. There is no reason to construe the section so as to deny this.
Finn J concluded that the idea behind s 60 of the Corporations Law was that
'the third party calls the tune and the directors dance in their capacity as 1 7Q
directors'. That aptly described Windsor's role. The crucial question posed
by s 60 of the Corporations Law was: 'Where, for some or all purposes, is the
locus of effective decision-making?'180 If it resided in a third party such as
Windsor, and if such person could not successfully rely on the 'business
relationship exemption' provided for, it was open to find that such person was a
director for purposes of the Corporations Law}*]
175 Ibid. Ibid.
176
'" Ibid. mIbid. X19Ibid. 180 Ibid 510. See further R C Schulte, Groups of Companies: The Parent-Subsidiary Relationship and Creditors' Remedies (1999) 198-205. 181 AS Nominees (1995) 18 A C S R 459 at 510.
218
6.4 Evaluation of position of group creditors
From the above discussion it is clear that where the insolvent trading provisions
of the Corporations Act have been contravened, the holding company may be
held liable as shadow director for the debts of its subsidiary pursuant to s 588G
of the Corporations Act. The first insolvent trading case under s 588G,
Metropolitan Fire Systems Pty Ltd v Miller1*2 was handed down only about
four years after the section became operative. It has been argued, however, that
the paucity of cases on s 588G of the Corporations Act has nothing to do with
any deficiencies inherent in the insolvent trading provisions. Indeed, it has been
argued that the main reasons for the dearth of cases under s 588G of the
Corporations Act resulted from the increase in the use of voluntary
administrations.x *3
However, a practical problem that arises under s 588G of the Corporations Act
is t hat i t m ay p rove d ifficult t o s how t hat a p erson a nd, m ore s pecifically, a
holding company, is a shadow director.184 This difficulty has been compounded
by the uncertainty that exists regarding the meaning of some of the elements
used in the definition of a shadow director, which are discussed below.
6.4.1 Meaning of 'directors of the body'
One of the elements of the definition of 'director' in s 9 of the Corporations Act
is that the 'directors of the body'185 are accustomed to act in accordance with
182 (1997) 23 A C S R 699. See further on this case Ch 7 paras 7.3.1.2 and 7.3.1.3. 183 See Herzberg, 'Why are there so few insolvent trading cases?', above n 63. For a discussion of the perceived shortcomings in the regime in Pt 5.3A of the Corporations A ct (regulating
voluntary administrations), including its effect on the current level of unsecured creditor protection contained in the insolvent trading provisions, see N Coburn, Insolvent Trading - A Practical Guide (1998) 75; J Purcell, 'A public policy analysis of the interaction between
insolvent trading and Part 5.3A administrations' (2000) 8 Insol Law Jnl 202 at 206ff. 184 IM Ramsay, 'Holding Company Liability for the Debts of an Insolvent Subsidiary: A Law and Economics Perspective' (1994) 17 UNSWLI520 at 528-530. 185 It should be noted that the definition of shadow director' in s 9 para (b)(ii) of the Corporations Act has been amended recently by replacing the phrase 'directors of the body'
with the phrase 'directors of the company or body'. The former phrase 'directors of the body' is used for purposes of this discussion, since it was still in use when most of the relevant cases on
219
the directions or instructions of a person w h o is not validly appointed as a
director.186 While 'directors of the body' obviously refers to the board of
directors, the uncertainty as to its proper interpretation is highlighted by the 1R7
difference in opinion on h o w the dictum by Lord Lowry in Kuwait quoted in
paragraph 6.3 above should be interpreted. One view is that this dictum is
authority that all the directors of the company have to be accustomed to act in
accordance w ith t he d irections o r i nstructions o f a p erson w ho i s n ot v alidly
appointed as a director. Another view is that the opposite holds true and that it
is sufficient if some of the directors of the company are accustomed to act in
this way.
Although his Lordship failed to address this issue in Re Hydrodan}** Millett J
seems to support the proposition that 'directors of the body' refers to all the
directors of the board. In a subsequent extra-judicial statement, his Honour
stated his view that 'directors' refers to the whole board, and not only some of
its members:189
The definition, therefore, does not cover the case where one person is there to do what somebody else (a relative, a business associate, or some other company whose interests he represents) wants him to do. What the term covers is a case where the whole board has effectively abandoned its responsibility for making its own decisions and instead has become accustomed to follow the directions of a third party.
To date, the Australian courts have not had occasion to interpret the element of
'directors of the body'. At least one commentator has, however, argued that to
require all the directors of the board to act in accordance with the person's
shadow directors were decided, and the fact that the current phrase is in slightly different terms has no bearing on the discussion.
It should also be noted that the definition of 'shadow director' in s 9 para (b)(ii) of the Corporations Act has been amended recently by replacing the phrase 'directions or instructions'
with the phrase 'instructions or wishes'. The significance of this replacement is pointed out in para 6.4.3 below. In all other parts of this discussion the former phrase 'directions or instructions' is used for ease of reading, since it was still in use when most of the relevant cases on shadow directors were decided. 187 [1991] 1 A C 187. 188 [1994] B C C 161. 189 Millett, above n 111. See further P Fidler, 'Banks as shadow directors' [1992] 3 JIBL 97 at 98.
220
directions or instructions, would be to ignore the purpose of the section.190 The
argument is that not much will be gained from a requirement that all the
directors must be accustomed to act in accordance with the person's directions
or instructions. If the majority of the directors act in accordance with the
person's directions or instructions, the company will carry it out. It is not
logical to permit a person to escape falling within the definition of a shadow
director simply because one director or a minority of directors are not
accustomed to act in accordance with the person's directions or instructions.
This would create a considerable loophole. The judgment of Hodgson J in
Antico m a y support this argument to an extent. Instead of scrutinising
Pioneer's control over individual directors, in finding that Pioneer was liable as
a director of Giant, Hodgson J relied on Pioneer's 'willingness and ability' to
control the 'management and financial affairs' of Giant.192
The position in New Zealand on this issue at least is clear. Section 126(l)(b)(i)
of the Companies Act 1993 (NZ) provides that a 'director', in relation to a
company, includes 'a person in accordance with whose directions or
instructions a person referred to in paragraph (a) of this subsection m a y be
required or is accustomed to act'.193 The definition of director has therefore
clearly been extended to include persons w h o control or direct the actions of a
single director. It is submitted that there is no reason not to impose a shadow
directorship when only one director is controlled. It seems to be the accepted
position in Australia that a shadow directorship m a y be imposed where a
majority of the directors (rather than all of them) is controlled. If an individual
director can be liable for insolvent trading, there is no reason w h y an entity that
controls an individual director should not be so liable.
Markovic, 'The law of shadow directorships', above n 118, 329. 191 (1995) 38 NSWLR 290. 192 Ibid 328. 193 Paragraph (a) of sub-s 126(1) of the Companies Act 1993 (NZ) reads as follows 'A person occupying the position of director of the company by whatever name called' and therefore encompasses both a dejure and a de facto director.
221
6.4.2 Meaning of 'accustomed to act'
The element of 'accustomed to act' in accordance with the person's directions
or instructions in the definition of 'shadow director' appears to be accepted
among commentators as well as the judiciary to indicate the necessity of an
ongoing relationship between the parties.194 However, there is uncertainty
regarding the exact nature of this relationship because of a divergence of
opinion among the courts in the different jurisdictions. This is so because the
usual test does not state the frequency with which instructions must be provided
and because it m a y be difficult to prove that instructions had been given or
some other means used to ensure the compliance of the company.195 O n the one
hand, Millett J in Re Hydrodan196 indicated that, for a shadow directorship to
exist, there must be a pattern of behaviour in which the directors did not
exercise any discretion or judgment of its own, but acted in accordance with the 1 Q7
directions of others. O n the other hand, Finn J in AS Nominees was of the
view that the directions or instructions did not have to embrace all matters that
involved the board. Finn J stated that it was only necessary to prove that, as and
when directed or instructed, the directors were accustomed to act as required by
the section.198
The meaning of the words 'to act' in this context is also important. In Bluecorp
Pty Ltd (in liq) formerly Lloyds Ships Holdings Pty Ltd (in liq) v ANZ Executors
Trustee Co Ltd199 the Queensland Supreme Court considered the operation of a
previous definition of shadow director. The issue was whether the operators of
the Qintex group of companies had so directed the officers of one of the
subsidiaries t hat t he b oard o f t he 1 atter w as a ccustomed t o a cf i n a ccordance
194 Markovic, "The law of shadow directorships', above n 118, 331.
As a result, the Cork Report in the UK, above n 21, recommended that a holding company should be presumed, in the absence of evidence to the contrary, to be a shadow director of any company where a majority of directors were its nominees, or where the boards of the two companies consisted of substantially the same persons: para [1937]. This proposal was, however, not implemented in the UK. C/"the proposal in Ch 10 para 10.2.3. 196 [1994] BCC 161. 197 (1995) 18 ACSR 459. 198 Ibid 509. 199 (1994) 13 ACSR 386. See further Murphy, above n 15, 261-2.
222
with those directions. Mackenzie J found that the necessary criteria had not
been established to constitute any of the persons alleged to be 'directors' as
(shadow) directors. In reaching this conclusion, Mackenzie J relied upon the
analysis set out by Wells J in Harris v S?00 The analysis required that in being
accustomed to act in accordance with the direction or instructions of a third
party:
(a) the directors must act in their capacity as directors;
(b) the d irectors m ust p erform p ositive a cts, n ot o nly forbear t o a ct o r d esist
from acting; and
(c) the w ill o f t he t hird p arty (not t he w ill o f t he b oard) m ust d etermine t he
resolutions of the board.201
Crucial here is (b) above, entailing that directors who so not take any action
cannot be said to be accustomed to act on the instructions of an outsider. This
suggests that, if directors of a subsidiary fail to act because of instructions given
or wishes expressed by the holding company, and such inactivity causes losses
to creditors of the subsidiary, the holding company will not be rendered liable
for such losses as a shadow director. It m a y be argued, however, that it would
not be within the spirit of the statutory definition of 'director' to allow the
holding company to escape liability as a shadow director under these
circumstances.202 It is not difficult to see that this form of negative influence by
the holding company can take place at the expense of other parties such as
creditors.203
6.4.3 Meaning of 'directions or instructions'
The courts in the United Kingdom have not directly addressed the issue of
whether actual directions or instructions must be given. The judgment of Millett
zuu(1976)2ACLR51at63. 201 Bluecorp Pty Ltd (in liq) formerly Lloyds Ships Holdings Pty Ltd (in liq) v ANZ Executors Trustee Co Ltd (1994) 13 A C S R 386 at 402-403. 202 J O'Donovan, Lender Liability (2000) at 582-583.
223
J in Re Hydrodan204 suggests, however, that the alleged shadow director must
necessarily have given directions or instructions before a shadow directorship
will be established.205 This suggestion is supported by the judgment of the N e w
Zealand High Court in Dairy Containers?06 Although in this case all the
directors of the company were employees of the alleged shadow director, it was
found that no shadow directorship existed. While the responsibility of running
the company had been delegated to the directors, they were not given
identifiable directions or particular instructions.2071 n retrospect this might be
seen as too lenient a test because there are many ways in which to convey
wishes without necessarily issuing identifiable instructions.
In contrast to the interpretation of the United Kingdom and New Zealand
courts, the General Division of the Federal Court in AS Nominees clearly
recognised that actual directions or instructions were not always necessary to
establish a shadow directorship. This is also in line with the decision in
Antico? where a shadow directorship was found to exist despite limited
evidence of formal directions or instructions to the board of Giant. The fact that
the wording in the definition of 'shadow director' in s 9 of the Corporations Act
has been amended from 'directions or instructions' to 'instructions or wishes' is
a further indication that actual instructions m a y not be a requirement for
shadow directorship in Australia.210 A wish m a y b e communicated subtly. In
this regard it has been suggested that 'directions or instructions' as used in the
former s 60(2) of the Corporations Law involve 'an element of compulsion', so
that the recipient of the 'directions or instructions' does not exercise any
discretion in the decision-making process.211 The importation of the new phrase
'instructions or wishes'212 in s 9 of the Corporations Act makes it less certain
204 Re Hydrodan [1994] BCC 161. 205 Ibid 164. See further P M C Koh, 'Shadow director, shadow director, who art thou?' (1996) 14CdfcSL/340at344. 206 [1995] 2 NZLR 30. 101 Ibid 9\. 208 (1995) 18 ACSR 459. 209 (1995) 38 N S W L R 290. 210 Own emphasis. 211 Hobson, above n 119, 204. 212 Own emphasis.
224
that an element of compulsion is involved. It would appear as though the use of
the word 'wishes' implies that, even if the recipient does exercise some
discretion, the person whose 'wishes' are being granted m a y still be a shadow
director.213
See also G Breen and B Martelli, 'Directors' liability for insolvent trading' (2002) AU 3 at
4.
7 INSOLVENT TRADING: HOLDING COMPANY AS SHAREHOLDER
7.1 Background 225
7.2 Addressing the problem 226
7.3 Liability of holding company 230
7.3.1 Criteria to be satisfied for contravention 230
7.3.1.1 'Incurs a debt' 233 (a) General 233 (b) Narrow approach - directors m a y easily escape liability 235 (c) Flexible approach - more difficult for directors to 238
escape liability (d) Voluntary and involuntary debts 240
7.3.1.2 'Insolvent' 243
7.3.1.3 'Reasonable grounds for suspecting' 247
7.3.2 Defences 250
7.3.2.1 Reasonable grounds to expect insolvency 251
7.3.2.2 Reliance on another 256
7.3.2.3 Illness or some other good reason 257
7.3.2.4 Reasonable steps to prevent incurring a debt 264
7.4 Evaluation of position of group creditors 265
7.4.1 Disadvantages as a result of intermingling 265
7.4.2 Other disadvantages 266
7 INSOLVENT TRADING: HOLDING COMPANY AS SHAREHOLDER
7.1 Background
It appears from the discussion in Chapter 6 that the Corporations Act 2001
(Cth)1 initially followed the United Kingdom model on group liability in the
context of insolvency and the protection of creditors. Like the United Kingdom
wrongful trading provision, the Australian insolvent trading provisions may
potentially impose liability on a holding company for the debts incurred by its
subsidiary. It m a y do so by virtue of the provisions of s 588G of the
Corporations Act and its predecessors, and the fact that it is possible for a
holding company to be regarded as a shadow (or de facto) director of its
subsidiary. In implementing the Harmer Report reforms, however, the
Corporate Law Reform Act 1992 also introduced sections 588V-588X into the
Corporations Act. These sections are specially designed to protect creditors and
impose a duty on a holding company to prevent its subsidiary from engaging in
insolvent trading in its capacity as shareholder and not as shadow (or de facto)
director.
The current regime on insolvent trading relating to holding companies
contained in sections 588V-588X of the Corporations Act had no predecessor
in Australia. This legislative development can be ascribed partly as a response
to a number of judicial pronouncements, and partly as a response to the
economic fallout of the 1980's.3 As far as the case law is concerned, Rogers CJ
figured prominently in commenting on the unsatisfactory state of affairs where
intricate and massive corporate groups declined into insolvency on a large
scale. The huge contrast between commercial reality and legal rules became
1 (Corporations Act). 2 Australian Law Reform Commission (ALRC), General Insolvency Inquiry Report No 45
(1988) (AGPS, Canberra), (Harmer Report). The Harmer Report recommendations are
discussed in Ch 9 para 9.2. 3 K Strasser and I Ramsay, Transcript of Symposium, held at Connecticut in 1998, published in
(1999) 13 Conn J MIL 391 at 482-3.
226
apparent in a number of cases.4 In response to the economic fallout there was
the Harmer Report dealing with insolvency laws in 1988, in which the
provisions of sections 588V-588X of the Corporations Act had their origin.
7.2 Addressing the problem
Part 5.7B Division 5 of the Corporations Act, containing sections 588V-588X,
derives directly from the Harmer Report recommendations, although it has been
watered down significantly. Where a subsidiary has carried on business while it
was insolvent or on the verge of insolvency, a holding company may be held
liable for the debts of its subsidiary pursuant to sections 588V-588X of the
Corporations Act. The pivotal provision is s 588V(1) of the Corporations Act,
which reads as follows:
(1) A corporation contravenes this section if:
(a) the corporation is the holding company of a company at the time when the company incurs a debt; and
(b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and
(c) at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be; and
(d) one or both of the following subparagraphs applies: (i) the corporation, or one or more of its directors, is or are aware at that time that there are such grounds for so suspecting; (ii) having regard to the nature and extent of the corporation's control over the company's affairs and to any other relevant circumstances, it is reasonable to expect that: (A) a holding company in the corporation's circumstances would be
so aware; or
(B) one or more of such a holding company's directors would be so aware; and
(e) that time is at or after the commencement of this Part.5
Thus, in terms of s 588V of the Corporations Act, a holding company may
under certain circumstances be held liable for the debts incurred by its
subsidiary while the latter is insolvent, or if it will become insolvent by
4 Notable is Qintex Australia Finance Ltd v Schroders Australia Ltd (1991) 9 A C L C 109, discussed in Ch 3 para 3.4.
Part 5.7B of the Corporations Act commenced on 23 June 1993.
227
incurring such debts. Reasonable grounds must exist for suspecting that the
subsidiary was or would become insolvent. Another requirement is that the
holding company or one or more of its directors were aware of grounds for
suspecting insolvency or could reasonably be expected to be aware of the
insolvency. In essence, the holding company or one or more of its directors
must have actual knowledge that the subsidiary was trading while it was
insolvent or in the circumstances they should have known that the subsidiary
was trading while i nsolvent.6 Todetermine this, the nature and extent o f the
control of the holding company over the affairs of the subsidiary and any other
relevant circumstances are taken into account.7
Where a holding company allows its subsidiary to trade while it is insolvent,
the liquidator of the subsidiary m a y recover from the holding company an
amount equal to the loss or damage suffered by the unsecured creditors of the
subsidiary.8 Each of the following preconditions must be satisfied. First, the
holding company must have contravened s 588V of the Corporations Act in
relation to the incurring of a debt by a subsidiary.9 Secondly, the creditor must
have suffered loss or damage in relation to the debt because of the subsidiary's
insolvency.10 Thirdly, the creditor's debt must have been wholly or partly
unsecured when the loss or damage was suffered.11 Fourthly, the company must
be wound up.12 The intention of the section is clearly to protect unsecured
creditors. In this regard s 588Y of the Corporations Act provides that any
money recovered is to be applied for the benefit of unsecured creditors in
priority to secured creditors.
6 Strasser and Ramsay, above n 3, 471-4. 7 Section 588V(l)(d)(ii) of the Corporations Act. The elements of the contravention are
discussed in more detail in para 7.3.1 below. 8 Section 588W(1) of the Corporations Act. The equivalent provision in respect of directors is contained in s 588M(1) of the Corporations Act. It should be noted that, unlike the position in regard to s 588G of the Corporations Act, no provision is made in the context of s 588V of the Corporations Act for a creditor to institute proceedings with the consent of the liquidator or the
leave of the court. The liquidator is the only person with standing to institute action pursuant to s 588V of the Corporations Act. See further J Dabner, 'Trading whilst insolvent - a case for
individual creditor rights against directors' (1994) 17 UNSWLI546. 9 Section 588W(l)(a) of the Corporations Act. 10 Section 588W(l)(b) of the Corporations Act. See also the discussion of the meaning of the
phrase 'loss or damage' further on in para 7.2. Section 588W(l)(c) of the Corporations Act.
228
The Corporations Act contains a number of defences for a holding company to
an action for recovery of compensation for loss resulting from the insolvent
trading of a subsidiary.13 The defences are essentially the following.14 First, it is
a defence if the holding company had reasonable grounds to expect that the
subsidiary was solvent at the time the debt was incurred.15 It is also a defence if
the holding company reasonably relied on a competent and reliable person to
inform it of the solvency of the subsidiary.16 T w o things must be shown here.
First, it must be shown that the holding company and each relevant director17
had reasonable grounds to believe that a competent and reliable person was
responsible for providing adequate information to assess the solvency status of
the subsidiary.18 Secondly, it must be shown that, on the basis of that
information, both the holding company and each relevant director expected that
the company was solvent at the time the subsidiary incurred the debt.19
Moreover, the fact that a directors was aware of the subsidiary's insolvency is
to be disregarded where he or she did not participate in managing the affairs of
the holding company when the subsidiary incurred the debt because of his or
her illness or some other cause. Furthermore, it is a defence if the holding
company took all reasonable steps to prevent the corporation from incurring the
debt.20
12 Section 588W(l)(d) of the Corporations Act.
Section 588X of the Corporations Act. The four defences available to a holding company to avoid liability are similar to those for directors. See the discussion in para 7.3.2 below. 14 Section 588X(4) of the Corporations Act. 15 Section 588X(2) of the Corporations Act. 16 Section 588X(3) of the Corporations Act. 17 A 'relevant director' is a director who was aware, as mentioned in s 588V(l)(d)(i), read with s 588X(6) of the Corporations Act. 18 Section 588X(3)(a) of the Corporations Act. 19 Section 588X(3)(b) of the Corporations Act.
Section 588X(5) of the Corporations Act. It should be noted that 'reasonable steps' do not include appointing a receiver, because this is a step taken by the creditor. In the equivalent provision providing a defence for directors, s 588H(5) of the Corporations Act, matters such as
the action taken to place the company in voluntary administration m a y be taken into account: see s 588H(6) of the Corporations Act. There is no equivalent of this sub-s in s 588X of the Corporations Act.
229
If the holding company is not successful in pleading any of these four
alternative defences available, it is obliged to compensate the subsidiary.21 The
measure of compensation is the amount equal to the loss or damage suffered by
creditors as a consequence of the subsidiary's insolvency. The meaning of the
phrase 'loss or damage' in the context of directors was recently considered by
the Full Court of the Supreme Court of South Australia in Fryer v Powell?2
Olsson J, with w h o m Duggan and Williams JJ agreed, rejected the argument for
the directors that various amounts, such as dividends the creditor would receive
in the winding-up, should be deducted in determining a particular creditor's
loss. Olsson J stated that the 'novel and extraordinary' arguments put forward
on behalf of the directors 'fly in the face of the plain intention of the
legislation'. His Honour found that the loss and damage was the amount of
the unpaid debt due to the creditor in question.24
As far as the provisions providing for the liability of a holding company for the
debts of its insolvent subsidiary is concerned, s 588V of the Corporations Act
apparently h as n o counterpart i n any o ther c ountry.25 It i s a u nique s tatutory
provision, although it is akin to the United Kingdom wrongful trading provision
imposing personal liability on directors where the holding company has been
substituted for the directors.26 In enacting legislation, the Australian legislature
went further than its United Kingdom counterpart and also removed the
advantage of limited liability enjoyed by holding companies as shareholders of
21 A subsidiary's insolvent trading only has civil consequences: s 588V(2) of the Corporations Act. Unlike a director, a holding company is not subject to civil penalty orders or criminal sanctions if it fails to prevent its subsidiary from engaging in insolvent trading unless, of course, it qualifies as a shadow (or de facto) director. See further the discussion of the liability of a holding company as a shadow (or de facto) director in Ch 6. 22 (2001) 159 F L R 433. 23 Ibid 447.
Ibid. Olsson J noted that this was also the view taken by Austin J in Tourprint International Pty Ltd (in liq) v Bott (1999) 17 A C L C 1,543 (Tourprint v Bott) at 1,557. Cf Metropolitan Fire Services Pty Ltd v Miller (1997) 23 A C S R 699 (Metropolitan v Miller) at 708-709. It is
arguable that the amount of compensation recoverable from directors could conceivably include consequential loss, since s 553 of the Corporations A ct admits to proof in a winding-up all debts and claims, present and future, certain or contingent, ascertained or sounding only in damages.
This is different from s 588G of the Corporations Act, where the holding company can be held 1 iable f or t he d ebts o f i ts i nsolvent su bsidiary o n t he b asis t hat i t i s a shadow d irector, something that is possible in many other countries as well. 26 Strasser and Ramsay, above n 3, 482-3.
230
their subsidiaries. Section 588V of the Corporations Act shifts the risk of loss
resulting from an insolvent subsidiary from the creditors of the subsidiary to the
holding company. It may be said that, by enacting s 588V of the Corporations
Act, the legislature has consciously adopted an enterprise perspective.27
7.3 Liability of holding company
7.3.1 Criteria to be satisfied for contravention
.Part 5.7B Division 5, and in particular s 588V of the Corporations Act,
borrows to a large extent from s 588G of the Corporations Act that deals with a
director's duty not to trade while insolvent. Although the courts have had little
opportunity to consider the provisions of s 588 V of the Corporations Act, they
have considered the most important elements of s 588G of the Corporations Act 7R
and its predecessors. Since the provisions of s 588V and those of s 588G of
the Corporations Act overlap in crucial respects, the courts' interpretation of s
588G and its predecessors is relevant in projecting how the courts will interpret
the provisions of s 588V of the Corporations Act?9 The provisions of s 588V
and s 588G of the Corporations Act are therefore discussed alongside each
other.
The criteria that have to be satisfied before a corporation contravenes s 588V of
the Corporations Act mirror the criteria required to be satisfied before a director
contravenes s 588G of the Corporations Act. The criteria are that:30
This enterprise perspective is not limited to a particular subject matter, such as an aspect of tax liability, as in some other countries: Strasser and Ramsay, above n 3, 482-3.
One of the few cases in which the liability of the holding company was specifically mentioned is Konica Australia Pty Ltd v Aprolab Flashpoint (Australia) Pty Ltd (1999) 17 A C L C 1,651. O n the facts, however, the court found that pursuing the holding company in question under s 588V or s 5 8 8 W of the Corporations Act was likely to be futile due to the fact that the holding company's assets did not even cover its own debt to its subsidiary. Also in Re ACN 007 537 000 Pty Ltd (1997) 15 A C L C 1,752, decided in the context of a claim by the subsidiary for set-off under s 553C of the Corporations Act, the practical problem confronting
the applicant was that the holding company had no assets. Even if the claim were successful, it would not mean an increase in the funds available for distribution to creditors.
For a discussion of the conflicting case law that has arisen in regard to the predecessors of s 588G of the Corporations Act, see, generally, C Bevan, Insolvent Trading (1994). 30 Section 588V(1) and s 588G(1) of the Corporations Act.
231
• the corporation is the holding company of the subsidiary at the time when
the subsidiary incurs a debt as contemplated in s 588 V of the Corporations •71
Act, or that the person is a director of the company at the time when the
company incurs a debt as contemplated in s 588G of the Corporations
Act?2
• at that time, the subsidiary as contemplated in s 588V of the Corporations
Act?3 or the company as contemplated in s 588G of the Corporations Act?4
is insolvent or becomes insolvent by incurring that debt or debts including
that debt;
• at that time, there are reasonable grounds for suspecting that the subsidiary
as c ontemplated ins 5 88V o f t he C orporations A ct?5 o r t he c ompany a s
contemplated in s 588G of the Corporations Act,36 is insolvent, or would
become insolvent;
• as contemplated in s 588V of the Corporations Act, the holding company,
or one or more of its directors, must have actual knowledge that the debt is
incurred at a time when insolvency is suspected37 or, alternatively, that it is
reasonable to expect that either a holding company in the corporation's
circumstances would be aware, or one or more of the holding company's
directors would be aware, of the subsidiary's insolvency; and that, as
contemplated in s 588G of the Corporations Act, the director fails to
prevent the company from incurring the debt in circumstances where the
director was aware at the time there were such grounds for suspecting that
the company is insolvent, or would become insolvent by incurring the debt
31 Section 588V(l)(a) of the Corporations Act. 32 Section 588G(l)(a) of the Corporations Act. 33 Section 588V(l)(b) of the Corporations Act. 34 Section 588G(l)(b) of the Corporations Act. 35 Section 588V(l)(c) of the Corporations Act. 36 Section 588G(l)(c) of the Corporations Act. 17 Section 588V(l)(d)(i) of the Corporations Act. Such knowledge will be attributed to the holding company where a director is on the board of both the holding company and the
insolvent subsidiary. 38 Section 588V(l)(d)(ii) of the Corporations Act. To determine this, regard must be had to the
nature and extent of the holding company's control over the subsidiary's affairs and to any other relevant circumstances.
232
or, alternatively, a reasonable person in a like position in a company in the
company's circumstances would have been so aware; and
• the debt must have been incurred after the commencement of Part 5.7B of
the Corporations Act, being 23 June 1993.40
As far as s 588V of the Corporations Act is concerned it is specifically
provided that the corporation must be the ' holding c ompany' of a subsidiary
when the subsidiary incurs a debt.41 The meaning of 'holding company',
including the problems raised by its narrow scope, is discussed in Chapter 2 and
does not warrant a more elaborate discussion here.42 It should be noted,
however, that the scope of the operation of Part 5.7B Division 5 is confined to a
'holding company', and does not extend to other related companies. 3 As far as
s 588G of the Corporations Act is concerned it is specifically provided that the
person must be a 'director' at the time when the company incurs a debt.44 The
meaning of 'director', including the term 'shadow director', that has specific
relevance in the context of holding companies, is discussed in Chapter 6.45 The
terms 'incurs a debt', 'insolvent' and 'reasonable grounds for suspecting'
insolvency are found throughout sections 588V and 588G of the Corporations
Act and are discussed in more detail in paragraphs 7.3.1.1 to 7.3.1.3 below.
Section 588G(2) of the Corporations Act. The phrase 'in a like position' will allow the court to look at any particular expertise held by the individual director and the size and business of the company: Corporate Law Reform Bill 1992, Explanatory Memorandum, para 39. 40 Section 588V(l)(e) and s 588G(l)(d) of the Corporations Act. 41
42
43
Section 588V(l)(a) of the Corporations Act. See Ch 2 para 2.2.
Two companies are 'related' where one company is the holding company of the other, or where e ach o f t he t wo c ompanies i s a su bsidiary o f t he sa m e h olding c ompany: s 5 0 o f t he Corporations Act. The recommendations contained in para 334 of the Harmer Report, above n 2, were broader than the current provisions of s 588V of the Corporations Act. It recommended that any related company (and not only a holding company) should be held liable for insolvent trading. The legislature did not accept this recommendation when it enacted s 588V of the Corporations Act. The proposed model in Ch 10 also limits the liability to the holding company: see Ch 10 para 10.2. 44 Section 588G(l)(a) of the Corporations Act. 45 See Ch 6 para 6.3.
233
7.3.1.1 'Incurs a debt'
(a) General
An important element of both s 588V(1) and s 588G(1) of the Corporations Act
is that the subsidiary or company in question 'incurs a debt'.46 The term 'incurs
a debt' refers to the exact time when the solvency of the company is considered
- if the company is not solvent at the moment when it 'incurs a debt' this may
be found to be a contravention of the insolvent trading provisions of the
Corporations Act. Incurring a debt concerns the incurring of an obligation
sounding in money or money's worth. It must also be ascertainable, relating to
an obligation to pay a liquidated sum. Equitable damages for breach of
fiduciary or any other similar duty by a company or its directors would
represent an obligation to pay unliquidated damages.47 Such damages and the
unliquidated debts of involuntary creditors or the incurring of liability for
damages in contract do not, therefore, constitute the incurring of a debt for
purposes of the insolvent trading provisions.
For purposes of s 588G of the Corporations Act there are two types of debts
that can be incurred, namely, where a company incurs an ordinary debt and also
where a c ompany i s d eemed t o i ncur a d ebt b y virtue o f t he p rovisions o f s
588G(1A) of the Corporations Act.49 There is no equivalent provision for
deemed debts in relation to s 588V of the Corporations Act. The incurring of
debts discussed in the rest of this chapter relates to ordinary debts. As far as the
latter are concerned, the Corporations Act does not define the words 'incurs' or
'debt'. One therefore has to rely on judicial interpretations of the phrase 'incurs
a debt', most of which have been in relation to former s 556 of the Companies
46 See in general, J Mosley 'Insolvent trading: what is a debt and when is one incurred?' (1996)
4 Insol Law Jnl 155. 47 3M Australia Pty Ltd v Watt (1984) 9 A C L R 203 at 206-207; affirmed at [1984] 2 N S W L R
671. See also Hawkins v Bank of China (1992) 26 N S W L R 562 at 569-570. 48 A refusal to accept goods under a contract does not, for example, constitute the 'incurring of a debt', although it gives rise to a claim for damages in contract: see Hamilton v Abbott (1980)
5 A C L R 391 at 394. 49 A company is deemed to incur a debt where it enters into certain transactions that adversely
affect its share capital or where it misapplies its assets in particular ways.
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Act 1981 (Cth) and the Companies Codes (Companies Code), SL predecessor to s
588G of the Corporations Act.
One of the flaws that crept in when the courts interpreted the elements in former
s 556(1 )(a) of the Companies Code was that they relied on the interpretation
placed on its predecessor, s 303(3) of the Companies Act 1961 (NSW), despite
the fact that the language differed. Former s 303(3) of the Companies Act 1961
(NSW) provided:
If in the course of the winding-up of a company it appears that an officer of the company who was knowingly a part to the contracting of a debt provable in the winding-up had, at the time the debt was contracted, no reasonable or probable ground of expectation, after taking into consideration the other liabilities, if any, of the company at the time, of the company being able to pay the debt, the officer shall be guilty of an offence against this Act.
The High Court in Shapowloffv Dunn50 held that, for purposes of s 303(3) of
the Companies Act 1961 (NSW), a debt was contracted not when the debt was
computed, but when the liability arose.51 In other words, where a series of
contracts were made from time to time which resulted in a liability on behalf of
the company to pay in respect of each of them, each such liability constituted a
debt. The time when each such debt was contracted was the time when each
respective liability arose, and not when the balance was declared or computed.
By contrast to the provisions of former s 303(3) of the Companies Act 1 961
(NSW), s 556(1) of the former Companies Code provided as follows:
If-(a) a company incurs a debt, whether within or outside the State; (b) immediately before the time when the debt is incurred -
(i) there are reasonable grounds to expect that the company will not be able to pay all its debts as and when they become due; or
(ii) there are reasonable grounds to expect that, if the company incurs the debt, it will not be able to pay all its debts as and when they become due; and
50 (1981) 148 CLR 72. 51 Ibid 78 (Stephen J). In casu the debt was contracted by the company on the date that the broker bought the shares.
235
(c) the company is, at the time when the debt is incurred, or becomes at a later time, a company to which this section applies, any person who was a director of the company, or took part in the management of the company, at the time when the debt was incurred is guilty of an offence and the company and that person or, if there are 2 or more such persons, those persons are jointly and severally liable for the payment of the debt. Penalty: $5,000 or imprisonment for 1 year, or both.
The 'contracting of a debt' provided for in former s 303(3) of the Companies
Act 1961 ( N S W ) should be distinguished from 'incurring a debt' in s 556 of the
Companies Code and its successors. Just like in s 556 of the Companies Code,
the notion of 'incurring a debt' (rather than 'contracting of a debt') is also
contained in s 588G and s 588V of the Corporations Act. While 'incurring a
debt' m a y take place without any element of volition,52 'contracting of a debt'
is a much narrower concept. It involves a conscious decision to enter into a
contract and private obligations under the contract. Although the difference in
wording between 'contracting of a debt' in former s 303(3) of the Companies
Act 1961 and 'incurring a debt' in subsequent companies legislation pointed to
a difference in legislative purpose, the courts paid little attention to it. The
reliance by the judiciary on the interpretation of 'contracting of a debt' in
former s 303(3) of the Companies Act 1961 ( N S W ) when it had to interpret the
phrase 'incurring a debt' resulted in a narrow application of the insolvent
trading provision. This was unsatisfactory.
(b) Narrow approach - directors m a y easily escape liability
The fact that the elements of the insolvent trading provisions were directed to a
point in time and not to the comprehensive conditions under which the trading
took place was a further impediment to the interpretation of these provisions by
the courts.53 Various inconsistent decisions serve as proof of this difficulty. In
2 Cf Byron v Southern Star Group Pty Ltd (1996) 22 A C S R 553 at 564, applying Standard Chartered Bank of Australia Ltd v Antico (1995) 38 N S W L R 290 (Antico) and Metal Manufacturers v Lewis (1986) 11 A C L R 122 (Metal Manufacturers), where it was held that
consent to the incurring of debts can be implied from the mere inactivity of a director who has
no authority to incur or prevent the incurring of debts. 53 See, eg, Australia Pty Ltd v Watt; NEC Home Electronics Australia Pty Ltd v White (1984) 2
ACLC 621.
236
Russell Halpern Nominees Pty Ltd v Martin54 for example, the court held that
where a tenant defaults on monthly rental payments the debt is incurred when
the lease is entered into and not when the failure to pay occurs (that is, on each
rent day).55 In this regard the court stated:56
To hold otherwise would be to say that if a company when in all respects financially sound were to enter into a lease for a term of years and at some time thereafter and for reasons which could not be anticipated it were to fall on bad times and be unable to pay its debts, the directors would thereafter and on every rent day within the remainder of the term be guilty of an offence for the reason that on that rent day the company 'incurs a debt'. I am unable to accept that.
The decision in Russell Halpern, however, meant that, if a company was in a
good financial state when entering into an agreement of lease, but ran into
financial difficulties later on so that it could not pay the rent, the directors could
escape liability. This would be the case because the company was not insolvent
when it incurred the debt. The application of s 556(1) of the Companies Code
would be limited to exceptional circumstances, where the company was unable
to pay its debts as they fell due at the time when the agreement was entered
into. Thus, the way the words 'incurs a debt' were interpreted resulted in the
financial position of the company being directed to a point in time rather than
an objective contemplation of its situation.
This decision should be contrasted with that in Hussein v Good. In the latter
case, concerning the delivery of goods, the court held that the debt was incurred
only when goods were delivered and payment was due.58 The court in Hussein
54 (1986) 4 A C L C 393 (Russell Halpern). 55 In John Graham Reprographics Pty Ltd v Steffens (1987) 5 A C L C 904 (John Graham) Connolly J likewise held that periodic interest on the outstanding balance of a trading account was a debt incurred when the terms of the account were agreed upon and not each month when the interest accrued. See also Castrisios v McManus (1991) 9 A C L C 287; BL Lange & Co v Bird (1991) 9 A C L C 1,015. 56 Russell Halpern (1986) 4 A C L C 393 at 396. In Rema Industries and Services v Coad (1992) 7 A C S R 251 (Rema) at 258, Lockhart J stated that the time when a debt is 'incurred' will vary
on a case by case basis, and will depend mainly on the terms of the agreement between the parties, whether express or implied. " (1990) 8 A C L C 390. See also Hamilton v Abbott (1980) 5 A C L R 391. 8 Cf Reed International Books Australia Pty Ltd (t/a Butterworths) v King& Prior Pty Ltd
(1993) 11 A C L C 935, where it was found that a debt was not incurred where money is accepted
but goods are not delivered. This is because an action for damages of breach of contract will be available in such a case.
237
v Good59 distinguished the decision in Russell Halpern60 on the following basis.
While the tenant in the circumstances of a lease enjoys a right of possession
from the very beginning, in a delivery of goods case neither party receives a
benefit or suffers harm until the goods are delivered. This distinction m a y be
criticised as follows.61 O n the facts in Hussein v Gooof2 neither party seemed to
benefit o r s uffer h arm u ntil d elivery o ccurred. It i s, h owever, n ot d ifficult t o
imagine a situation where the seller w h o manufactures the goods would suffer
harm by incurring expenses in manufacturing the goods before delivery or by
sacrificing other sales with regard to the goods in question.63
The decision in Hussein v Gooa*4 meant that directors could avoid personal
liability under the insolvent trading provisions where they purchased goods on
behalf of their company when it was solvent, but experienced financial
difficulties subsequently when the goods were delivered. For directors to be
held liable, the incurring of the debt has to take place at the time when the
company is or becomes insolvent. This decision did not promote the purpose of
the legislative provisions that was to '[encourage] directors of insolvent
companies to stop trading and invoke some form of insolvency
administration'.65 The problem was exacerbated by the finding in this case that
the concept of 'debt' in 'incurs a debt' was limited to exclude contingent debts.
Although the judgments in Russell Halpern66 and Hussein v Good3 had
different outcomes, the result of both these decisions was to reduce the
legislative impact of the insolvent trading provisions.
"(1990) 8 ACLC 390. 60 (1986) 4 ACLC 393. 61 TN Antrobus, 'Section 592 - When does a company incur a debt?' (1990) 8 C&SLJ 324. 62 (1986) 4 ACLC 393. 63 Antrobus, above n 61, 326. 64 (1986) 4 ACLC 393. 65 A Herzberg, 'Insolvent trading- civil liability of company officers under insolvent trading provisions' (1991) 9 C&SLI 285 at 295. See also A Herzberg, 'Duty to prevent insolvent
trading' in JPG Lessing and JF Corkery (eds) Corporate Insolvency Law (1995) at 8 and 23. 66 (1986) 4 ACLC 393. 67 (1990) 8 ACLC 390. 68 See NF Coburn, 'Insolvent trading in Australia: the legal principles' in I Ramsay (ed) Company Directors' Liability for Insolvent Trading (2000) 73 at 97.
238
(c) Flexible approach - more difficult for directors to escape
liability
The phrase 'incurs a debt' was given flexibility for the first time in the
judgment in Hawkins v Bank of China.69 In this case the N e w South Wales
Court of Appeal had to determine whether the execution of a guarantee and
indemnity constituted the 'incurring of a debt' within the meaning of s 556(1)
of the Companies Code. The directors argued that no 'debt' was incurred since
the guarantee, properly construed, rendered them liable to pay damages.
Gleeson CJ, Kirby P and Sheller JA applied the words of the section in a
manner consistent with their purpose. In direct contrast to the decision in
Hussein v Good, the court held that 'debt' under s 556(1) of the Companies
Code included a contingent liability71 In this regard Gleeson CJ stated:72
The words 'incurs' and 'debt' are not words of precise and inflexible denotation ... the word 'incurs' takes its meaning from its context and is apt to describe, in an appropriate case, the undertaking of an engagement to pay a sum of money at a future time, even if the engagement is conditional and the amount involved uncertain.
Gleeson CJ acknowledged that the rights of a creditor against a guarantor
depended on the terms of the guarantee in question and the nature of the
obligation guaranteed. If the subject of a guarantee was the payment of a debt
or sum of money, the creditor could sue the guarantor for a liquidated amount.
If, however, the subject of a guarantee was the performance of another type of
obligation, the creditor was only entitled to sue the guarantor for damages for
breach of contract.74 Since the guarantee in casu fell within the first of these
categories, the company's contingent liability to pay the guaranteed debt -
being for a sum of money or a liquidated amount - fell within the scope of s
556(1) of the Companies Code. A debt for purposes of s 556(l)(a) of the
Companies Code was incurred when the company entered into the guarantee
69 (1992) 26 N S W L R 562. 70 (1986) 4 A C L C 393. 71 (1992) 26 N S W L R 562 at 572 (Gleeson CJ). See also the judgments of Kirby P at 576-578 and Sheller JA at 578. 12 Ibid 512. 73 Ibid 569. nIbid.
239
pursuant to which it had to pay a liquidated amount of money contingent upon
demand in the case of default.75
Directly relevant here are the remarks by Kirby P where he explained that the
legislative purpose behind the provision was to increase rather than to restrict
the obligations imposed on company officers:76
The expression 'incurs a debt' in s 556(1) is, in isolation, entirely apt to describe an act on the part of a corporation whereby it renders itself liable to pay a sum of money in the future as a debt. The act of 'incurring' happens when the corporation so acts as to expose itself contractually to an obligation to make a future p ayment o f a sum o f money a s a d ebt. T he mere fact t hat su ch su m o f money will only be paid upon a future contingency does not make the assumption of the obligation any less 'incurring' a 'debt'.
Subsequent decisions on the meaning of 'incurs a debt' support the approach in
Hawkins v Bank of China?1 In Leigh-Mardon Pty Ltd v Wawn1* Hodgson J was
of the view that it was not necessarily the case that a company incurred a debt at
the time when goods were delivered to it - the debt could also be incurred at an
earlier time. His Honour found that the debt in casu had not been incurred on
delivery of the goods, but rather at the last opportunity when it was possible to
cancel the orders without causing the company to become liable for
considerable damages. An example of where a debt could be incurred before
delivery would be where an order had been placed for the manufacturing of Of)
goods w ith a p articular brand, s o t hat t hey a re not s aleable elsewhere. T he
approach by Hodgson J in Leigh-Mardon,*1 like that in Hawkins v Bank of
China,*2 is an undeniable change in focus from the previous narrow
interpretation to a more flexible approach, considering the financial position of
15 Ibid 510. 76 Ibid 576. 77 (1992) 26 N S W L R 562. 78 (1995) 17 A C S R 741 (Leigh-Mardon). 79 Ibid 749. The reasoning of Hodgson J in Leigh-Mardon seems to be even more flexible than
that in Hawkins v Bank of China (1992) 26 N S W L R 562. 80 If, however, the goods ordered are readily saleable elsewhere at the same price it is more likely that the debt was incurred by accepting delivery, not by placing the order. The saleability
of the goods is therefore an important factor in determining when the debt was incurred. See J O'Donovan, 'When do companies incur debts? Sooner than you think!' (1996) 14 C&SLJ 120. 81 (1995) 17 A C S R 741. 82 (1992) 26 N S W L R 562.
240
the company in the light of commercial reality. In Antico Hodgson J also
supported this new approach, taking into account substance and commercial
reality.85
At first blush it seems as though the decisions in Hussein v Good and Leigh-
Mardon*1 are irreconcilable. However, the different approaches in these two
judgments may be reconciled by looking at whether in fact the goods to be
delivered are customised or not. The approach taken in Hussein v Good** is
appropriate in cases where the goods are not customised. Debts would then
arise on delivery because of the possibility that they can be sold on open market
where delivery does not eventuate. However, where the goods to be delivered
are customised, the approach in Leigh-Mardon* may be more appropriate. The
position i s a nalogous t o t he p osition w here a n a 11 a ccounts t ype g uarantee i s
signed - a debt is not incurred when the guarantee is signed since liability for
the future can be revoked.
(d) Voluntary and involuntary debts
Conflicting case law has caused uncertainty about whether the phrase 'incurs a
debt' for purposes of the insolvent trading provisions is restricted to debts that a
company incurs voluntarily. In Jelin Pty Ltd v Johnson90 it was held that where
the company has not taken a positive act to incur a debt and instead a liability
has been imposed on the company, such as in the case of an award of damages,
it might not amount to the 'incurring of a debt'. Similarly, in Castrisios v
McManus,91 in the context of an obligation to pay sales tax, it was held that, for
a debt to exist, a positive act on the part of the company was required to bring it
into existence. Sales tax, for instance, was held not to be a debt incurred,
83 Coburn, 'Insolvent trading in Australia: the legal principles', above n 68, 98. 84 (1995) 38 N S W L R 290. 85 Antico (1995) 38 N S W L R 290. 86 (1990) 8 ACLC 390. 87 (1995) 17 ACSR 741. 88 (1990) 8 ACLC 390. 89 (1995) 17 ACSR 741. 90 (1987) 5 ACLC 463 at 464-465. 91 (1991) 9 ACLC 287.
241
because there was no act on the part of the relevant company that could be
identified as one which brought the debt into existence. These decisions should
be contrasted with the decision in Commissioner of State Taxation (WA) v
Pollock, where it was held to be fairly arguable that a liability to pay tax was a
'debt' and that a company could, in various circumstances, 'incur' such a Q-\
debt. Thus, for example, engaging a person when there were reasonable
grounds to expect that the company would be unable to pay its debts, or in
circumstances in which the company knew that it could not pay future wages or
payroll tax, was 'incurring a debt' in the relevant sense.94
In this context Hodgson J in Antico formed the view that 'a company incurs a
debt when, by its choice, it does or omits something that, as a matter of
substance and commercial reality, renders it liable for a debt for which it
otherwise would not have been liable'.96 This line of reasoning did not find
favour with Bryson J in Shepherd v ANZ Banking Corporation Ltd.91 His
Honour was of the view that the relevant statutory expression did not, in any
way, express an element of choice. Bryson J stated:98
[T]he practical implications to which Hodgson J referred ... do not require any limitation of the language so as to apply only to the consequences of acts or omissions of the company's choice or to obligations which the company chose to be involved in.'
(1994) 1 2 A C L C 2 8 (Pollock) at 4 1. Ipp J, with w h o m Wallwork J a greed, stressed that, although the normal meaning of the word 'incur' is to become liable to, or subject to, through one's one action, it did not exclude rendering oneself liable through acts of omission. '3 This is similar to the decision in State Government Insurance Corporation v Pollock (1993) 11 A C L C 839. In this case it was held that failure to meet the payment of a premium pursuant to a workers' compensation policy, a voluntary act of the company, could amount to a debt for purposes of the insolvent trading provisions. See also FAI Traders Insurance Co Limited v
Ferrara (1996) 41 N S W L R 91, where the Court of Appeal concluded that ongoing, accruing workers' compensation premiums payable after the occurrence of insolvency were debts which had been incurred within the meaning of s 556 of the former Companies Code.
See also Sands & McDougall Wholesale Pty Ltd (in liq) v Commissioner of Taxation (Cth) (1999) 1 V R 4 89 a t 504, w here C harles J A a greed with t he r easoning i n P ollock (1994) 12 A C L C 28 and Sutherland v Liquor Administration Board (1997) 24 A C S R 176 that a tax liability constituted a 'debt' in the relevant statutory sense and, by implication, that it could be incurred. 95 (1995) 38 N S W L R 290. 96 Ibid 314. (emphasis added). 97 (1996) 20 A C S R 81 (Shepherd) at 89; affirmed (1996) 41 N S W L R 431. 98 Shepherd (1996) 20 A C S R 81 at 89.
242
Bryson J held that obligations imposed by law, including revenue law, could be
'debts' for purposes of the insolvent trading provisions. This was the case
whether or not they originated from acts or omissions that the company chose
to be involved in.99 His Honour held that the matter had to be decided by
reference to the test enunciated in Hawkins v Bank of China?00 This clearly led
to the conclusion that a revenue liability that arose from a company's activities
was a debt incurred.101
The reasoning in Antico}02 namely, that an element of choice had to be present
before a company could incur a debt, also did not find favour with the Full
Court of the Supreme Court of South Australia in the recent decision of Fryer v
Powell. In this case Olsson J stated that, in resolving the different
approaches, the clear duty of the court is not to depart from an interpretation
already placed on the relevant provisions of the Corporations Law by another
Full Court unless convinced that it was plainly wrong.104 A s a result, his
Honour adopted the approaches in Hawkins v Bank of China105 and Pollock}06
with which Shepherd101 was consistent. In this regard Olsson J stated:108
In my opinion, not only is it well established that a statutory impost is capable of constituting a debt, but it is also the situation that, if, by reason of the normal, ongoing operations of a company (including the mere passive retention of existing staff or premises) it is rendered liable to pay a statutory impost, then it may properly be said that such impost has been 'incurred', as a debt, by the entity in question.
99 Ibid. 100 (1992) 26 N S W L R 562. 01 Shepherd (1996) 20 ACSR 81 at 89 102 (1995) 38 N S W L R 290. 103 (2001) 159 FLR 433.
See the High Court decision oi Australian Securities Commission v Marlborough Gold Mines Ltd (1993) 177 CLR 485 at 492. 105 (1992) 26 N S W L R 562. 106 (1994) 12 ACLC 28. 107 (1996) 20 ACSR 81. 1)8 Fryer v Powell (2001) 159 FLR 433 at 444. This approach is reflected in the reasoning of Sutherland v Liquor Administration Board (1997) 24 ACSR 176 at 179.
243
7.3.1.2 'Insolvent'
Sections 588G and 588V of the Corporations Act apply only where the
company is 'insolvent' at the time the debt in question is incurred.109 The
Corporate Law Reform Act 1992 introduced a statutory definition of
insolvency, contained in s 95A of the Corporations Act}10 Subsection (l)of
this section provides that 'a person is solvent if, and only if, the person is able
to pay all the person's debts as and when they become due and payable'.111
Subsection (2) then explains that 'a person who is not solvent is insolvent'.112
Since s 22(l)(a) of the Acts Interpretation Act 1901 (Cth) defines a 'person' as
including a 'body corporate', insolvency may also be formulated as the inability
of a company to pay its debts as and when they become due and payable.113
Section 95A of the Corporations Act implies that a cash flow test should be
applied when determining the ability of a company to pay its debts. Subsequent
case law has confirmed that s 95A of the Corporations Act indicates a 'cash
Section 588V(l)(b) and s 588G(l)(b) of the Corporations Act, respectively. The presumptions of insolvency for purposes of the recovery proceedings in Pt 5.7B of the Corporations Act, which includes liability under ss 588V and s 588G, are discussed in Ch 5 para 5.2.3. O n the meaning of 'insolvency' generally, see J Duns, "Insolvency': problems of concept, definition and proof (2000) 28 A Bus L Rev 22; D Morrison, 'When is a company insolvent?' (2002) 10 Insol LawJnl4. 110 Section 95A is not limited to Pt 5.7B but has a general application throughout the Corporations Act. A person will only rely on s 95 A of the Corporations Act where the person is unable to invoke the statutory presumptions of insolvency discussed below in this para 7.3.1.2 against a director, or where the presumptions are rebutted. See further S M Pollard, 'Fear and loathing in the boardroom: directors confront new insolvent trading provisions' (1994) 22 A Bus L Rev 392 at 402-4. 111 A debt does not necessarily become due on the date originally stipulated for payment. In assessing solvency, the court may take into account any extensions of time allowed by a creditor: 3M Australia Pty Ltd v Kemish (1986) 10 A C L R 371 (Kemish) at 378; Taylor v Carroll (1991) 6 A C S R 255; Pioneer Concrete (Vic) v Stule (1996) 14 A C L C 534; cf Carrier Air Conditioning v Kurda (1993) 11 ACSR. See also Calzaturificio Zenith Pty Ltd (in liq) v
NSW Leather and Trading Co Pty Ltd [1970] V R 605. 112 It should be noted that Item 329 of Pt 2, Sch 1 of the Financial Services Reform Act 2001 repealed s 95A of the Corporations Act. The Financial Services Reform Act, however, was intended only to remove sub-s (3) of s 95 A of the Corporations Act. Section 95A(1) and (2) of the Corporations Act were reintroduced on 11 March 2002: see the Financial Services Reform
(Consequential Provisions) Act 2002, Item 1, Sch 2. 113 The word 'due' has been held to mean 'payable': Carrier Air Conditioning v Kurda 247 (1993) 11 A C S R 247 at 254 and Pioneer Concrete Pty Ltd v Ellston (1995) 10 A C L R 289
(Ellston) at 3 01. Palmer J i n Southern Cross v Deputy Commissioner of Taxation (2001) 39 A C S R 305 (Southern Cross) at 312 refers to the distinction between a debt that is 'due' as distinct from 'payable' as 'incipient heresy'. See further G Hamilton, 'An insolvency riddle: when is a debt which is due not a debt which is due and payable?' (1997) 5 Insol Law Jnl 78.
244
flow' rather than a 'balance sheet' test of insolvency.114 The cash flow test
provides that a company is insolvent when it is unable to pay its debts as they
fall due. B y contrast, the balance sheet test provides that a company is insolvent
if its total liabilities outweigh the value of its assets so that its assets are
insufficient to discharge its liabilities.115
The definition of insolvency introduced in s 95 A of the Corporations Act is
different from t he t raditional t est o f i nsolvency 1 aid d o w n ins 122( 1) o f t he
Bankruptcy Act 1966 (Cth). The latter section requires proof that the person is
unable to pay his or her debts as and when they become due and payable, 'from
the person's own money'. In this regard the Harmer Report recommended that s
95A of the Corporations Act should be enacted with those words included. The
definition of insolvency contained in the 1992 draft legislation also included the
phrase 'from the person's own money'. The Explanatory Paper states that this
phrase did not exclude liquid funds to which the company had access by way of
borrowing or mortgaging or selling assets within a reasonable period.
The words 'from the person's own money' were, however, not ultimately
included in the legislation. The effect of the omission is that, under s 95 A of the
Corporations Act, it is necessary to prove that the person was unable to pay all
his or her debts, no matter from what resources. External resources could
include a holding company or a major supplier. Since the Explanatory
Memorandum did not comment specifically on the omission, it is unlikely that
the change from the draft to the ultimate legislation was a substantial
amendment. Given that the new solvency definition uses wording similar to that
included in s 122(1) of the Bankruptcy Act 1966 (Cth), it is likely that the courts
will refer to case authority interpreting the latter subsection to give meaning to s
114 See Melbase Corporation Pty Ltd v Segenhoe Ltd (1995) 17 A C S R 187 at 198. 115 For a further discussion of the distinction between 'cash flow' and 'balance sheet' insolvency, see A Keay, 'The insolvency factor in the avoidance of antecedent transactions in corporate liquidations' (1995) 21 Mon ULR 305 at 307-308; L Sealy, 'Modern insolvency laws and Mr Salomon' (1998) 16 C&SU 176 at 178. 116 Corporate Law Reform Bill 1992, Exposure Draft Legislation and Explanatory Paper, para 571.
245
95A of the Corporations Act.ni This view is supported by reported decisions
on insolvent trading that considered case authorities analysing s 122(1) of the
Bankruptcy Act 1966 (Cth) to determine the scope of s 95 A of the Corporations
Actm
The Australian c o m m o n law developed its own understanding of insolvency by
making use of both the cash flow and balance sheet tests of insolvency derived
from the English common law.119 The decision in Bank of Australasia v Hall120
suggested that the test of solvency, the ability to pay debts as they fall due, was
not an automatic test of assets over liabilities.121 Also in Rees v Bank of New i >>*y
South Wales solvency was not assessed merely by the availability of ready
cash to cover commitments as they fall due for payment. It was found in this
case t hat, tod etermine whether p ersons c an p ay their d ebts a s t hey fall d ue,
regard must also be had to their realisable assets. In other words, one must look
at whether the persons are able to raise finance by selling or mortgaging their
assets.123
In Sandell v Porter}24 Barwick CJ affirmed that insolvency required a
consideration of all the circumstances of the debtor and did not entail a
temporary shortage of cash. His Honour stated that 'the conclusion of
insolvency ought to be c lear from a debtor's financial position in its entirety
and generally speaking ought not to be drawn simply from evidence of a
117 For an analysis of s 122(1) of the Bankruptcy Act 1966 (Cth), see C Darvall and NTF Fernon, McDonald, Henry and Meek - Australian Bankruptcy Law & and Practice (1996) at
para 122.1.05. '8 See, eg, Stargard Security Systems Pty Ltd v Goldie (Stargard) (1994) 13 A C S R 805 at 811. 119 Although some inconsistency exists, and despite the introduction of s 95A of the Corporations Act, the courts generally continue to have regard to both the common law tests (cash flow and balance sheet) in determining the solvency of a company. See, eg, Antico (1995) 38 N S W L R 290 at 329; Leslie v Howship Holdings (1997) 15 A C L C 459 (Leslie) at 465-467;
and Kenna & Brown Pty Ltd v Kenna (1999) 32 A C S R 430 at 444-445. 120 (1907) 4 C L R 1514. See also Taylor v Carroll (1991) 6 A C S R 255 at 259. 121 Bank of Australasia v Hall (1907) 4 C L R 1514at 1528 (Griffiths CJ). 122(1964)111CLR210. 123/ta/218. 124 (1966) 115 C L R 666.
246
temporary lack of liquidity'.125 Insolvency was rather an indication of the
debtor's inability to utilise cash resources through disposing of or charging his
assets.126 Mahoney J in Dunn v Shapowloff21 applied a commercial reality test
in explaining the words 'inability to pay'. His Honour stated:128
What will constitute ability to pay must be determined, in a realistic way, by reference to the facts of the particular case, after taking into consideration, inter alia, the company's assets and liabilities and the nature of them, and the nature
and circumstances of the company's activities.
The considerations referred to above include the ability of the company to
borrow money. In contemplating a company's ability to pay O'Bryan J in Heide
Pty Ltd t/a F armhouse Smallgoods v L ester1291 ikewise t ook i nto a ccount a 11
cash and credit resources available to the company.
The scope of s 95A of the Corporations Law was considered in Stargard
Security Systems Pty Ltd v Goldie}30 This case was decided in the context of an
application for summary judgment for the payment of compensation for loss
and damage as a result of a breach of s 588G of the Corporations Law. Master
Bredmeyer relied on the earlier authorities on s 122(1) of the Bankruptcy Act
1966 (Cth) in evaluating the company's insolvency. The average weekly cash
flow of the company before the debt was incurred as well as weekly cash flow
predictions and expectation of sales and returns were taken into account. The
Master was of the opinion that 'in assessing solvency or insolvency, it is
relevant to look not only at the company's likely income, but also at the
company's likely debts'.131
125 Ibid 670. Sandell v Porter was cited with approval by Ipp J in Re Bond Corporation Holdings Ltd (1990) 1 ACSR 350 at 358 and also by Thomas J in Taylor v Carroll (1991) 6 ACSR 255 at 259. 126 This view was reaffirmed by Jacobs J in Hymix Concrete Pty Ltd v Garrity (1977) 13 ALR 321 at 327-328. 127 [1978] 2 N S W L R 235. mIbid244. 129 (1990) 3 ACSR 159 (Heide) at 165. 130 (1994) 13 ACSR 805. 131 Ibid 814. See also Leslie (1997) 15 ACLC 459 at 466 and In the Matter of Simionato Holdings Pty Ltd (1991) 15 ACLC 477 at 482.
247
A more contemporary decision on s 95A of the Corporations Law is
Metropolitan Fire Services Pty Ltd v Miller.132 Einfeld J was of the view that it
was necessary to take into account the whole of the company's resources,
including its credit resources. To establish this one may have to take into
account the time extended to the company to pay its creditors and the time it
will take to receive payment of its debts.133 In Quick v Stoland Pty Ltd}34
another recent decision that considered s 95A of the Corporations Law, the
court pointed out issues that may be relevant to establish whether a company is
insolvent at a given time, namely:
• all of the company's debts as at that time in order to determine when those
debts were due and payable;
• all of the company's assets as at that time in order to determine the extent to
which those assets were liquid or realisable within a timeframe that would
allow each of the debts to be paid as and when it became payable;
• the company's business as at that time in order to determine its expected net
cash flow from the business by deducting from projected future sales the
cash expenses which would be necessary to generate those sales; and
• arrangements between the company and prospective lenders, such as its
bankers and shareholders, in order to determine whether any shortfall in
liquid and realisable assets and cash flow could be made up by the
borrowings which would be repayable at a time later than the debts.135
7.3.1.3 'Reasonable grounds for suspecting'
Even if a company is insolvent, before liability will arise under s 588V or s
588G of the Corporations Act, it must be established that there were
'reasonable grounds to suspect' that the subsidiary/company was insolvent or
would become insolvent.136 The notion of reasonable grounds for suspecting
132 (1997) 23 ACSR 699. 133 Ibid 102. 134 (1998) 29 A C S R 130 (Stoland). In this case it was pointed out by Emmett J (at 139) that, although other tests than cash flow may be convenient indicators of the solvency of a company,
they cannot provide a final answer. 135 Stoland (1998) 29 A C S R 130 at 138 (Emmett J). 136 Section 588V(l)(c) and s 588G(l)(c) of the Corporations Act, respectively.
248
insolvency introduces an objective test for suspicion that requires reference to a
director of ordinary competence or reasonable ability. The idea is to remove
any subjective elements from the test.138 The standard of foresight that a
director should disclose has been described as falling between that expected of 1 ̂ Q
an office boy and the standard expected of an auditor.
The predecessor of s 588G of the Corporations Act, s 592(l)(b) of the
Corporations Law, contained the expression 'reasonable grounds to expect'.
The Australian L a w Reform Commission recommended that the wording
should be changed from 'expect' to 'suspect'.140 The rationale behind this
change was to increase potential liability, thereby encouraging directors (and,
since 1993, when s 588V of the Corporations Act was introduced, also holding
companies) to be more scrupulous in taking into account the financial affairs of
the subsidiary/company and, if timely, commence insolvency administration.
The word 'suspicion' has been described, in a similar context, as 'more than a
mere idle wondering whether or not [something] exists; it is a positive feeling
of actual apprehension or mistrust, amounting to 'a slight opinion, but without
sufficient evidence'.'141 In 3M Australia Pty Ltd v Kemish142 it was stated that
the word 'expecting' was very different from 'suspecting', and was
synonymous with 'predicting'.143 The comments by Foster J in this case
indicate that the concept of 'suspicion' is wider than 'expectation'. In the light
thereof it will be easier to establish 'reasonable grounds for suspicion' under s
588V o r s 5 88G o f the Corporations A ct than i t h as b een formerly top rove
expectation of insolvency by a director under s 592 of the Corporations Law}44
Kemish (1986) 10 ACLR 371 at 382-3; Rema (1992) 7 ACSR 251 at 259. 138 Kemish (1986) 10 ACLR 371 at 372-3, 376 and 378; Commonwealth Bank of Australia v Friedrich (1991) 9 ACLC 946 (Friedrich) at 953-954; Rema (1992) 7 ACSR 251 at 259. 139 Kemish (1986) 10 ACLR 371 at 373. 140 Harmer Report, above n 2, para 287. 141 Queensland Bacon Pty Ltd vRees (1966) 115 CLR 266 at 303 (Kitto J). This case was decided in the context of the preference provisions of s 95 of the Bankruptcy Act 1966 (Cth). 142 (1986) 10 ACLR 371. 143/ta/378.
Sections 588V and 588G of the Corporations Act impose a less vigorous test of insolvent
trading than s 592. See further N Coburn, 'When a director 'suspects' insolvency: the new insolvent trading provisions' (1996) 5 Butt Comm L Bull 74.
249
Suspicion requires a lower threshold of knowledge or awareness than
expectation. This is in line with the legislative policy behind the amendment.
The holding company (in s 588V) or director (in s 588G), respectively, must
predict from prevailing circumstances the anticipated financial position of the
subsidiary/company. Section 588V of the Corporations Act imposes a very
burdensome duty upon the holding company to monitor the financial position of
its subsidiary in the same way as s 588G of the Corporations Act confirms the
previously raised director's duty to monitor the financial position of his/her
company. The inquiry whether there are reasonable grounds to suspect that
the subsidiary/company will not be able to pay its debt when it is due is a
factual question that must be decided as a matter of commercial reality in the
light of all the surrounding circumstances.
To date there has been no consideration by the courts of the expression
'reasonable grounds to suspect' in the context of s 588V of the Corporations
Act by the courts and there have been only a few authoritative judicial
considerations of this expression in the context of s 588G.147 Einfeld J in
Metropolitan v Miller14* acknowledged that, in the context of s 588G of the
Corporations Law, an objective test was applicable in determining
reasonableness and stated:149
Irrespective of how the test is formulated, it is one of objectively reasonable grounds, which must be judged by the standard appropriate to a director of ordinary competence ... Questions of knowledge of and participation in the incurring of the relevant debt are now relegated to the status of factual matters which may arise should the director seek to establish one of the statutory defences afforded by the legislation. The establishment of liability is, therefore, not contingent on elements personal to the respondent.
I4i Metropolitan v Miller (1997) 23 A C S R 699 at 711. 146 Kemish (1986) 10 A C L R 371 at 378. 147 In Tourprint v Bott (1999) 17 A C L C 1,543, eg, Austin J stated (at 1,554) that it was not
necessary to explore the reach and limits of the concept 'reasonable grounds for suspecting' in the light of the clear facts of the case. 148 (1986) 10 A C L R 371. 149 Metropolitan v Miller (1997) 23 A C S R 699 at 703. For a consideration of proceedings
instituted under s 588M of the Corporations Act, see Stoland (1998) 29 A C S R 130. See also Mullenger v Dana Australia Pty Ltd, unreported, [1998] V S C A 30 (27 August 1998).
250
While it is not entirely clear what meaning will be attached to 'suspect' in the
context of s 588G and s 588V of the Corporations Act, a higher standard of
care than before is expected from directors, which one m a y assume will apply
to holding companies as well. All indications are that the courts will interpret it
in a manner that will increase the potential scope of the provisions in this
context.150
7.3.2 Defences
Section 588X of the Corporations Act deals with the defences available to a
holding company where there is an alleged contravention of the provisions of s
588V of the Corporations Act. It borrows to a large extent from s 588H of the
Corporations Act that deals with the defences available to a director where
there is an alleged contravention of the provisions of s 588G of the
Corporations Act}51 While the courts have had little opportunity to consider the
provisions of s 588X of the Corporations Act, they have considered some of the
defences contained in s 588H of the Corporations Act and its predecessors.
Although the provisions of ss 588X and 588H of the Corporations Act
introduced both new wording and new defences into the insolvent trading
provisions, the new defences duplicate some of the wording contained in the
predecessors of s 588H of the Corporations Act. The case law interpreting the
predecessors of s 588H therefore remains relevant in an examination of both s
588X and s 588H of the Corporations Act. Like the provisions of s 588V and s
588G of the Corporations Act, the provisions containing the defences available
Coburn, 'When a director 'suspects' insolvency: the new insolvent trading provisions', above n 1 (in relation to s 588G of the Corporations Act). For criticism of the introduction of 'suspect' see, eg, R P Austin, 'The Corporate Law Reform Bill - its effect on liability of holding companies for debts of insolvent subsidiaries' (1992) 6 Butt Corp LB para 103; Dabner, above n 8, 562.
The defences contained in s 588X mirror the defences in s 588H of the Corporations Act, with only slight differences in the wording to provide for the fact that s 588X deals with holding companies while s 588H of the Corporations Act deals with directors.
251
for holding companies/directors, contained in s 588X and s 588H of the
Corporations Act respectively, are therefore discussed together.
7.3.2.1 Reasonable grounds to expect solvency
The defence contained in s 588X(2) of the Corporations Act reads as follows:
It is a defence if it is proved that, at the time when the debt was incurred, the corporation, and each relevant director (if any), had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.
The equivalent defence in respect of directors is contained in s 588H(2) of the
Corporations Act. A distinguishing feature of the defence is that it contains
the words 'reasonable grounds', rather than the words 'reasonable cause' used
previously in s 592(2)(b) of the Corporations Law, the predecessor of s
588H(2) of the Corporations Act. 5 Former s 592(2)(b) of the Corporations
Law exempted a director or manager of a company from liability if he/she did
not have 'reasonable cause to expect' that the company would not be able to
pay all its debts as and when they became due, or that, if the company incurred
the debt in question, it would not be able to pay all its debts as and when they
became due.
See, generally, I Trethowan 'Directors' personal liability for insolvent trading: at last, a degree of consensus' (1993) UC&SLI 102. 153 This defence requires a person to have an expectation of solvency. It retains the word 'expect' from the former provisions that make the cases on the former provisions applicable. 154 Sub-section 588H(2) of the Corporations Act reads as follows: '[Reasonable grounds to
expect company solvent] It is a defence if it is proved that, at the time when the debt was incurred, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.' It was pointed out in Tourprint v Bott (1999) 17 A C L C 1,543 at 1,555, relying on Kemish (1986) 10 A C L R 371 at 378 and Dunn v Shapowloff [1978] 2 N S W L R 235 at 249, that 'expectation' in this context means a higher degree of certainty than
'mere hope or possibility' or 'suspecting'. 155 To determine the standard of reasonableness in the context of s 588H(2) of the Corporations Act, one should have regard to earlier cases. In all likelihood the standard to be applied will be the degree of competence and care expected of a director in the relevant position: see, eg, Friedrich (1991) 9 A C L C 946 at 955; and Antico (1995) 38 N S W L R 290 at 332.
252
Section 592(2)(b) of the Corporations Law was identical to its predecessor, s
556(2)(b) of the Companies Code, in all material respects. The latter subsection
also used the phrase 'reasonable cause to expect' rather than 'reasonable
grounds to expect' as contained in ss 588X(2) and 588H(2) of the Corporations
Act. Subsection 556(2) of the former Companies Code read as follows:156
In any proceedings against a person under sub-section (l),157 it is a defence if the
defendant proves -(a) that the debt was incurred without his express or implied authority or consent;
or (b) that at the time when the debt was incurred, he did not have reasonable cause
to expect -(i) that the company would not be able to pay all its debts as and when they became due; or (ii) that, if the company incurred that debt, it would not be able to pay all its debts as and when they became due.
The inadequacies in former s 556(2)(b) of the Companies Code and s 592(2)(b)
of the Corporations Law became clear when the courts purported to tie in the
policy assumptions with the wording of these provisions. This resulted in
conflicting decisions as to the circumstances in which this defence would be
available.
In Pioneer Concrete Pty Ltd v Ellston15* Carruthers J considered the operation
of the defence under s 556(2)(b) of the Companies Code and found that the
words 'reasonable cause to expect' involved a blending of subjective and
objective considerations. In the course of his judgment Carruthers J relied to a
large extent on the decision of Wilson J of the High Court in Shapowloff v
Dunn159 when s 303(3) of the Companies Act 1961 (NSW) was still in
operation. Carruthers J held that a defendant relying on subsection 556(2)(b) of
the Companies Code had to prove at the time each debt was incurred that:160
See para 7.3.1.1 (a) above for the wording of former s 303(3) of the Companies Act 1961 (NSW).
See para 7.3.1.1(a) above for the wording of sub-s 556(1) of the former Companies Code. 158 (1995) 10 ACLR 289. 159 (1981) 148 CLR 72 at 85. 160 Ellston (1995) 10 ACLR 289 at 301. Although Connolly J in John Graham (1987) 5 ACLC
904 adopted a similar approach as Carruthers J, Connolly J (at 911) referred to the test as 'an objective standard that is to be applied to the facts as known to the defendant'. O'Bryan J in
253
[H]e had no cause reasonably grounded in the whole of the circumstances then existing as he knew them to expect that the company would not be able to pay all its debts as and when they became due or that if the company incurred that debt it would not be able to pay all its debts as and when they fell due.
Hodgson J in Metal Manufacturers^ criticised the approach of Carruthers J in 1 f\)
Ellston. Hodgson J was of the opinion that such an approach did not pay
proper attention to the wording of s 556(2)(b) of the Companies Code. His
Honour pointed out that the wording of s 556(2)(b) of the Companies Code was
significantly different from that of former s 303(3) of the Companies Act 1961
(NSW). Hodgson J was of the view that Carruthers J did not attempt to consider
the meaning of the ordinary language c ontained in s 556(2)(b) of the former
Companies Code.
In the course of his judgment Hodgson J also considered the approach of Foster
J in Kemish. Foster J was of the view that, in assessing whether there was
'reasonable cause to expect' that the company would not be able to pay all its
debts depended on the knowledge of the director at the time in question and the
grounds of expectation assessed objectively. Although Hodgson J at first
instance in Metal Manufacturers^64 agreed with the substance of the decision of
Foster J in Kemish}65 his Honour adopted a different approach towards the
interpretation of s 556(2)(b) of the Companies Code.
Hodgson J in Metal Manufacturers166 was of the view that the decision of
Foster J in Kemish might be read as imposing too much of a burden on a
defendant. More specifically, Hodgson J stressed that in former s 303(3) of the
Companies Act 1961 ( N S W ) the onus was on the prosecution to prove that a
person did not have 'reasonable grounds to expect' the company would be able
Heide (1990) 3 ACSR 159 also followed the approach of Carruthers J in Ellston (1995) 10 ACLR 289. 161 (1986) 11 ACLR 122. 162 (1995) 10 ACLR 289. 163 (1986) 10 ACLR 371. 164(1986)11ACLR122. 165 (1986) 10 ACLR 371.
254
to pay its debts as they fell due. Under s 556(2)(b) of the Companies Code the
defendant bore the onus of proof. In analysing the defences Hodgson J
considered that the words 'reasonable cause to expect' imported circumstances
actually known to the defendant, and circumstances that the defendant ought to
know, having regard to his position in the company and the duties associated
with that position.167 In the light thereof Hodgson J was of the opinion that the
best approach to the provision was to ask if the defendant had proved that he
did not have 'reasonable cause to expect' that the company would be unable to
pay its debts as they fell due. In this regard one m a y take into account facts and
circumstances known to the defendant and also facts and circumstances which 1 fSl
by reason of his duties ought to have been known to the defendant.
Different once again from the approaches referred to above is the approach of
Ormiston J in Morley v Statewide Tobacco Services Ltd}69 His Honour was of
the view that directors could successfully defend themselves only by relying on
the provisions of s 556(2)(b) of the Companies Code if they could prove that
they had no 'reasonable cause' to believe that the company was insolvent.
Ormiston J held that the ability of a company to pay its debts as and when they
became due was a question of 'reasonable cause to expect', directed at the
financial position of the company generally.17 This expectation related partly
to the enquiry that a director or manager should make about the solvency of the 1 *71
company. These conclusions overlap largely with the conclusions reached by
Kirby P in the N e w South Wales Court of Appeal decision in Metal
Manufacturers}12 Just like Kirby P, Ormiston J found that, by enacting
amendments to the insolvent trading provisions, the legislature had required
166 (1986) 11 A C L R 122. 167 Ibid 129. 168 Ibid 130. 169 [1993] 1 V R 423; confirmed by the Full Court of the Supreme Court of Victoria in Morley v Statewide Tobacco Services Ltd [1993] 1 V R 423 at 45 Iff (Morley). 170 Ibid 447. 171/taf448. 172 (1988) 13 N S W L R 315. In the context of s 556(2)(b) of the Companies Code Ormiston J in Morley [1993] 1 V R 423 adopted a much wider version of the test than Hodgson J at first instance in Metal Manufacturers (1986) 11 A C L R 122.
255
directors to act with greater responsibility that they had been required to do
under the previous legislative provisions.173 Ormiston J placed less emphasis on
what a director knows and greater emphasis on what he or she reasonably ought
to have known regarding the ability of the company to pay its debts.174
The same issue subsequently came before Tadgell J in Commonwealth Bank of 1 7^
Australia v Friedrich. In finding that the defendant was unable to rely on the
defence contained in s 556(2)(b) of the Companies Code, Tadgell J held that
'reasonable cause to expect' meant that the court considered what the defendant
knew as well as what he ought reasonably to have known.176 In deciding this,
Tadgell J accepted the approach of Ormiston J in the court of first instance in
Morley and Kirby P on appeal in Metal Manufacturers11* and considered
paragraph (b) of s 556(2) of the Companies Code objectively.179 In turn the Full
Court of South Australia in Group Four Industries Pty Ltd v Brosnan 181 189
followed the approach by Tadgell J in Friedrich. In Group Four the court
held that 'reasonable cause to expect' had to be considered against the
background of and in conjunction with the duties and responsibilities that the
then Companies Code imposed on a director, requiring each director to have an
active interest in the company. Other courts have also followed this
approach.183
173 Morley [1993] 1 VR 423 at 430. 174 Ibid 449. 175 (1991) 9 ACLC 946. 176 Ibid 957-958. 177 [1993] 1 VR423. 178 (1988) 13 NSWLR 315. 179 Tadgell J distinguished Dunn v Shapowloff'[1978] 2 NSWLR 235 on the ground that that decision had examined s 303(3) of the Companies Act 1961 (NSW) and was not relevant to s 556 of the Companies Code. Carruthers J in Ellston (1995) 10 ACLR 289 and Foster J in Kemish (1986) 10 ACLR 371 accepted the application of the reasoning in Dunn v Shapowloff
[1978] 2 NSWLR 235 to s 556 of the Companies Code. 180 (1992) 8 ACSR 463 (Group Four). 181 (1991) 9 ACLC 946. 182 (1992) 8 ACSR 463. 183 See, eg, Leigh-Mardon (1995) 17 ACSR 741 at 751. This approach was not referred to in Stargard (1994) 13 ACSR 805 where the court had to consider whether a defence under s
588H(2) of the Corporations Act could be established.
256
7.3.2.2 Reliance on another
The defence of reliance on another person acknowledges the fact that the sheer
size of a company m a y force a holding company/director to rely on information
provided by third parties in the carrying out of its/his/her duties. The provisions
of s 588X(3) of the Corporations Act permit a holding company to establish, on
reasonable grounds, a defence if it, and each relevant director, expected that the
company was solvent. This defence m a y be established by relying on
information from a competent and reliable third party responsible for providing
information about the company's solvency. The equivalent defence in respect
of directors is contained in s 588H(3) of the Corporations Act. The Australian
Law Reform Commission originally recommended that such a defence should
be inserted into the Corporations Act, in an effort to motivate companies to
ensure the existence of proper financial management systems.184
Section 588X(3) of the Corporations Act provides as follows:
Without limiting the generality of subsection (2), it is a defence if it is proved that, at the time when the debt was incurred, the corporation, and each relevant director (if any): (a) had reasonable grounds to believe, and did believe: (i) that a competent and reliable person was responsible for providing to the
corporation adequate information about whether the company was solvent; and
(ii) that the person was fulfilling that responsibility; and (b) expected, on the basis of information provided to the corporation by the
person, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.
This defence does not require that the person in whom reliance is placed should
be competent or reliable, but rather that there were reasonable grounds to
believe that this was the case.185 Some commentators have suggested that, while
s 588H(3) of the Corporations Act does not expressly state so, it requires a
director to be 'partially active' in the company by ensuring that proper
Harmer Report, above n 2, para 306. Ibid para 307.
257
procedures and delegations are adopted, and sets a higher standard for 1 87
directors. This argument would presumably also apply to holding companies
by virtue of the provisions of s 588X of the Corporations Act, so that an
equivalent higher standard is set for holding companies.
It seems that, unless they have particular responsibilities or expertise, the
responsibility of holding companies/directors under the defence would be
limited to requesting and receiving financial information regularly.188 If no
factors existed to arouse suspicion, holding companies/directors would be taken 1 80
to have acted reasonably in relying on the third party. They can be required
to seek more information only if the accounts of the company, together with
any other information from the company's executives, put them on inquiry.190
In Capricorn Society Ltd v Linke191 directors not involved in the day-to-day
management of the business successfully relied on this defence on the ground
that they had made regular enquiries about the financial position of the
company and were given positive reports by an executive director w h o m they
relied on.
7.3.2.3 Illness or some other good reason
A holding company may raise a successful defence if a particular relevant
director was not in a position to participate in the management of the holding
company at the time when its subsidiary incurred the debt. Section 588X(4) of
the Corporations Act, relating to holding companies, provides as follows:
186 R Baxt, 'New insolvent trading rules for directors' (1993) 9 Co Dir 12. 187 Pollard, above n 110, 407. 188 It may be argued that it is insufficient for a director merely to obtain information, since certain case law indicate that a director is also required to make inquiries into the basis of the information that he received: Friedrich (1991) 9 A C L C 946. 189 Morley [1993] 1 V R 423 at 448. 190 Ibid. 191 (1995) 17 A C S R 101.
258
If it is proved that, because of illness or for some other good reason, a particular relevant director did not take part in the management of the corporation at the
time when the company incurred the debt, the fact that the director was aware as
mentioned in subparagraph 588V(l)(d)(i) is to be disregarded.
The equivalent defence in respect of directors is contained in s 588H(4) of the
Corporations Act}92 It is possible to interpret this defence as follows. If a
director can prove that, at the time when the debt was incurred, he/she was ill or
had another good reason for not participating in the running of the relevant
company, the director is exempted from liability. This m a y have arbitrary
results because of the requirement of non-participation in management at the
time when the debt was incurred.194 The defence m a y also lead to uncertainty
since the phrase 'illness or for some other good reason' potentially has a very
wide meaning.195 This section has furthermore been criticised on the basis that
the defence will prove too complicated to rely upon196 and that it does nothing
to further the legislative purpose.197
There was an attempt to rely on the defence in s 588H(4) of the Corporations
Law in Tourprint International Pty Ltd v Bott. The liquidator of Tourprint
International Pty Ltd brought an application under s 5 8 8 M of the Corporations
Law, seeking compensation for losses incurred by the company as a result of
the directors continuing to trade when the company was insolvent, thereby
contravening s 588G of the Corporations Law. As one of the two directors of
the company, Moore, was deceased, the action was brought against the
remaining director, Bott. Austin J held that there were reasonable grounds for
Section 588H(4) of the Corporations Act provides as follows: '[Director ill, etc] If the person was a director of the company at the time when the debt was incurred, it is a defence if it is proved that, because of illness or for some other good reason, he or she did not take part at that time in the management of the company.'
Coburn, 'Insolvent trading in Australia: the legal principles', above n 68, 94-106. See the discussion of 'incurs a debt' in para 7.3.1.1 above. Coburn, 'Insolvent trading in Australia: the legal principles', above n 68, 94-106; G
Montserrat, 'Commonwealth v Christopher Skase: a matter of life or death or a nomination for an Oscar?' (1995) 18 UNSWLR 502. 196 Pollard, above n 110, 407.
A Herzberg, 'Insolvent trading D o w n Under' in J Ziegel (ed) Current Developments in International and Comparative Corporate Insolvency Law (1994) at 510. 198 (1999) 17 A C L C 1,543 (Tourprint v Bott).
259
Bott to suspect that the company was insolvent.199 His Honour found that Bott
did not ask Moore or the company's accountant for any financial formation
prior to his appointment to the board.200 Austin J furthermore found that Bott
did not seek balance sheets, profit and loss statements or creditor ledgers from
Moore, the company's accountant or bookkeeper, and did not do anything else
to inform himself of the company's financial position during the relevant
period.201
To escape liability Bott sought to rely, inter alia, on the defence contained in s
588H(4) of the Corporations Law, namely, that he did not take part in the
management of the company at the relevant time for some other good reason
than illness. The other good reason was said to be that Bott was excluded
from management by the deception of, inter alios, Moore. Bott alleged that
Moore had not disclosed the true financial situation and had not allowed him
access to company records.203 Regarding the defence in s 588H(4) of the
Corporations Law, Austin J found that Bott had been given information by
Moore that led Bott to believe that the company's financial situation was less
serious t nan i t a ctually was.204 H owever, h is H onour h eld t hat t he failure b y
Bott to take a more active role in the financial management of the company was 205
not a 'good reason' for the purposes of s 588H(4) of the Corporations Law.
Although Bott did not take part in the financial management of the company,
Austin J doubted that Bott had not taken part in the management of the
199 Ibid 1,554-1,555. 200 Ibid 1,550. 20XIbid. 202 Bott also relied o n the defence that at the time the debt was incurred he had reasonable grounds to expect, and did expect, that the company was solvent and would remain solvent if it incurred the debt, but Austin J held that Bott could not successfully utilise this defence, as he would be hiding behind his ignorance: Tourprint v Bott (1999) 17 A C L C 1,543 at 1,555-1,556. 203 Tourprint v Bott (1999) 17 A C L C 1,543 at 1,556. 204 Ibid. 105 Ibid.
260
company at all, since he had played an important part in sales and in debt
206
recovery.
In the course of his judgment Austin J pointed out that there were no previously
reported decisions that interpreted the words 'other good reason' in the context
of s 588H(4) of the Corporations Law. His Honour did, however, refer to case
law under the former s 592 of the Corporations Law, which is differently 707
worded, that considered the following circumstances:
• where an alternate director, who acts only when a regular director is not
able to do so, is not acting as a director when the debt is incurred;208 and
• where a director goes overseas and requests another director to be appointed
in his place.209
Austin J w as o f t he v iew t hat, i f t he facts oft hese c ases o ccurred u nder t he
current section, they may well have constituted 'other good reason' under s
588H(4) of the Corporations Law?m
After Tourprint v Bott2U the Supreme Court of New South Wales had the
opportunity to interpret the words 'other good reason' in the context of s
588FGB(5) of the Corporations Act. The wording of the latter subsection is
for all practical purposes identical to the wording of s 588H(4) of the
Corporations Act?13 In Southern Cross Interiors Pty Ltd (in liq) v Deputy
Ibid. Although Bott was not financially sophisticated, he was not financially naive, as he had previously been managing director of another company with an annual turnover of about $3.5m, and had received financial reports on a monthly basis on that capacity. 207 Tourprint v Bott (1999) 17 A C L C 1,543 at 1,556. 208 Playcorp Pty Ltd v Shaw (1993) 11 A C L C 641. 209 Androvin v Figliomeni (1996) 14 A C L C 1,461. 210 Tourprint v Bott (1999) 17 A C L C 1,543 at 1,556. 211 (1999) 17 A C L C 1,543.
Although the proceedings were commenced under the Corporations Law, judgment was reserved until after 15 July 2001 when the Corporations Act came into effect. Pursuant to ss 1383 and 1399 of the Corporations A ct the proceedings are now deemed to be p roceedings under the Corporations Act.
Section 588FGB(5) of the Corporations Act reads as follows: '[Defence of illness] It is a
defence if it is proved that, because of illness or for some other good reason, the person did not take part in the management of the company at the payment time.' Subsections (3)-(7) of s 588FGA afford the same defences to a claim by the Deputy Commissioner of Taxation under s
261
Commissioner of Taxation the liquidator of Southern Cross Interiors Pty Ltd
(SCI) commenced proceedings against the Deputy Commissioner of Taxation
(DCT) for an order that the D C T had obtained an unfair preference. The action
was instituted pursuant to ss 588FA, 588FE and 588FF(1) of the Corporations
Act. In its defence the D C T claimed that the payments were not voidable. The
D C T further sought a declaration that the directors of SCI were liable to
indemnify the D C T pursuant to s 588FGA(2) of the Corporations Act for all
payments that the D C T might be obliged to make to the liquidator.
At all relevant times Mr and Mrs Clarke were the directors of SCI. They were
unsuccessful on both arguments put forward as to why the liquidator was
prevented from bringing the action against the D C T that resulted in the D C T
claim against them. In the final instance Mrs Clarke argued that she had a
defence to the claim by the D C T under s 588FGB(5) of the Corporations Act
since she did not take part in the management of the company 'because of
illness o r for s ome o ther g ood r eason'. S ince s he w as n ot i 11 a t a ny r elevant
time, the sole issue for consideration was whether Mrs Clarke did not
participate in the management for some 'other good reason'. At no time during
the period that Mrs Clarke was a director of SCI did she participate in the
management of the company in any degree whatsoever. Palmer J was
satisfied on the facts that Mrs Clarke had 'acted at her husband's request,
relying entirely on his implied assurance that her appointment was a formality
because the company needed two directors'. In doing so, she believed and
trusted her husband.
In considering whether the trust and confidence placed in her husband
constituted a 'good reason' for not taking part in the management of SCI,
Palmer J stated that 'any reason which the law holds sufficient, according to
588FGA as are afforded by sub-ss (2)-(6) of s 588H to a claim for insolvent trading under ss 588G, 588M and 588R of the Corporations Act. 214 (2001) 39 A C S R 305 (Southern Cross). 2X5 Ibid 309. 2X6 Ibid 323.
262
accepted legal principle, to excuse a person from the legal consequences of his
or her acts or omissions is a 'good reason' for the purposes of a defence under
ss 588H(4) and 588FGB(5) [of the Corporations Act].'211 In this regard his
Honour mentioned examples of such conduct developed in the civil law to
include non est factum?1* duress, undue influence, deceit, misleading and
deceptive conduct and unconscionable conduct. Palmer J then turned to the
reasoning in Yerkey v Jones,219 as affirmed and explained in Garcia v National
Australia B ank?20 In G arcia t he c ourt h eld t hat t he b ank's e nforcement o f a
guarantee against a wife w h o had given the guarantee for her husband's
business based on their relationship of 'trust and confidence' was
unconscionable.
Palmer J held that a wife's failure to appreciate the reality of her responsibilities
as a director in the circumstances referred to in Garcia m a y be a 'good reason'
for failing to participate in management for the purposes of a defence under s
588H(4) or s 588FGB(5) of the Corporations Act?21 His Honour stressed that
'[w]hether the wife has truly failed to appreciate her responsibilities and
whether such failure has anything to do with trust and confidence in the marital
relationship are questions of fact in each case.'222 Palmer J pointed out that it
would be a comparatively rare case in which a wife is able to establish such a
defence on the facts. In most cases there would either be no relationship of trust
and confidence which induced the acceptance of the directorship, or the
defendant would be sufficiently experienced in commercial matters to have
appreciated the duties of a director, or the defendant would be sufficiently
involved in the company's affairs not to be able to claim non-participation in
217Ibid331.
This is apparently a reference to an act that is legally invalid or void. 219 (1939) 63 CLR 649. 220 (1998) 194 CLR 395 (Garcia). 221 Southern Cross (2001) 39 ACSR 305 at 333.
263
22^
management. Palmer J found that the present case was one of those rare cases
in which the defence should succeed.224
It is submitted that the approach in Tourprint v Bott225 is to be preferred to that
in Southern Cross. The Explanatory Memorandum to the Corporate Law
Reform Bill 1992 states that the words 'other good reason' should be
interpreted in the light of a director acting in a diligent manner.227 This
statement is not vindicated by the decision in Southern Cross?2* despite Palmer
J's comment that recognition of a wife's failure to appreciate the reality of her
responsibilities as a director due to a deferral to her husband in the
circumstances referred to in Garcia229 would not undermine the policy of the
law. Unfortunately the decision in Southern Cross231 is not of assistance as
far as the position of a holding company is concerned since it is of course not
possible for a holding company to entrust something to a husband. In this
regard the decision in Tourprint v Bott222 also does not throw much light on the
meaning of the words 'other good reason' in the context of a holding company -
not even the reference by Austin J to alternate directors will apply to a holding
company.233
223 Ibid. 224 Ibid. 225 (1999) 17 A C L C 1,543. 226 (2001) 39 A C S R 305. 27 Explanatory Memorandum para 1086.
(2001) 39 A C S R 305. See also S Pascoe, 'Insolvent trading: director uses Garcia defence' (2002) 13 JBFLP 47'. 229 (1998) 194 C L R 395. 230 Southern Cross (2001) 39 A C S R 305 at 333. 231 (2001) 39 A C S R 305. 232 (1999) 17 A C L C 1,543.
It remains to be seen how this defence will apply to a holding company. For example, in a
takeover scenario the question arises whether a holding company would be able to rely on the defence of 'other good reason' where it does not participate in the management of the holding
company while it legitimately defends the takeover, allowing its subsidiary to decline into insolvency.
264
7.3.2.4 Reasonable steps to prevent incurring a debt
Section 588X(5) of the Corporations Act provides as follows:
It is a defence if it is proved that the corporation took all reasonable steps to prevent the company from incurring the debt.
The equivalent defence in respect of directors is contained in s 588H(5) and (6)
of the Corporations Act. The policy on which this defence is based is that
responsible holding companies/directors should be rewarded and encouraged,
when they realise that their company is in financial trouble, to take steps to stop
trading or commence appropriate insolvency administration in an effort to
minimise potential loss to creditors.234 This defence is based on s 214(3) of the
Insolvency Act 1986 (UK) which reads as follows:
'The court shall not make a declaration under this section with respect to any person if it is satisfied that after the condition specified in subsection (2)(b) was first satisfied in relation to him that person took every step with a view to minimising the potential loss to the company's creditors as (assuming him to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation) he ought to have taken.'
The defence in s 588H(5) of the Corporations Act (relating to directors),
however, differs from its United Kingdom counterpart. It is supported by s
.588H(6) of the Corporations Act, referring to elements that prove
reasonableness.235 Section 588H(6) of the Corporations Act specifically states
that a court m a y take into account any action taken by the director in question
to appoint an administrator, when that action was taken, and the result of that
action. Other actions, such as resigning as a director in the event that other
directors insist on continuing with the company's business, m a y also be taken
into account by the court as reasonable steps. Section 588H(5) of the
Corporations Act, relating to directors, also ties in with the discretion given to
234 Harmer Report, above n 2, para 310. See also 436A(1) of the Corporations Act. Section 588H(6) of the Corporations Act provides: 'In determining whether a defence under
sub-s (5) has been proved, the matters to which regard is to be had include, but are not limited to: (a) any action the person took with a view to appointing an administrator of the company; and (b) when that action was taken; and (c) the results of that action.' There is no equivalent of this sub-s in s 588X of the Corporations Act.
265
the court to exempt directors from liability where they have acted diligently,
even though they were unable to prevent the incurring of the debt.236
7.4 Evaluation of position of group creditors
From the above discussion it is clear that the holding company may be liable in
its capacity as shareholder for debts incurred by its subsidiary, pursuant to
sections 588V-X of the Corporations Act. These provisions, together with the
provisions m aking d irectors (including shadow and de facto d irectors) 1 iable,
and which are discussed in Chapter 6, would arguably make the plight of 7^7
creditors much easier. There are, however, a number of limitations to the
remedies available where a group company goes into liquidation, in particular
the insolvent trading provisions in relation to holding companies, that make
them less useful for their contemplated purpose and therefore require 238
comment.
7.4.1 Disadvantages as a result of intermingling
In its Final Report CASAC lists various limitations of Pt 5.7B Div 5 of what is
now the Corporations Act dealing with the provisions relating to the liability of 7^Q
a holding company for insolvent trading by its subsidiary. C A S A C raises a
preliminary point that, as a result of the application of the separate entity
doctrine, Australian law still requires that the creditors, as well as the assets and
liabilities of each separate group company, should be identified before any
distribution will be made. The possible complex and costly legal inquiry that
236 See s 1317S of the Corporations Act. 237 A number of recent cases firmly favour the retention of accentuating creditor protection by imposing a sufficient standard of performance on directors, especially in relation to the financial aspects. See, eg, Australian Securities Commission v Forem-Freeway Enterprises Pty Ltd (1999) 17 A C L C 511; Kenna (1999) 32 A C S R 430 and Tourprint v Bott (1999) 17 A C L C
1,543. 238 See IM Ramsay, 'Holding Company Liability for the Debts of an Insolvent Subsidiary: A Law and Economics Perspective' (1994) 17 UNSWLI520 for a discussion of these limitations, including that s 588V of the Corporations Act is deficient to a serious extent as it provides no
protection for tort claimants of insolvent subsidiaries.
266
should be embarked upon to determine with which company particular creditors
dealt m a y be prejudicial to creditors.240 Those creditors w h o have dealt with the
most viable company in the group m a y be regarded either as 'exceptionally
astute, or simply unusually fortunate', as stated in ANZ Executors and Trustee
Co Ltd v Qintex Australia Ltd?41 Even those creditors w h o have diligently
ensured that they contract with a particular group company m a y be at a
disadvantage as a result of the cost and time involved in an attempt to unravel
the intra-group dealings.
7.4.2 Inherent disadvantages
CASAC further points out that, apart from the possible disadvantages faced by
creditors as a result of the intermingling of the businesses of the various group
companies, the insolvent trading provisions also have a number of inherent
limitations for creditors.243 These are the following:
• One limitation is that the insolvent trading provisions rely on the legal
definition of holding/subsidiary companies. This m a y pose a problem, since
business activities with a higher than usual risk of failure m a y be organised
to avoid falling within such definition.
• Another limitation is that the insolvent trading provisions m a y require that
an express and expensive investigation of the financial situation of the
company at the time that specific debts are incurred must be carried out to
determine whether the company was solvent at that stage. This is a very big
problem in practice.
• A third limitation pointed out by C A S A C is that the insolvent trading
provisions do not cover debts that the subsidiary incurred while it was still
C A S A C Corporate Groups Final Report, May 2000 (Final Report). 240 Ibid para 6.26-6.27.
[1991] 2 Qd R 360 at 365. This case is discussed in more detail in Ch 5 para 5.2.1 and Ch 8 para 8.2.2.1. 242 C A S A C Final Report, above n 239, para 6.27. 243 Ibid para 6.28.
The problem is often to establish when the debts were incurred because the records are inadequate. See Fryer v Powell (2001) 159 FLR 433 where it was agreed between the parties
267
solvent, but which remain outstanding, and for which there are insufficient
funds, after the insolvency of the subsidiary.
• Furthermore, the insolvent trading provisions do not cover transactions such
as asset-stripping that m a y eventually, although not immediately, lead to the
insolvency of the subsidiary.245
• Finally, the insolvent trading provisions do not extend to the assets of other
group companies, but are limited to the assets of the holding company.
Regarding reliance on the legal definition of holding company/subsidiary, the
following comments m a y be made. As pointed out in Chapter 2, the consequent
application of the definition of 'subsidiary' in s 588V of the Corporations Act
has wider implications as it dramatically affects the efficiency of the provisions
dealing with holding company liability for insolvent trading by its subsidiary.246
The scope of s 588V of the Corporations Act has generally been seen as too
narrow, as it relies upon a definition of subsidiary that can be circumvented in 0AT1
many circumstances. However, C A S A C has suggested in its Final Report
that the definitions of 'holding company' and 'subsidiary' should no longer be
used, but that they should be replaced with the c oncepts of' controlling' and
'controlled' entities. This is discussed in more detail in Chapter 2. Although the
C A S A C recommendations in this regard m a y be criticised, it can be accepted in
principle that the definition of 'holding/subsidiary' should be amended to be
wider than it is currently.248 This problem will then belong to the past, and is
therefore not discussed further. The other inherent limitations listed by C A S A C
are dealt with in Chapter IO.249
that the company was insolvent at a certain date because it could not be proved that debts were
incurred earlier. 245 It should be noted, however, that asset stripping through share buy-backs will only be allowed if it does not materially prejudice the ability of the company to pay its creditors: s 257A
of the Corporations Act. 246 See Ch 2 para 2.2.1. 247 Ramsay, 'Holding Company Liability for the Debts of an Insolvent Subsidiary: A Law and Economics Perspective', above n 238, 527; J Farrar, 'Legal issues involving corporate groups'
(1998) 16 C&SU 184 at 191. 248 See Ch 2 para 2.3.2 for criticism of the C A S A C proposal in this regard and for suggestions. 249 See Ch 10 para 10.2.
268
A n important limitation of the insolvent trading provisions that C A S A C has not
pointed out in its Final Report relates to focus. In addition to the fact that the
phrase 'incurs a debt' has led to a number of difficulties of interpretation, the
problem is that the provisions of both s 588V and s 588G of the Corporations
Act focus on the incurring of debts while the company is insolvent. This implies
that the holding company and directors respectively are unable to take into
account the long-term prospects of the company. Section 588V and s 588G of
the Corporations Act respectively provide that a holding company/director may
be held personally liable for the debts of the subsidiary/company where the
company is insolvent at the time the debt is incurred or becomes insolvent by
incurring the debt.251 Section 588G of the Corporations Act has replaced s 592
of the Corporations Law, which still applies where the debt was incurred before 7S7
23 June 1993. Although the provisions inserted by the Corporate Law
Reform Act 1992 (Cth) is a vast improvement on the previous position, the
same inherent flaw present in s 592 of the Corporations Law exists after the
amendments, namely, that the focus is wrong. One commentator has described
it as an 'inherent design defect'.253 The same criticism applies to s 588V of the
Corporations Act, which mirrors s 588G of the Corporations Act and also
makes use of the concept of 'incurring a debt'. Making liability dependent on a
debt being incurred makes it easier for a holding company/director to evade
liability and limits the usefulness of the insolvent trading provisions.254
The position in New Zealand on this issue is also unsatisfactory. In this regard s
136 rather than s 1 35 o f the Companies A ct 1 993 (NZ) m ay b e criticised.255
so See the discussion in para 7.3.1.1. See further T Noble, 'When does a company incur a debt under the insolvent trading provisions of the Corporations LawT (1994) 12 C&SLJ 297; J Mosley, above n 46; P Grawehr, 'A comparison between Australian and European insolvent
trading laws' (1996) 14 C&SLJ 16. There is still some inconsistency in the Australian courts' interpretation of this section, despite the judgment of Hodgson J in Antico (1995) 38 N S W L R 290. 251 Section 588V(l)(b); s 588G(l)(b) of the Corporations Act. 2 The continued operation of s 592 is provided for by s 1384 of the Corporations Act. A Herzberg, 'The Metal Manufacturers case and the Australian Law Reform Commission's
insolvent trading recommendations' (1989) 7 C&SLI 111 at 184. 254 See further Grawehr, above n 250, 34-5. 55 See further Ch 6 para 6.2.3 on ss 135 and 136 of the Companies Act 1993 (NZ).
269
Section 1 35 of the Companies Act 1 993 (NZ) does notreferto the financial
position of the company when the prohibited action occurs. This section allows
the company to carry on any activity, provided it is not 'likely to create a
substantial risk of serious loss' to the company's creditors. This has been held
to include situations other than the incurring of debts.256 However, the same
criticism that has been brought against s 588G of the Corporations Act may be
brought against s 136 of the Companies Act 1993 (NZ). Although it is clear that
the word 'obligations' in the latter provision covers more than just debts, the
inherent defect in the phrase 'incurs a debt' in s 588V and s 588G of the
Corporations Act is also present in the phrase 'incurring an obligation'.257 B y
importing the phrase 'incurring an obligation' into the legislation, the
interpretation problem that has arisen in Australia has been transposed into the
N e w Zealand law. O f even greater significance is that this phrase suggests -
similar to the position in Australia - that the insolvency has to be brought about
by a particular type of trading activity.259
By contrast to the position in Australia and New Zealand, the trigger event for
liability for wrongful trading in the United Kingdom relates to the
consequences of continued trading. It does not require that the insolvency
should be brought about by a specific kind of trading activity, such as the
incurring of debts or obligations. In this regard s 214 of the Insolvency Act
1986 (UK) places little emphasis on the financial position of the company when
the contravention occurs. Contravention takes place where one 'knew or would
have concluded that there was no reasonable prospect that the company would
"6 Re Wait Investments Ltd (in liq) [1997] 3 N Z L R 96. 257 T G W Telfer, 'Risk and insolvent trading' in R Grantham and C Rickett (eds), Corporate Personality in the 20th Century (1998) 127 at 145. 258 Ibid. See further V C S Yeo and JLS Lin, 'Insolvent trading - a comparative and economic approach' (1999) 10 Aust Jnl of Corp Law 216 at 219-225. The implications of the Australian cases on N e w Zealand law are discussed in H Rennie and P Watts, Directors' Duties and
Shareholders' Rights, N e w Zealand Law Society Seminar (1996) 38-40. 259 See further Grawehr, above n 250, 17 and 35; Mosley, above n 46, 168-169. 260 D Prentice, 'Corporate personality, limited liability and the protection of creditors' in R Grantham and C Rickett (eds), Corporate Personality in the 20th Century (1998) 99 at 111-125.
270
avoid going into insolvent liquidation'.261 This means that directors have more
leeway to continue with the business of the company when it is experiencing
financial difficulties.262 In other words, directors are able to take a long term
view of the company's business and will not contravene s 214 of the Insolvency
Act 1986 (UK) if there is a reasonable prospect of recovery, even if they
continue with the company's business while it is insolvent.
It is submitted that, in so far as focus is concerned, the provisions of s 214 of
the Insolvency Act 1986 (UK) are of a superior quality.2 3 The United Kingdom
model avoids the difficult question of when a debt has been incurred that has
arisen under Australian law and has been transposed into the N e w Zealand
law.264 At the same time, s 214 of the Insolvency Act 1986 (UK) concentrates
on the relevant question, namely, whether the creditors have been prejudiced as
a result of the director's continued trading. It focuses liability on persons who
are in a position to ascertain whether a company is carrying on business to the
detriment of its creditors.266 It is submitted that, instead of concentrating on the
incurring of debts, the Australian insolvent trading provisions should rather
focus on whether the company's creditors have been prejudiced as a result of
the continued trading of the holding company or director. This should
encourage holding c ompanies/directors of insolvent subsidiaries/companies to
261 Section 214(2)(b) of the Insolvency Act 1986 (UK). "2 There is no equivalent of s 588V of the Corporations Act in the U K legislation, so it does not make provision for the liability of holding companies in these circumstances. 263 Grawehr, above n 250, 24-27 succinctly states the difference between wrongful trading in the U K and insolvent trading in Australia: "Wrongful trading' is liability for continuing 'business as usual' in circumstances where insolvency is looming; 'insolvent trading' is liability for 'incurring a debt' in such circumstances.'
Situations other than the incurring of debts are covered by s 214 of the Insolvency Act 1986 (UK), including, eg, the depletion of the company's assets as a result of paying excessive directors' fees. See further L S Sealy, 'Personal liability of officers and directors for debts of insolvent corporations. Jurisdictional perspective - England', Paper presented as the 23 Annual Workshop on Commercial and Consumer L a w Conference on International and
Comparative Commercial Insolvency Law, Toronto, June 1993, at 7. 265 D Prentice, above n 260, 111-125, especially at 119. 266 Ibid 125.
stop trading immediately under these circumstances and initiate an insolvency 7^7
administration.
267 See Herzberg, 'Insolvent trading- civil liability of company officers under insolvent trading
provisions', above n 65, at 286.
8 CONTRIBUTION AND POOLING: THE CURRENT POSITION
8.1 Background 272
8.2 Indirect pooling by the regulator 274
8.2.1 Shortcomings ofDeeds of Cross Guarantee vis-a-vis creditors 276
8.2.1.1 Multiple insolvencies 276
8.2.1.2 Release from obligations 280 (a) Revocation 280 (b) Sale 281
8.2.2 Shortcomings ofDeeds of Cross Guarantee vis-a-vis directors 282
8.2.2.1 Breach of fiduciary duty 282 (a) Committal 283 (b) Revocation 285
8.2.2.2 Breach of insolvent trading provisions of the Corporations Act 286
8.3 Indirect pooling by the courts 287
8.3.1 Schemes of arrangement and compromises/arrangements with 287 creditors
8.3.2 Other avenues 292
8.3.2.1 Rights of contribution and subrogation under inter-company 292 guarantees
8.3.2.2 Section 447A of the Corporations Act 296
8.3.2.3 Section 510 of the Corporations Act 303
8.4 Evaluation of position of group creditors 312
8.4.1 Indirect pooling by the regulator 312
8.4.2 Indirect pooling by the courts 315
8 CONTRIBUTION AND POOLING: THE
CURRENT POSITION
8.1 Background
As discussed in Chapter 7, the Harmer Report recommendations in respect of
contribution were watered down to the provisions of s 588V-588X of the
Corporations Act, and its recommendations in respect of pooling were omitted
without e xplanation. T he A ustralian S ecurities a nd Investments C ommission
(ASIC) nonetheless attempted to improve the position of creditors in the
context of liquidations of group companies. This resulted in the introduction of
Deeds of Cross Guarantee pursuant to Class Orders issued by ASIC,3 an
indirect pooling mechanism whereby a wholly-owned subsidiary effectively
pools its assets with its h olding company.4 These Deeds of Cross Guarantee
have, however, various shortcomings, as discussed in more detail in paragraphs
8.2.1 and 8.2.2 below.
Although no specific provision exists for court-ordered pooling like in N e w
Zealand, the Corporations Act has long contained a few potential avenues to
voluntary pooling of the assets and liabilities of group companies.5 The most
obvious are schemes of arrangement and compromises/arrangements with
1 See Ch 7 para 7.2 for a discussion of ss 588V-588X of the Corporations Act 2001 (Cth)
(Corporations Act). 1 Australian L aw Reform Commission (ALRC), General Insolvency Inquiry Report No 45 (1988) (AGPS, Canberra), (Harmer Report). For a more detailed discussion of the Harmer Report recommendations, see Ch 9 para 9.2. The only form of 'contribution' that is currently possible under the Corporations Act is contained in s 588V, pursuant to which the holding company may be held liable for the debts of its insolvent subsidiary in certain circumstances.
See further Ch 7. 3 See ASIC Class Order 98/1418 'Wholly-owned entities' (CO 98/1418); ASIC Pro Forma 24 'Deed of cross guarantee' (Pro Forma 24). It should be borne in mind that, under current C O 98/1418, the deed is couched in the form of a guarantee. Each of the companies in the group guarantees payment in full to every creditor of any debt pursuant to the deed. The predecessor of C O 98/1418, National Companies and Securities Commission (NCSC) Release 633, worked as an indemnity. Therefore no mechanism existed for creditors to enforce it - the deed was between the holding company and its subsidiaries. The appropriate person to enforce it would
have been the liquidator, acting on behalf of the company. 4 A S C Digest 3, Update 41 'Report on the Public Hearing on Accounts and Audit Relief for
Wholly-owned Subsidiaries' (1991) para 31.
273
creditors, discussed in paragraph 8.3.1 below. In recent years, however, when
the drawbacks of these two possible avenues became more fully recognised, the
courts have also allowed pooling by making use of other provisions of the
Corporations Act, notably under the voluntary administration provisions in Part
5.3A and the voluntary winding up provisions in Part 5.5. These alternative
avenues are discussed in more detail in paragraph 8.3.2 below.
It should be pointed out at the outset that a pooling order might create a conflict
between unsecured creditors if the total assets of all the group companies are
insufficient to meet all the claims in full. Creditors in favour of pooling will
state that they have relied on the assets of the whole group and that it would be
inequitable that the notional separate legal status of companies should prevent
their prospects of recovery against the total assets that they have bargained for.
Conversely, creditors against pooling will argue that they have contracted with
a particular company relying on its separate assets and that it would be
inequitable to reduce their prospects of recovery by including the liabilities of
another group company.6
It has to be conceded that a pooling order may disadvantage the creditors of a
group company in liquidation which is obliged to make available its assets to
other group companies in liquidation. The Corporations Act, however, already
provides that a holding company m a y be held liable in certain circumstances for
the debts of an insolvent group company.7 In this regard it is submitted that the
approach of the courts in the United States towards pooling orders provides a
fair solution. They take into account fairness to unsecured creditors as a whole
by considering whether the savings to the collective class of creditors would
outweigh incidental detriment to individual creditors. If pooling orders are
used only in the limited circumstances suggested in Chapter 9,9 namely, where
the level of intermingling justified creditors' reliance on the assets of the group
5 For a discussion of the N e w Zealand pooling orders, see Ch 9. J Farrar and A Darroch, 'Insolvency and corporate groups - the problem of consolidation' in J
Lessing and J Corkery (eds), Corporate Insolvency Law (1995) at 256. See s 588V of the Corporations Act, discussed in Ch 7 para 7.3. In re Commercial Envelope Manufacturing Company 14 Collier Bankr. Cas. (MB) 191
(S.D.N.Y. 1977).
274
as a whole or where it is virtually impossible or prohibitively expensive to
unravel the affairs of the various group companies, it is arguable that unsecured
creditors as a whole will be better off.
8.2 Indirect pooling by the regulator
Subject to certain conditions stipulated by ASIC in the relevant Class Orders,10
wholly- owned entities whose holding entity is a company or a registered
foreign company m a y obtain relief from certain requirements relating to
financial reports, directors' reports and auditor's reports.11 This includes relief
from the requirement to prepare and lodge reports with ASIC.12 One of the
conditions for relief from the financial reporting requirements is that these
wholly owned-entities must have entered into a Deed of Cross Guarantee.13
Initially the Deeds of Cross Guarantee were entered into only between the
holding company and each of the wholly-owned subsidiaries. The execution of
the Deeds of Cross Guarantee was, however, later extended to all companies
that formed part of the 'Closed Group'.14 In terms of the Deed of Cross
Guarantee, therefore, every wholly-owned subsidiary in the group as well as the
holding company currently have to guarantee the debts of every other company
forming part of the group in order to obtain the relevant accounting and
auditing relief.15 The Class Order relief does not extend to partly-owned
subsidiaries, and ASIC considers that it would not usually be appropriate for an
entity that is not wholly owned to be a party to a so-called Deed of Cross
Guarantee.16
9 See Ch 9 para 9.6.2.3. 10 C O 98/1418, above n 3, Conditions (a) - (w). 11 See sub-s 292(1) paras (b) and (c); sub-s 310(1); sub-ss 314(1), 315(1), 315(4) and s 316; s 317; sub-s 319(1) and sub-ss 327(1) to (5) of the Corporations Act. 12 See sub-s 319(1) of the Corporations Act. 13 C O 98/1418, above n 3, Condition (l)(i). 14 'Closed Group' is defined in C O 98/1418 as 'the Holding Entity and the Wholly-Owned
Entities'. 15 Pro Forma 24, above n 3, cl 3. See also M Corrigan, 'Accounting relief for 'Closed Group' Companies' (1992) 62 The Australian Accountant 64. 16 C O 98/1418, above n 3, Editorial Note 28.
275
The Deed of Cross Guarantee contemplates the appointment of a company as
trustee w h o will hold on behalf of creditors the benefit of the covenants made
by the other parties to the deed. The trustee m a y b e a related company.17 If,
however, the trustee is a Group Entity,18 it will be necessary to appoint two
trustees. The first trustee will hold as trustee the benefit of the promises made
by all the other Group Entities, while the second trustee will act as trustee in
respect of the covenants made by the first trustee and is provided for as a party
to the deed where necessary.19 Further subsidiaries can be added as parties to an
existing Deed of Cross Guarantee by way of an assumption deed.20 The
assumption deed has to be executed by the holding company, the trustee and the
new company. 1
Initially it was thought that consolidated accounts would more accurately
reflect the commercial realities of the financial statements of holding companies
and their wholly-owned subsidiaries as they have many interests in common.
The regulator was also of the view that there would be sufficient protection for
creditors by virtue of a guarantee on the strength of which creditors had access
to the assets of the other companies in the group if one of the companies should
go insolvent. It emerged, however, that both creditors and directors could be at
a s erious d isadvantage astheuseofc ross-guarantees g ave r ise t o s ignificant 71
problems in practice, involving risks for both these groups.
Holding companies and all their subsidiaries are related companies: see s 50 of the Corporations Act. 18 'Group Entity' is defined as follows in the Deed of Cross Guarantee: '(a) anyone of the entities listed in Part 1 of the Schedule; and (b) any entity joined to this Deed of Cross Guarantee by the execution of an Assumption Deed'. 19 Pro Forma 24, above n 3, cl 3 and C O 98/1418, above n 3, Editorial Note 20 both deal with the appointment of the trustee. 20 Pro Forma 24, above n 3, cl 5. 21 C O 98/1418, above n 3, Editorial Note 25. A S C Media Release 91/64, Public Hearing: Accounting relief for wholly-owned subsidiaries,
para 3. CfFL Clarke and G W Dean, 'Law and Accounting - the Separate Legal Principle and Consolidation Accounting' (1993) A Bus L Rev 246 at 253. 23 For a discussion of the complex problems that arise from ASIC's requirement of a group guarantee as a prerequisite for granting accounting relief, see D Murphy, 'Holding company
liability for debts of its subsidiaries: corporate governance implications' (1998) 10 Bond L Rev 241. For a discussion of the protection of creditors by the existence of cross-guarantees, see G Dean, F Clarke and E Houghton, ' Corporate restructuring, creditors' rights, cross-guarantees and group behaviour' (1999) 17 C&SLJ 85.
276
8.2.1 Shortcomings of Deeds of Cross Guarantee vis-a-vis creditors
8.2.1.1 Multiple insolvencies
A significant shortcoming of the Deed of Indemnity under the N C S C Release
633, a predecessor of current ASIC Class Order 98/141824 that provides for a
Deed of Cross Guarantee, was that it did not provide for a situation where
multiple insolvencies occurred.25 This gave rise to uncertainty and meant that
creditors could be potentially left out in the cold. JnReJN Taylor Holdings Ltd
(in liq) (No7)26 JN Taylor Holdings Ltd and eight of its subsidiaries executed a
Deed of Indemnity in terms of which each company undertook to satisfy the
other's deficiency to meet creditors' claims in the event of liquidation. In this
case all the companies that executed the deed became insolvent at more or less
the same time. Debelle J stated obiter that the Deed of Indemnity did not
operate where the holding company as well as its subsidiary was in liquidation
and the assets of the companies involved were insufficient. The reasons
advanced by his Honour for holding this view were twofold. First, the Deed of
Indemnity did not provide for the event that the holding company and its
subsidiaries go insolvent simultaneously. Secondly, a literal interpretation of
the Deed of Indemnity would lead to absurd results where all the companies
that have executed the Deed were insolvent, and therefore should not be
applicable in such a case.28
24 A n A S C Class Order issued on 19 December 1991 replaced N C S C Release 633. After the enactment of the First Corporate Law Simplification Act 1995 (Cth), which made certain companies subject to full accounts and audit requirements, the A S C issued a revised consolidated C O 95/1530 replacing earlier class orders. In 1998 ASIC replaced C O 95/1530
with C O 98/1418. 25 For more detail on previously existing problems, see A S C Digest 3, Update 41, above n 4, paras 7 and 21. See further J Hill, 'Corporate Groups, Creditors Protection and Cross Guarantees: Australian Perspectives' (1995) 24 Can Bus LI 321 at 340 and 347; A Nolan, 'The Position of Unsecured Creditors of Corporate Groups: Towards a Group Responsibility
Solution Which Gives Fairness and Equity a Role' (1993) 11 C&SU461 at 477. 26 (1991) 6 A C S R 187 (Taylor). 27 The point was not litigated and all parties accepted that this was the proper construction of
the Deeds of Indemnity. 28 See further G W Dean, PF Luckett and E Houghton, 'Notional Calculations in Liquidations
Revisited: The Case of the A S C Class Order Cross Guarantees' (1993) 11 C&SLJ at 46-51 and
204-226; Clarke and Dean, above n 23, 253.
277
However, an opposite conclusion was reached in Westmex Operations Pty Ltd
(in liq) v Westmex Ltd (in liq),29 which is submitted to be the better view. In this
case Westmex Ltd, the holding company, and certain of its wholly-owned
subsidiaries entered into N C S C Deeds of Indemnity. Both Westmex Ltd and the
subsidiaries subsequently became insolvent. While Westmex Ltd did not have
assets of value and little likelihood of any dividend to creditors, the subsidiaries
did have assets and would, but for the Deeds of Indemnity, have been able to
pay substantial dividends to creditors. The insolvent subsidiaries and the
liquidator of each of them sought a declaration stating that none of the N S C S
Deeds of Indemnity was enforceable between a particular insolvent subsidiary
and Westmex Ltd and its liquidator.
They argued that the Deeds of Indemnity did not operate in circumstances
where both the holding company and its subsidiaries were in liquidation. In
those circumstances, they argued, the Deed of Indemnity could not be given a
meaningful operation. This was the case because as an obligation on one party
to pay under the Deed of Indemnity would give rise to a corresponding
obligation on the other to make up for the shortfall so caused in the first party.
This would in turn create another obligation and so on, with the effect that the
Deeds of Indemnity would operate to create infinite regression.
The State Bank of New South Wales (SBNSW), a creditor of Westmex Ltd,
instituted a cross-claim. S B N S W sought declarations, inter alia, that:
• each one of the Deeds of Indemnity entitled the liquidator of Westmex Ltd
to prove once in the liquidation of each of the insolvent subsidiaries for an
amount equal to the difference between the assets and liabilities of
Westmex Ltd;
• each one of the Deeds of Indemnity entitled the liquidator of each of the
insolvent subsidiaries to prove once in the liquidation of Westmex Ltd for
an amount equal to the difference between the assets and liabilities of the
particular insolvent subsidiary; and
29 (1992) 8 ACSR 146. (Westmex). See further G Dean, P Luckett and E Houghton, 'Case Note: Westmex Operations (in liq) v Westmex Ltd (in liq) & ors' (1993) 11 C&SLI 549.
278
• the respective claims of the liquidator of Westmex Ltd and the liquidator of
each of the particular insolvent subsidiaries (which arose under the Deeds of
Indemnity) did not have to be set off pursuant to section 86 of the
Bankruptcy Act 1966 (Cth) or otherwise.30
The cross-claim was significant because the position of SBNSW was different
from other creditors of the Westmex group. The loans made by S B N S W to
Westmex Operations Pty Ltd (Westmex Operations), a subsidiary of Westmex
Ltd, were not guaranteed by Westmex Operations. If the Deeds of Indemnity
were not effective, this would result in S B N S W receiving a significantly lower
dividend than other creditors of the Westmex group if all the loans made by
S B N S W were taken into account. This was so because the value of the net
assets in the Westmex group accumulated predominantly to Westmex
Operations and not to Westmex Ltd. S B N S W submitted that, if the Deeds of
Indemnity were effective, this outcome could be altered. Then the net
deficiency of the claims against Westmex Ltd could be taken into account in the
winding up of Westmex Operations.
The relevant question for purposes of this thesis that had to be determined was
whether on their true construction the Deeds of Indemnity had any operation as
between Westmex and a subsidiary where both companies were insolvent and TI - -
m liquidation. McLelland J in the court a quo considered the construction of
the D eed o f Indemnity clauses. In c ontrast t o w hat D ebelle J s aid i n Taylor,
McLelland J stated first that there was no express term in the Deeds of
Indemnity stating that it would not operate where Westmex Ltd as well as its
subsidiaries went insolvent. McLelland J then considered whether an implied
term existed to the effect that the Deeds of Indemnity would not operate where
30 Westmex (1992) 8 A C S R 146 at 151. 31 Ibid. Because the answer to the first question was 'Yes', a second question arose, namely, what was the most equitable method of operationalising the resulting guarantees? O n the second question, McLelland J regarded it as unnecessary to consider mathematical procedures: see Westmex (1992) 8 A C S R 146 at 152. For criticism of McLelland J's view on this point, see Dean, Luckett & Houghton, 'Notional Calculations in Liquidations Revisited: The Case of the A S C Class Order Cross Guarantees', above n 28, 211-212. Although the authors agreed with McLelland J regarding the construction of the NCSC-approved Deeds, they were of the view that McLelland J's views regarding set-off of the deficiency obligations did not ensure an
equitable result.
279
the holding company and its subsidiaries went insolvent simultaneously, and
concluded that this was also not the case.33
His Honour pointed out that the subsidiaries could obtain relief from
compliance with statutory requirements for the preparation and lodgment of
individual audited financial statements for each of the subsidiaries, on the
condition that they enter into a Deed of Indemnity. It was therefore reasonable
to infer that the primary purpose of the imposition of the condition was to give
the creditors of a subsidiary in insolvency (indirect) access to the holding
company's assets.34 Reciprocally the creditors of the holding company were to
be given (indirect) access to the assets of each subsidiary. This would not be
achieved if the Deeds of Indemnity did not operate where both the holding
company and the subsidiaries went insolvent at the same time.
McLelland J was also of the view that an absurdity would not necessarily result
- it would depend on the construction of the particular clause under
consideration. His Honour did not agree with the view held by Debelle J in
Taylor on this issue and found that, since the construction of the relevant clause
that might lead to absurdities was not the only possible construction, it should
be rejected.37 McLelland J held that the preferred construction was that the
debts and claims referred to in the Deed of Indemnity were intended to denote
only the debts and claims external to the Deed of Indemnity itself and anterior
to the obligations arising thereunder.38 His Honour likewise held that the 'funds
available to the liquidator' within the meaning of the Deed of Indemnity was
intended to denote only assets external to the Deed of Indemnity itself.
Accordingly, McLelland J held that the Deeds of Indemnity were operable
where more than one company in a Closed Group were wound up
'- Westmex (1992) 8 A C S R 146 at 151. 33 Ibid.
Ibid. Cf the discussion in para 8.2.2.1(b) below, 35 Ibid 151-152. * Ibid 152. 31 Ibid. 38 Ibid 152-153.
280
simultaneously. The Supreme Court of N e w South Wales confirmed this
decision on appeal.40
8.2.1.2 Release from obligations
(a) Revocation
Creditors are at a disadvantage if Deeds of Cross Guarantees are used, because
a party to a Deed of Cross Guarantee may be released from the obligations
imposed by it. There are two ways in which creditors may be prejudiced in this
context. First, creditors are at a disadvantage because a party to a Deed of Cross
Guarantee may be released from the obligations imposed by it where it revokes
the cross guarantee. Previously, under N C S C Deeds of Indemnity, the legal
position with regard to revocation was that the holding company and
subsidiary, as parties to the Deed of Indemnity, could simply revoke it and
thereby destroy any protection for creditors. This was unsatisfactory, as a
company could take advantage of the accounting relief without making
available information regarding huge operating losses to creditors.41
Under the current ASIC Deeds of Cross Guarantee, the position of creditors has
been improved. The parties cannot revoke and release the Deed of Cross
Guarantee except as expressly permitted by it. Although group companies that
have signed the Deed of Cross Guarantee may still execute a deed of revocation
with regard to any or all the companies in the group, the effectiveness of such
revocation deed is conditional upon various factors, namely:
• that the deed of revocation be lodged with ASIC;
40 Westmex Operations Pty Ltd v Westmex Ltd (1994) 12 A C L C 106 at 109-110. 41 See Re Egnia Pty Ltd (in liq) (1992) 10 A C L C 185 (Re Egnia) at 188 where Anderson J agreed that this was unsatisfactory. See further JD Heydon, 'Directors' Duties and the Company's Interests' in P D Finn (ed), Equity and Commercial Relationships (1987) 120; J Hill,
'Cross guarantees in corporate groups' (1992) 10 C&SLJ 312 at 314.
281
• that each company which is part of the group publicly notifies its creditors
by m eans o f p ublic a dvertisement w ithin a m onth o f t he r evocation d eed
being executed; and
• that no winding-up or commencement of winding-up of any of the
companies in the group takes place within six months after the revocation
deed had been executed.42
(b) Sale
Secondly, and more importantly for present purposes, creditors are at a
disadvantage, because a party to a Deed of Cross Guarantee m a y be released
from the obligations imposed by the Deed of Cross Guarantee where a party to
the deed is sold. A party to the Deed of Cross Guarantee (the debtor) or an
entity holding shares in a party to the Deed of Cross Guarantee is entitled to sell
the debtor's shares to a third person on certain conditions. O n the basis hereof
the debtor and its wholly-owned entities which are parties to the Deed of Cross
Guarantee m a y be released from their obligations under the Deed of Cross
Guarantee.43 In this regard it is required that 'the directors of the Holding Entity
upon disposal certify in writing that the disposal is a bona fide sale and that the
consideration for the sale is fair and reasonable'.44 It is thus relatively easy to
dispose of shares in subsidiaries forming part of a corporate group. The
purchaser m a y be confident that the creditors of the purchased company are
only those who are creditors of that particular company (the sale creditors)
without taking into account the obligation of the company to other creditors
under the Deed of Cross Guarantee.45
42 Pro Forma 24, above n 3, cl 4.5. 43 Ibid cl 4.2.
Ibid cl 4.2(c). This condition was calculated to ensure that a group company is not sold below value and thereby to protect the interests of the remaining creditors. The other conditions stated in Pro Forma 24, above n 3, cl 4.2(c) are that a copy of the relevant certificate and of the notice of disposal must be lodged with ASIC. See further C A S A C Corporate Groups - Final Report (May 2000) (Final Report) para 2.68. 45 See J Farrar, 'Legal issues involving corporate groups' (1998) 16 C&SLJ 184 at 192-194, agreeing with D Murphy, who criticised this practice. This is an example of adherence to the entity theory.
282
The condition that the directors of the holding company certify that it is a bona
fide sale and that the consideration for the sale is fair and reasonable protects
the interests of the creditors of companies in the group other than the company
sold (the remaining creditors) to an extent. However, they are in a detrimental
position vis-a-vis the sale creditors. Although the remaining creditors have
access to the proceeds of the sale, the purchase price will be reduced, taking
into account the liabilities to all the group creditors before the sale. This means
that the remaining creditors m a y not be paid in full while the sale creditors will
probably be compensated fully. The reason for this is that a purchaser will not
usually buy a company contemplating that it is going to fail shortly after the
sale. The remaining creditors will therefore have to be content with what is
left over after the sale creditors have been paid in full.47 Thus, the Deed of
Cross Guarantee m a y be thwarted in the exact circumstances for which it was
supposed to provide.48
8.2.2 Shortcomings of Deeds of Cross Guarantee vis-a-vis directors
8.2.2.1 Breach of fiduciary duty
There are two main reasons why directors are at a disadvantage if use is made
of Deeds of Cross Guarantee. The first reason is that the directors m a y be in
breach of their fiduciary duty by committing their company to a Deed of Cross
Guarantee or by joining the revocation of the Deed of Cross Guarantee. The
relevant fiduciary duty that could be breached in these circumstances is the duty
of directors to act bona fide in the interests of their company and for a proper
49
purpose.
46 Farrar, above n 45, 192-194. 41 Ibid. 48 Ibid. See further C A S A C Final Report, above n 44, Recommendation 4: 'There should be no change to the current provision in the prescribed ASIC Deed of Cross Guarantee whereby a non-consolidated wholly-owned corporate group has no liability under that Deed for the debts of one of its group companies incurred before that group company was sold to an outsider. However, the prescribed Deed of Cross Guarantee should be redrafted to indicate more clearly this limitation on its application.' 49 This duty is discussed further in C h 4.
283
(a) Committal
It is a requirement of the Deeds of Cross Guarantee under the Class Orders that
the directors have to include a statement in their company's annual return to the
effect that they' reassessed the advantages and disadvantages associated with
the Entity remaining a party to the Deed of Cross Guarantee'.50 It is not clear
whether the advantages and disadvantages to the company remaining a party to
the Deed of Cross Guarantee should be appraised from the viewpoint of the
particular company involved or that of the group as a whole as suggested in
Charterbridge Corporation Ltd v Lloyds Bank Ltd.51 In this regard it was stated
by the then A S C in its Issues Paper to the Public Hearing on Deeds of Cross
Guarantee: '[I]t could be argued that if a financially sound subsidiary enters
into a deed to which less financially robust subsidiaries are also party, this
could in certain circumstances prejudice the interests of both shareholders and
creditors of the financially sound subsidiary'.52
Relevant here is ANZ Executors & Trustee Co Ltd v Qintex Australia Ltd,
where the creditors of a holding company attempted to hold liable its subsidiary
companies for the debts of the holding company, a strategy which may be
described as 'reverse veil-piercing'.54 The holding company, Qintex Australia
Ltd (QAL), covenanted with a lender to procure its wholly-owned subsidiaries
to guarantee repayment of a loan. Q A L , which was insolvent, defaulted on the
payments and the lender wished to obtain specific performance of the covenant.
All the subsidiaries were also insolvent by that stage. The directors of the
subsidiaries contended that the giving of a guarantee would constitute a breach
of their fiduciary duty to take into account the interests of the creditors of the
subsidiary companies.55
50 CO 98/1418, above n 3, Condition (k)(iii). 51 [1970] 1 Ch 62. See also Ch 4 para 4.2.1 for a discussion of this case. See further Hill, 'Corporate Groups, Creditors Protection and Cross Guarantees: Australian Perspectives', above n25,352-353. 52 A S C Media Release 91/64, above n 22, para 11. 53 (1990) 2 A C S R 307, confirmed on appeal [1991] 2 Q d R 360 (ANZ v Qintex). 54 It is 'reverse' veil-piercing because usually the corporate veil is pierced to hold liable the holding company for the debts of its financially less viable subsidiaries.
See further C h 5 para 5.3 on the duty to take into account the interests of creditors.
284
The Queensland Full Court per McPherson J refused to order specific
performance of the covenant. The court held that it was a fundamental principle
that the powers and funds of a company should only be used for corporate
purposes.56 To order a shareholder (QAL) to require a company (the
subsidiaries) to give a guarantee would infringe this principle. If the
subsidiaries used their power to guarantee the corporate loan, this would be for
the benefit of the holding company and not the subsidiaries. The interests of the
creditors of the insolvent subsidiaries had to be taken into account in
determining what was for the benefit of the subsidiary companies. Accordingly,
it was held that neither the board of directors nor the shareholders of the
subsidiary could give the guarantee.
The appellants in ANZ v Qintex unsuccessfully attempted to rely upon Thorby co
v Goldberg to establish that the relevant time for considering whether the
procurement of the guarantees would be for the benefit of the subsidiaries was CQ
when t he d eeds w ere e xecuted. T here w as n o c ompelling e vidence t hat t he
subsidiaries were insolvent at that time. McPherson J distinguished Thorby v fjr\
Goldberg on the basis that in the latter case all the organs of the company
(that is, all the shareholders and directors) agreed in advance to act in a Al ftO
specified manner in the future. In ANZ v Qintex, however, only Q A L as
controlling shareholder of each subsidiary company entered into the deeds with
A N Z . The directors of the subsidiaries, whose function it was under the
56 ANZ v Qintex [1991] 2 Qd R 360 at 371. See also Brick & Pipe Industries Ltd v Occidental Life Nominees Pty Ltd (1991) 9 ACLC 324. See further R Grantham, 'Ultra vires: gone but not
forgotten' (1993) 10 Austl B Rev 233. 57 [1991] 2 Q d R 360. 58 (1964) 112 CLR 597. 59 [1991] 2 Qd R 360 at 372. In other words, the appellants argued that the relevant time for considering the propriety of the subsidiaries executing guarantees was not at the time of trial or
when the specific order would be made or obeyed. 60 (1964) 112 CLR 597. 61 [1991] 2 Qd R 360 at 374-375. The transaction in Thorby v Goldberg (1964) 112 CLR 597 was one that at the time was visibly for the benefit of the company, and the interests of creditors were not likely to be adversely affected by performing the agreement: [1991] 2 Qd R 360 at
373. 62 [1991] 2 QdR360.
285
constitution to enter into guarantees on behalf of the subsidiaries, were not
parties to the transaction.
(b) Revocation
In Re Egnia Pty Ltd (in liq)64 the issue of whether revocation of a NCSC Deed
of Indemnity by the directors was a breach of fiduciary duty arose incidentally.
The case involved a proposed scheme of arrangement pursuant to s 411 of the
Corporations Act for a subsidiary company that the court described as
'hopelessly insolvent with an estimated deficiency of some $16m.' The A S C
opposed the approval of the scheme of arrangement. One of the grounds of
opposition was that, in terms of the proposed scheme, the liquidator of the
subsidiary would forgo any claim against the holding company pursuant to an
N C S C Deed of Indemnity. The holding company alleged, however, that the
Deed of Indemnity was not binding any longer since the parties to it, the
holding company and the subsidiary, had revoked it.
In the course of his judgment, Anderson J made the following obiter
comments:66
H o w the responsible officers of the company could have done such a thing consistently with their duty to protect the interests of the company, cries out for explanation. It amounted to a destruction of the company's principal asset, the only thing that it had to make up the large deficiency in its balance sheet, on a winding up... It is difficult not to suspect that the revocation of the indemnity was contrived for the ultimate benefit, not of the company, but of [the holding company].
Anderson J found that N C S C Release 633 did not impose the condition that the
Deed of Indemnity should not be revocable. As a result any such Deed was
wholly revocable with the mutual consent of the parties to it.67 This was the
63 Ibid 374. See further J O'Donovan, 'Grouped therapies for group insolvencies' in M Gillooly (ed), The Law Relating to Corporate Groups (1993) at 57. 6 4(1992)10ACLC185. 65 Ibid 186. 56 Ibid 189. It is presumed that even if the conditions set out in para 8.2.1.2(a) are all met (see the text to n 29 above), directors may still be in breach of their fiduciary duties if they join the revocation of the Deed of Cross Guarantee under the ASIC Class Orders. See further Hill, 'Cross guarantees in corporate groups', above n 41, 314. 67 Re Egnia (1992) 10 A C L C 185 at 188.
286
case despite the fact that the company had made use of the accounting relief
afforded by the class order, resulting in denying the creditors the advantage of
access to information regarding the substantial operating losses of the company.
Anderson J stated that the only consequence of the revocation seemed to be that
the subsidiary ceased to be relieved of its obligation of preparing separate
audited accounts and filing a more informative annual return.68 His Honour
acknowledged that this would be cold comfort to a creditor w h o had relied on
the Deed of Indemnity in extending credit to the company, and described the
position as 'indeed an unsatisfactory state of affairs'.69
8.2.2.2 Breach of insolvent trading provisions of the Corporations Act
The second reason that directors are at a disadvantage where use is made of
Deeds of Cross Guarantee is that they m a y possibly be in breach of the
insolvent trading provisions of the Corporations Act in the light of the
decision in Sunbird Plaza Pty Ltd v Moloney?1 In this case the High Court
identified two types of guarantee. The first type is a conditional agreement to
pay a liquidated sum, giving rise to a debt. The second type is an undertaking
by the guarantor that the debtor will perform its obligations, sounding in
damages only. This distinction is important for purposes of the insolvent
trading provisions. If entry into a Deed of Cross Guarantee falls under the first
category of guarantee, thereby constituting a 'debt', the directors m a y
potentially be held liable personally if the company is insolvent or if it becomes
insolvent by entering into such guarantee.
Both the court of first instance in Bank of China v Hawkins and the New
South Wales Court of Appeal in Hawkins v Bank of China14 made it clear that
68 Ibid. 69 Ibid. 70 See further Ch 6 for a discussion of insolvent trading by directors under s 588G of the
Corporations Act. 71 (1988) 166 C L R 245 (Sunbird Plaza). 72 See further A D Brown, 'Does section 592 apply to guarantees? The risks increase after the
Hawkins case' (1993) UC&SU34. 73 (1992) 7 A C S R 262. 74 (1992) 26 N S W L R 562 (Gleeson CJ, Kirby P, Sheller AJ). See further on this case Ch 7 para
7.3.1.1(c).
287
entering into a guarantee may amount to the incurring of a debt by a company.
Such an action could precipitate liability of the directors of the company for
insolvent trading.75 Rogers CJ in the Commercial Division held that the
execution of the guarantee in question was the incurring of a debt as
contemplated by a predecessor of s 588G of the Corporations Act? His
Honour stated that the guarantee was not of the second type in Sunbird Plaza?1
It was rather a hybrid one and, if the borrower did not pay, the guarantor could
be exposed to an action for a money sum. Although the execution of the
guarantee only created a contingent debt, it could still fall under the insolvent
trading provisions.79 O n appeal Gleeson CJ, with Kirby P and Sheller J
concurring, s tated that the c laim w as for a 1 iquidated s um, falling within the
first type in Sunbird Plaza?0 Gleeson CJ further stated that it was unlikely that
guarantees were intended to fall outside the scope of the insolvent trading
provisions, as companies commonly used them.
8.3 Indirect pooling by the courts
8.3.1 Schemes of arrangement and compromises/arrangements with
creditors
A potential avenue to pooling is by way of schemes of arrangement pursuant to
s 411 of the Corporations Act. If approved by the required majority of the
creditors of each company affected as well as the court, such schemes are
binding on all creditors - even on those who are apathetic or who do not
P reviously, most c ases su ggested t hat c ontingent d ebts d id n ot fall within t he meaning o f 'debt'. 76 Bank of China v Hawkins (1992) 7 A C S R 262 at 270. This case was actually a decision on s 556 of the Companies (NSW) Code, a predecessor of s 592 of the Corporations Law, which preceded s 588G of the Corporations Act. 77 (1988) 166 C L R 245. 78 Bank of China v Hawkins (1992) 7 A C S R 262 at 266. In this regard Rogers CJ referred to NRG Vision Ltd v Churchfield Leasing Ltd (1988) 4 B C C 56. 79 Bank of China v Hawkins (1992) 7 A C S R 262 at 270. See further A Herzberg, 'Insolvent Trading' (1991) 9 C&SLJ 285 at 295. 80 Hawkins v Bank of China (1992) 26 N S W L R 562 at 570. 81 Ibid 571-572. See further J O'Donovan and J Phillips, The Modern Contract of Guarantee
(1996) at 526 for a discussion of all accounts guarantees where a debt is not incurred when the guarantee is signed since liability for the future can be revoked.
288
consent.82 However, schemes of arrangement are both costly and time-
consuming, as they involve two applications to court and at least one creditors'
meeting for each company involved.83 Compromises or arrangements with
creditors pursuant to s 477 of the Corporations Act, as a form of voluntary
pooling, also have a drawback. It would be unlikely for a court to advise a
liquidator in a court winding-up to pool the assets and liabilities of the
companies in the group, unless all creditors agreed or there was a regime
devised so that creditors could object.
oc
In Austcorp Tiles a group of four companies carried on business together to
such an extent that all the income was deposited into and all the expenses paid
from one bank account. There was total interdependence of investment,
financing and managerial activities among the companies. Three of the
companies went into liquidation. The liquidators were unsure of which assets or
what proportion of the funds held by them belonged to what company. Some of
the creditors were completely in the dark as far as the identity of the company
with which they had dealt was concerned. As it would be extremely expensive
and time-consuming to untangle the affairs of the group companies in question,
the liquidators of the three companies in liquidation applied for a court order to
allow them to apply the funds of the companies to all the creditors of each of
the companies. This would have the effect that each of the creditors would
receive a rateable dividend. The creditors were properly notified and no
objection was received.86
In terms of s 555 of the Corporations Law all debts proved in a winding-up
rank equally, unless otherwise provided for in the Corporations Law. If the
liquidators wished to distribute the assets of the companies otherwise than in
accordance with s 555 of the Corporations Law, the proper way to do it was
82 Re Austcorp Tiles Pty Ltd; Re Global Marble Pty Ltd; Austcorp Quarries Pty Ltd (in liq)
(1992) 10 ACLC 62 (Austcorp Tiles) at 64. 83 Dean-Willcocks v Soluble Solution Hydroponics Pty Ltd (1997) 24 ACSR 79 (Dean-
Willcocks) at 84. 84 Ibid 85. Cf Austcorp Tiles (1992) 10 ACLC 62 at 64. 85 (1992) 10 ACLC 62 at 63.
289
therefore pursuant to a scheme of arrangement.87 Thus, in the absence of a
scheme o f a rrangement, a 111 hat t he 1 iquidators c ould d o w as t o m ake a p ari
passu distribution to the creditors of each particular entity.88 The liquidators did
not follow this route. Rather, they suggested that a valid compromise with
creditors had been effected pursuant to s 477 of the Corporations Law, which QQ
could be laid before the court for approval.
Shanahan AJ did not decide the question whether this was indeed a compromise
that fell within the meaning of s 477 of the Corporations Law?0 His Honour
doubted whether s 555 of the Corporations Law could be overridden, except by
the provisions of the Corporations Law?1 Assuming this to be the correct view,
he held that, to enable the court to consider the application by the liquidators as
a compromise under s 477 of the Corporations Law, evidence of the creditors' — QO
consent was required. The lack of objections was not sufficient. The court
accordingly dismissed the applications for pooling by the liquidators.
The approach in the English case of In Re Bank of Credit and Commerce
International SA (No 3)94 stands in stark contrast to the approach to insolvency
law traditionally adopted as far as contracting out of the statutory pari passu
rule of distribution is concerned.95 In the liquidation of the Bank of Credit and
Commerce International (BCCI) group in the United Kingdom the court
allowed a pooling arrangement and a contribution agreement that were
87 Ibid. According to the principle of pari passu, like claims are to be treated alike, or creditors of the
same standing should receive equal treatment. 89 Austcorp Tiles (1992) 10 A C L C 62 at 64. 90 Ibid. 91 Ibid. 92 Following Plowman J in Re Trix Ltd [1970] 3 All E R 397. 93 Austcorp Tiles (1992) 10 A C L C 62 at 64. Furthermore, Shanahan AJ found at 64 that there was not sufficient evidence placed before the court to pierce the corporate veil and hold that the three companies were in fact one. See further A Wyatt and R Mason, 'Legal and accounting regulatory framework for corporate groups: implications for insolvency in group operations' (1998) 16 C&SL/424 at 431. 94 [1993] B C L C 106; confirmed on appeal [1993] B C L C 1490 (BCCI (No 3)). For an account of the pooling agreements in this case, see C Grierson, 'Issues in concurrent insolvency
jurisdiction: English perspectives' in J Ziegel (ed), Current Developments in International and Comparative Insolvency Law (1994) 577 at 608ff.
See, eg, the House of Lords decision in British Eagle International Airlines Ltd v Compagnie Nationale Air France [1975] 2 All E R 390.
290
consented t o b y t he 1 iquidators o f d ifferent c ompanies w ithin the group. T he
simplified facts of BCCI (No 3)96 were as follows. B C C I raised vast sums of
money through different entities from depositors. As a result of fraud
perpetrated by the management of BCCI, two of the companies in the group,
BCCI (SA) and B C C I (Overseas), went into insolvent liquidation. The
liquidators of B C C I (SA) applied to court to sanction various proposals
pursuant to the United Kingdom equivalent of s 477 of the Corporations Act.
One proposal was that the assets of BCCI (SA) and BCCI (Overseas) should be
pooled. Another proposal was that the Abu Dhabi government, the majority
shareholder in B C C I (SA), should contribute to the funds available to creditors.
There would be a mutual release of claims between the B C C I companies and
the government of Abu Dhabi and related parties. The Abu Dhabi parties would
be allowed as creditors in the liquidation of BCCI (S A ) and B C C I (Overseas),
so that part of the Abu Dhabi government contribution would be returned. The
creditors' committee opposed these proposals on the ground that the amount
offered was insufficient and argued that, if a higher amount could not be
agreed, it would be in the best interests of the creditors generally to commence
litigation.98
Both Sir Donald Nicholls V-C at first instance and the English Court of Appeal
approved the proposals. They largely based their decisions on the fact that it
was commercially impracticable for an alternative course. Both courts, at first
instance99 and on appeal,100 were of the view that a pooling compromise or
arrangement could with the sanction of the court be used to bind all creditors
and depart from the pari passu rule.101 The Court of Appeal agreed with the
court a quo and found that the views of the creditors' committee were not
96 [1993] BCLC 106; [1993] BCLC 1490. 97 [1993] BCLC 106 at 108. 98 Ibid 109. However, litigation instituted by the liquidators against the Abu Dhabi parties would be protracted, extremely expensive and have an uncertain result. 99[1993]BCLC106atlll. 100 [1993] BCLC 1490 at 1509-10. Russell LJ and Farquharson LJ agreed with Dillon LJ. 101 The compromise or arrangement was pursuant to s 167(1) coupled with paras 2 and 3 of Pt 1
of Sch 4 of the Insolvency Act 1986 (UK).
291
binding o n t he court, w hich w as v ested w ith a residual d iscretion t o d iverge 1 OO
therefrom where special circumstances warranted it as in this case.
As far as the proposed pooling agreements were concerned, it was found that
they were plainly for the benefit of the creditors as a whole.103 Although the
proposals involved a variation of creditors' rights that would normally not be
sanctioned by the court unless it was part of a scheme of arrangement under s
425 of the Companies Act 1985 (UK), this was an exceptional case.104 Because
of the vast number of depositors in many different countries who fell into
different classes and w h o had different interests, it was impractical to convene
any meetings to this end. The affairs of B C C I (S A ) and B C C I (Overseas) were
held to be so 'hopelessly intertwined' that the pooling of their assets was the
only realistic way to continue.105 The court held that it would not be sensible to
spend a lot of money and time in an effort to unravel the affairs of the different
companies.106 Furthermore, it was found that incidental departures from the
principle of pari passu, found in the contribution agreement, were permissible.
That is, it was allowed where it was ancillary to the exercise of any of the VfY7
powers that were exercisable with the sanction of the court.
As regards the aspect of pooling, the decision in BCCI (No 3)10* may be
justified on the basis that a pooling order should have been made, since it was
impossible to isolate the assets of the different companies.109 However, the
decision of the English Court of Appeal makes it clear that the pooling
arrangement would have been sanctioned in any event, since, as a whole, it was
found to be in the interests of creditors and since a scheme of arrangement was
102 [1993] BCLC 1490 at 1509-10. 103 [1993] BCLC 106 at 111. This was confirmed on appeal: [1993] BCLC 1490 at 1501.
A departure from the pari passu rule by way of a scheme of arrangement is possible in a liquidation under s 425 of the Companies Act 1985 (UK): BCCI (No 3) [1993] BCLC 1490 at 1510. 105 [1993] BCLC 106 at 111. See further IF Fletcher, The Law of Insolvency (1996) at 789, who is of the view that such a solution will only work where companies on the scale of BCCI become insolvent, otherwise there would not be sufficient funds to pay the fees of the specialists attempting to untangle the web. 106 [1993] BCLC 106 at 111. 107 BCCI (No 3) [1993] BCLC 1490 at 1510. 108 [1993] BCLC 106; [1993] BCLC 1490. 109 BCCI (No 3) [1993] BCLC 106 at 111.
292
found to be impractical.110 It is fair to say that the decision in BCCI (No 3)111
has caused the scope of a liquidator's authority to enter into a pooling
arrangement with court approval to attain liberal dimensions.112
8.3.2 Other avenues
8.3.2.1 Rights of contribution and subrogation under inter-company
guarantees
Before the other possible avenues to pooling are discussed, ie other avenues
than schemes of arrangement and compromises or arrangements with creditors,
problems arising under intra-group guarantees relating to the adjustment of
rights of subrogation and contribution between co-sureties need to be referred
to as a preliminary matter. These problems arise especially where some
subsidiaries contribute more than other subsidiaries to the indebtedness of their
holding company.
In AE Goodwin Ltd v AG Healing Ltd AG Healing Ltd (H) was the ultimate
holding company of a group comprising sixteen subsidiaries, including A E
Goodwin Ltd (G). H executed deeds charging its undertaking and assets in
favour of T E A Nominees Ltd (TEA) as trustee for debenture holders. All
sixteen subsidiaries guaranteed payment to T E A of the amount due under the
debentures. There was a number of inter-company loan accounts between H and
its subsidiaries and among the subsidiaries themselves. T E A subsequently
appointed a receiver in respect of H and each of the sixteen subsidiaries. The
receiver eventually realised the group's assets and paid T E A the entire principal
amount and interest owing under the debentures.
110 See further S Whelan, 'Administration of insolvent groups - the present state of 'pooling" (1998) 6 Insol Law Jnl 107 at 109-112. 111 [1993] BCLC 106; [1993] BCLC 1490. 112 Whelan, above n 110, 109-112. 113 (1979) 7 ACLR 481 (AE Goodwin).
293
The receiver collected an amount of $8 million in total. O f this amount, $2
million was obtained from H directly and $6 million from the subsidiaries,
including $1.5 million from G alone. Five of the sixteen subsidiaries made no
contribution. O f the eleven contributing subsidiaries, four owed money to H
and only one contributed an amount larger than it owed H. Six of the eleven
contributing subsidiaries paid more than one-sixteenth of the total contribution,
the other five paid less. H and all sixteen its subsidiaries were wound up. The
receiver sought the court's directions as to h o w the available funds should be
distributed i n v iew o f t he i nter-company d ebts a nd t he r ights o f c ontribution
and subrogation held by the various subsidiaries.
Powell J made a few general remarks about the doctrine of subrogation before
finding that it was immaterial that some of the claimants were persons who
owed more to H than they had themselves paid towards H's debts. In this regard
his Honour said:114
While I have n o difficulty in accepting that, before a surety is, or sureties are, entitled to be subrogated to the rights of the principal creditor, the creditor's debt should have been paid in full, I have the greatest difficulty in accepting that a right to subrogation arises in favour of a surety only when the surety has himself paid the creditor the full amount of the creditor's debt, for so to hold would, in m y view, permit the whole concept of subrogation, which is intended to prevent a creditor from acting in a capricious way to the detriment of the surety, itself to operate capriciously.
Powell J found that so simple a solution as set-off was not open in casu}15 and
proffered three reasons for this view. First, a claim to subrogation did not stop
short at securities given by the principal debtor, but, for the purpose of ensuring
that a surety paid only his due proportion of the principal debt, extended to all
securities given to the principal creditor.116 Secondly, co-sureties were required
to bring into 'hotchpot' payments received from counter-securities, where the
principal debt had been paid. Therefore any surety w h o had paid more than his
due proportion was entitled, as a means of enforcing his right to contribution to
the benefit of all securities taken by a co-surety, to indemnify himself against
m Ibid 481. 115 Ibid 488-489. 116 Ibid 489.
294
the c o m m o n liability.117 Thirdly, the right of subrogation was in the nature of a
class right, so that the mutuality necessary to give rise to a set-off would not 1 I Q
exist. Accordingly, each one of the eleven contributories was entitled to be
subrogated to TEA's rights against H.119
The decision in AE Goodwin120 should be contrasted with that in Brown v
Cork.121 In the latter case the English Court of Appeal was apparently
persuaded that monies outstanding on other accounts could be set off against
the respective liabilities of the group companies to a joint and several cross
guarantee to contribute to the c o m m o n debt.122 However, in Brown v Cork122
the indebtedness of each group company to the other group companies for its
contribution was an indebtedness secured by way of a fixed and floating charge
over the whole of each company's assets. It was not merely a case of
contribution; it was rather a case of subrogation to charged assets. A receiver,
appointed by a bank under these charges, realised the bank's security over the
assets of all the guarantor companies.124
The way in which this was done was, in broad terms, to pay over to the bank
the amount realised in respect of each company. The bank then applied this to
satisfy the principal indebtedness of that particular company. Any surplus was 1 9S
transferred to a suspense account in the name of the company concerned. The
moneys in the various suspense accounts were sufficient to discharge the total
indebtedness of the group of companies, with a surplus of £195,000 remaining
in the hands of the receiver. A dispute arose between the liquidator of one of
the group companies and the joint liquidators of the other companies regarding
17Ibid. 18 Ibid. 19 Ibid. 20 Ibid. 21 [1985] B C L C 363. 22 See O'Donovan, above n 63, 62-63. 23 [1985] B C L C 363. 24 Ibid 365-366. 25 Ibid 366.
295
the distribution of the surplus moneys that remained in the hands of the
receiver.
The English Court of Appeal found that, under s 5 of the Mercantile Law
Amendment Act 1856 (UK) where a co-surety paid off the creditor, to the extent
that he paid more than his due proportion of the debt, he was subrogated to the
rights of the creditor. H e could accordingly enforce any securities that the
creditor possessed against his co-sureties in order to obtain contribution. As
between co-sureties w h o have given security for the payment of the principal
debt, an over-paying surety was entitled, as between himself and his co
sureties, to have the charges 'marshalled'.127 This would ensure that co-sureties
contribute equally without the receiver haying to make any allowance for set-
off (or inter-company indebtedness on other accounts).
The proviso to s 5 of the Mercantile Law Amendment Act 1856 (UK), whereby
a co-surety was only entitled to claim against his co-sureties such 'just
proportion', for which the other sureties were 'justly liable', did not require a
consideration of the whole state of the accounts between the parties. The
proviso was simply devised to ensure that a surety standing in the shoes of the
creditor in any litigation would not by way of judgment obtain more than he
was justly entitled to by the contribution agreement.129 A s a result the moneys
in the hands of the receiver were not subject to any set-off claims as between
the co-sureties.
ilb Ibid 361. Ibid 373. The court did not use the word 'marshal' in its ordinary meaning. The doctrine of
marshalling is defined by B McDonald, 'Marshalling' in The Laws of Australia, volume 15, (loose-leaf), in para 23 as follows: 'The doctrine of marshalling applies when, in respect of two funds in the hands of one person, there is a double claimant (A) who can claim against both funds and a single claimant (B) who can claim against only one of the funds. The fund against which there are two claims is described henceforth as 'the double fund'; the fund against which there is only one claim is described as 'the single fund'. If A chooses to satisfy his or her claim out of the double fund, B has a right to stand in A's place in respect of the single fund, to the extent that the double fund would have satisfied B's claim if A had not claimed upon it first.' For a comprehensive discussion of marshalling, see R P Meagher, W M C G u m m o w and JRF Lehane, Equity: Doctrines and Remedies (1992), particularly para 1106. 128 Brown v Cork [1985] B C L C 363 at 374.
296
It is submitted that O'Donovan is correct in preferring the approach of Powell J
in AE Goodwin130 over the suggestion in Brown v Cork131 that sums due on 1 "X0
other accounts between group companies can be set off against their
unsecured liabilities to contribute to the common debt.133 In this regard
O'Donovan points out that subrogation is a right enjoyed as a member of the
class that has contributed to the payment of the principal debt and should
therefore not be available for a set-off against an individual debt.134
8.3.2.2 Section 447A of the Corporations Act
Apart from schemes of arrangement under s 411 and compromises/agreements
with creditors under s 477 of the Corporations Act, a form of voluntary pooling
is also possible under the voluntary administration provisions contained in Part
5.3 A of the Corporations Act.135 Of particular importance here is s 447A of the
Corporations Act, which reads as follows:
(1) The Court may make such order as it thinks appropriate about how this Part is to operate in relation to a particular company. (2) For example, if the court is satisfied that the administration of a company
should end: (a) because the company is solvent; or (b) because provisions of this Part are being abused; or (c) for some other reason;
the Court may order under subsection (1) that the administration is to end. (3) A n order may be made subject to conditions. (4) A n order may be made on the application of: (a) the company; or (b) a creditor of the company; or (c) in the case of a company under administration - the administrator of the
company; or (d) in the case of a company that has executed a deed of company arrangement - the deed's administrator; or (e) the Commission [ASIC]; or (f) any other interested person.
130 (1979) 7 A C L R 481. 131 [1985] B C L C 363 132
133 Other accounts would be, eg, trading accounts, which are quite separate from the guarantees. [ 1985] B C L C 3 63 a 13 69. S ee further P W ood, English and International Set-Off (1989)
paras 10.159-10.161. 134 O'Donovan, above n 63, 63. 135 Dean-Willcocks (1997) 24 A C S R 79; Mentha v GE Capital (1998) 16 A C L C 1,032
(Mentha).
297
The fact that liquidators of group companies m a y appoint an administrator
themselves gives an opportunity for creditors and the court to consider a
pooling arrangement under Part 5.3A of the Corporations Act.136 Court
approval is not required for deeds of company arrangement under this Part of
the Corporations Act. These deeds m a y therefore allow pooling in a more
flexible and less expensive way than under a scheme of arrangement. C A S A C
points out, however, that in most instances under Part 5.3 A of the Corporations
Act the creditors of every company involved should have the opportunity to
consider separately and vote separately on any proposal for pooling.
Consolidating the meetings effectively allows a person who is not a creditor of
a particular company to vote on a deed of company arrangement that affects the
property and 1 iabilities of that company. It distorts and m ay e ven n egate the
opportunity for creditors to vote for their preferred outcome.13
The decision in Dean-Willcocks139 relied on pooling pursuant to s 447 A of the
Corporations Law. The plaintiff was appointed administrator and was the
liquidator of two related companies.140 The companies, a manufacturer and a
retailer of hydroponic products, were operated as one by their sole director.1 '
The affairs of the companies had been managed without regard for the fact that
they were separate entities, as a result of which their assets and liabilities were
intermingled. There was one bank account and inadequate books and records to
show which creditors dealt with which company. Meetings of each of the
companies were held pursuant to s 439A(1) of the Corporations Law while the
companies were under administration. At these meetings the creditors resolved
that the companies should be wound up and that the assets and liabilities of
each company should be consolidated. N o one present dissented.142
136 Section 436B of the Corporations Act. C A S A C Final Report, above n 44, para 6.78.
138 See further Whelan, above n 110, 112-3. It should also be noted that an individual creditor cannot initiate a voluntary administration unless it is a substantial chargee. 139 (1997) 24 A C S R 79.
He was previously appointed as the administrator of each of these two companies pursuant to s 436A(1) of the Corporations Act.
The fact that the director died after the appointment of the voluntary administrator made the administration of the companies even more difficult.
Apart from the Deputy Commissioner of Taxation, all creditors of each company attended their respective meetings. The court did hold in the end that the appropriate notices should be
298
Since the relevant resolution to wind up was passed without dissent while the
companies were still under administration, Part 5.3A, and more specifically s
447A of the Corporations Law, was applicable. Having passed from
administration to liquidation, the company was deemed to be under voluntary
winding up by virtue of ss 43 9 A and 43 9C of the Corporations Law. Young J
in the Supreme Court of N e w South Wales did not attempt to invoke s 447 A to
have s 43 9C of the Corporations Law operate as if the winding-up were court-
approved. His Honour would have needed to do this if he wished to rely on a
court-appointed liquidator's compromise under s 477(1 )(c) and (2A) of the
Corporations Act.143 Young J acknowledged that a scheme of arrangement
under s 411 of the Corporations Law could be used without a problem, but
pointed out the disadvantages of the considerable costs involved in calling two
creditors' meetings and making a two-stage application to the court.144
Young J, heartened by the strong approach taken by the court in BCCI (No
3)}45 held that consolidation was possible in a corporate insolvency.146 His
Honour held that the bankruptcy rule that the assets and liabilities of different
group companies may be consolidated where it was impracticable to keep them
separate and where it was for the benefit of creditors generally, as long as no
creditor objected, applied in a corporate winding-up.147 Section 447A of the
Corporations Law empowered a court to make such an order as it deemed
served on the Deputy Commissioner of Taxation who could apply to have the pooling order
discharged: Dean-Willcocks (1997) 24 A C S R 79 at 85. 143 The type of direction that a liquidator could obtain from the court was wider under s 479(3) of the Corporations Act with court ordered liquidations than under s 511(1) of the Corporations Act with voluntary liquidations: Dean-Willcocks (1997) 24 A C S R 79 at 81. In particular, s 511(1) of the Corporations Act was not sufficiently wide to authorise the granting of an order that a liquidator would be justified in overriding the pari passu rule of distribution under s 555
of the Corporations Act. 144 Dean-Willcocks (1997) 24 A C S R 79 at 83. His Honour did not decide whether a liquidator's compromise or arrangement could be utilised under s 510 of the Corporations Act, but instead relied on s 447A of the Corporations Act as an avenue to pooling. See further the discussion in
para 8.3.2.2 below. 145 [1993] B C L C 106; [1993] B C L C 1490. 146 Dean-Willcocks (1997) 24 A C S R 79 at 85. See the discussion of BCCI (No 3) [1993] B C L C
106; [1993] B C L C 1490 in para 8.3.1 above. 147 Dean-Willcocks (1997) 24 A C S R 79 at 85. This bankruptcy principle is said to be derived from bankruptcy law via obiter dicta of Powell J inAnmi Pty Ltd v Williams [1981] 2 N S W L R
299
appropriate about h o w the statutory provisions dealing with voluntary
administration were to operate in relation to a particular company. His Honour
held that the court had jurisdiction under s 447A of the Corporations Law to
authorise the liquidator to treat the resolution as valid for all purposes and to act
upon it.148 Young J could apply the above bankruptcy rule in Dean-Willcocks149
because the relevant companies were under voluntary administration when their
creditors passed the resolution to wind them up. If this were not the case, the
court would presumably not have been able to order consolidation, despite the
consent of the creditors.150
The question of pooling again surfaced before Young J in Re Charter Travel Co
Ltd}51 The liquidators of two companies applied for an order that a combined
meeting of the creditors of each company should be convened. The purpose of
the meeting was to vote on a proposal that the assets and liabilities of the
companies should be pooled. His Honour held that pooling could be effected
where, as in this case, the companies had court-appointed liquidators. Young
J was of the view that, in an exceptional case, the court could make a direction
under s 479(3) of the Corporations Law that the liquidators were justified in
pooling.15 A n exceptional case would arise where it was impractical to keep
the assets and liabilities of the group companies separate and no creditor
objected. His Honour found that the individual businesses of the two
companies, ordered to be wound up by the court, were so intermingled that it
was held to be 'virtually impossible' to establish which creditors could claim
against which company.154 Young J added that 'even if it were possible, there
138 at 164. The order was made subject to the creditor who failed to attend the relevant creditors' meetings being given the opportunity to object. 148 Dean-Willcocks (1997) 24 A C S R 79 at 85. It should be noted that the judgment of Young J contained no reference to Austcorp Tiles (1992) 10 A C L C 62 relating to a court-ordered liquidation. See further KJ Bennetts, 'Voluntary administration: shaping the process through the exercise of judicial discretion' (1995) 3 Insol Law Jnl 135; A R Keay, 'Voluntary administrations: the convening and conducting of meetings' (1996) 4 Insol Law Jnl 9. 149 (1997) 42 N S W L R 209.
RP Austin, 'Corporate groups' in R Grantham and C Rickett (eds), Corporate Personality in the 20th Century (1998) 71 at 82-84. 151 (1997) 25 A C S R 337 (Charter Travel). 152 Ibid338. 153 Ibid. iS4Ibid.
300
would be tremendous waste of time and effort in rejecting proofs which the
liquidator thought were lodged against a wrong company only to have them
admitted against the other company'.155
In Charter Travel}56 Young J relied on his own decision in Dean-Willcocks151
in ordering that a combined meeting of the creditors of the related companies
should be held to consider a proposal for joint administration of the two
companies.158 The order in the latter decision stated that the liquidators could
carry out the proposal if the creditors unanimously gave their consent. Lack of
unanimous consent would mean that the matter had to be referred to court
again. Important for present purposes is that Young J gave an indication that
it has become necessary for the legislature to make provision for pooling when
he said:160
I should note that while the Courts can continue to deal with these sorts of problems on a case to case basis, the time may shortly be coming where it would be great saving for the Corporations Law itself to make provision for liquidators to consolidate in appropriate cases.
Although not so overwhelmingly in favour of pooling in these circumstances as
Young J, the judgments relating to the D I M group of companies before Hansen
J in the Supreme Court of Victoria and Finkelstein J in the Federal Court
echoed the same sentiments. In DIM Furniture (Vic) Pty Ltd v AKZO Nobel
Casco Products GmbH161 the voluntary administrators of the D I M group made
application that a single consolidated meeting of creditors pursuant to s 439A of
the Corporations Law should be held. The purpose of the proposed meeting
was to consider a sole consolidated Deed of Company Arrangement for the
whole group of companies. The voluntary administrators contended that the
155 Ibid. 156 Ibid 337. 157 (1997) 42 N S W L R 209. 158 (1997) 25 A C S R 337 at 338. X59 Ibid 339. mIbid. 161 Unreported, Supreme Court, Victoria, Hansen J, 16 November 1997. The transcript of the judgment in this case is not available but the author relied on the facts as stated by Whelan,
above n 110, 111-112, in discussing this matter.
301
authority to make such an order was contained in s 447A of the Corporations
Law}62
The main ground for the application by the voluntary administrators was not
that it was impossible to separate the creditors for the purpose of separate votes.
Rather, the administrators stressed that it was unfair to allow creditors to vote
separately, taking into account the high level of confusion among them as to the
company with which they had been dealing.163 The voluntary administrators
were afraid that those w h o incidentally happened to be creditors of more
solvent companies would vote against a proposed deed, prejudicing the
creditors of less solvent companies who were in a commercially identical
position. Hansen J dismissed the application, so that the voluntary
administrators were required to hold meetings of each of the separate
companies.164 Determined to succeed, the voluntary administrators composed a
complex pooling arrangement through separate deeds for each group company.
W h e n they put their proposal to the separate meetings of each company's
creditors, the creditors overwhelmingly supported the proposal in each case.165
The proposed arrangement for the DIM group was complex, but its main
features may be summarised as follows. The voluntary administrators proposed
that the other members of the group transfer all their assets, except real estate,
to one of the group companies. This company would also take over the
employees o f t he o ther group c ompanies, o perate t he v arious b usinesses t hat
had previously been carried on by the other companies, and assume
responsibility for all the group's liabilities other than those arising out of the
ownership of the real estate.166 Subject to approval of the deed assigning the
assets and the deed poll of novation in respect of the liabilities, a deed of
company arrangement was proposed. Pursuant to this arrangement, a fund
would be established to satisfy in part the group's liabilities. Failing this, the
162 Whelan, above n 110, 111. 163 Ibid. mIbid. X65Ibid. 166 Ibid 111-112.
302
group's assets would be sold over a period of six months and the proceeds
applied to discharge the liabilities.167
The v oluntary administrators r eturned t o t he F ederal C ourt, s eeking a n order
under s 442C of the Corporations Law that would allow them to dispose of the
encumbered property of each company in the D I M group other than the
company to which everything had been transferred. The voluntary
administrators also sought directions that it was appropriate for them to execute
and give effect to each of the three deeds.
In a decision reported as Mentha v GE Capital}6* Finkelstein J approved this
novel approach to deal with a corporate group in the context of a voluntary
administration. His Honour granted the administrators leave to dispose of the
assets under s 442C of the Corporations Law and made the directions requested
in respect of the deeds. In the course of his judgment Finkelstein J pointed
out that there was no doubt that pooling was allowed by way of a scheme of
arrangement.170 Regarding the 'pooling' regime proposed by the voluntary
administrators of the D I M group, Finkelstein J stated:171
In m y opinion the power to enter into a deed of company arrangement under Pt 5.3A is sufficiently broad to permit an arrangement binding on two or more insolvent companies pursuant to which their respective assets and creditors will be consolidated. There is no justification for a construction of this part of the Corporations Law that would lead to the conclusion that arrangements made pursuant to Pt 5.3A must be more narrowly confined than arrangements made under s 411.
His Honour left open the question of whether, in the absence of a scheme of
arrangement, an order for pooling could be made in relation to insolvent
companies where the assets had been intermingled to such an extent that their
167 Ibid 112. 168 (1998) 16 A C L C 1,032. 169 Ibid 1,036. Although Finkelstein J found that it was appropriate to make the orders sought by the administrator in respect of the assignment and novation, his Honour did not find it appropriate to make a similar order in relation to the deed of company arrangement. The reason for this was that the administrator was obliged to ensure that the deed of company arrangement came into existence by virtue of the provisions of the Corporations Act and that giving a direction that the administrator should execute the deed would not serve any purpose. 170 Mentha (1998) 16 A C L C 1,032 at 1,037.
303
1 no
separation was practically impossible. Finkelstein J expressed the view that the opinion of Young J that such an order could be made in Re Charter
Travel113 was obiter and said: 'One day it will be necessary to determine to
what extent, if at all, a c ourt can make a similar order [that is, similar to an
order for consolidation of bankrupt estates] in the case of insolvent
,174
companies.
8.3.2.3 Section 510 of the Corporations Act
A form of voluntary pooling can also be achieved by making use of the
provisions of s 510 of the Corporations Act, involving arrangements under a
voluntary winding-up. Section 510, contained in Part 5.5 of the Corporations
Act, provides as follows:
(1) A n arrangement entered into between a company about to be, or in the course of being, wound up and its creditors is, subject to subsection (4): (a) binding on the company if sanctioned by a special resolution; and (b) binding on the creditors if sanctioned by a resolution of the creditors. (IA) The company must lodge a copy of a special resolution referred to in paragraph 1(a) with ASIC within 14 days after the resolution is passed. (2) A creditor must be accounted a creditor for value for such sum as upon an account fairly stated, after allowing the value of security or liens held by the creditor and the amount of any debt or set-off owing by the creditor to the company, appears to be the balance due to the creditor. (3) A dispute about the value of any such security or lien or the amount of any debt or set-off may be settled by the Court on the application of the company, the liquidator or the creditor. (4) A creditor or contributory may, within 3 weeks after completion of the arrangement, appeal to the Court in respect of the arrangement, and the Court may confirm, set aside or modify the arrangement and make such further order as it thinks just.
Fewer attempts to obtain a pooling order under the procedure contained in s 510
have been made than under s 447A of the Corporations Act. Although s 447A
was also relied on as an avenue for pooling, the court in Re Switch
Telecommunications Pty Ltd (in liq)115 accentuated the provisions of s 510 of
the Corporations Law as a route to obtain a pooling order. Switch
— — .
172 Ibid. 173 (1997) 25 A C S R 337. 174 Mentha (1998) 16 A C L C 1,032 at 1,037. 175 (2000) 35 A C S R 172 (Switch Telecommunications).
304
Telecommunications dealt with pooling of the assets and liabilities of two
companies, each in a creditors' voluntary winding-up, pursuant to a voluntary
administration. In contrast to the position in Dean Willcocks v Soluble
Solution, the creditors had not passed a resolution for pooling at the time
when the company was under administration. The businesses of the companies
were inextricably intertwined.
In Switch Telecommunications111 the liquidators of the two companies applied
for such orders as might be necessary to combine the realisations, costs and
distributions to creditors of both companies that, between them, operated two
businesses.178 This process was referred to as 'pooling the liquidations'.179 The
affairs of the two companies were so intertwined that the liquidators had been
unable to ascertain exactly the assets owned by each company, whether each
business was operated solely by one company or the other, and whether
creditors were creditors of one company or the other.180 All that was certain was
that the creditors belonged to one or other of the two companies, but they could
not be matched with a particular company. A combined meeting of creditors of
both companies voted unanimously in favour of the proposal.
In an application under s 511(1) of the Corporations Law the liquidators
submitted a pooling deed made between them and the companies which
provided for:
• all realisations to be deposited into a single bank account;
• the order of distribution from the account - the statutory priority was to be
left undisturbed, save that those.entitled at each level with each company
were grouped together;
• mutual releases to be given by the liquidators and the companies save for
the provisions of the pooling deed, and claims by the liquidators for
remuneration; and
176 (1997) 24 ACSR 79. 177 (2000) 35 A C S R 172. 178 Ibid 173. 179 Ibid. 180 Ibid 174.
305
• the operation of the pooling deed to be subject to conditions precedent,
being a court direction to the liquidators under s 511(1) of the Corporations
Law that they were justified in entering into the pooling deed, a combined
meeting of the pooled creditors sanctioning the deed, and the court
approving any compromise which the pooling deed might be said to contain
(primarily that set out in the release clause) under s 477(2A) of the
Corporations Law.
The liquidators also submitted a draft explanatory memorandum to accompany
the notices of meeting. This memorandum set out the implementation steps, the
reasons for pooling, a summary of the effect of pooling or not pooling in table
form,181 and the supporting recommendation of the liquidators.182 It specified
that the Supreme Court had the discretion to give or withhold any approval or
other order. The explanatory memorandum also specified the hearing date for a
proposed further application by the liquidators and stated that any creditor who
opposed the provisions of the pooling deed c ould appear before the c ourt on
that date, as contemplated by s 510(4) of the Corporations Law. A n
advertisement to alert creditors whose claims might not have appeared in
company records was also required.183
Santow J held that pursuant to s 511(1) of the Corporations Law the liquidators
were justified in entering into the proposed pooling deed and in convening a
combined meeting of all known creditors of the two companies for the purpose
of the meeting approving the pooling deed.184 W h e n the matter came back
before the court after consideration of the liquidator's proposal by the creditors
and contributories, the evidence disclosed that the pooling deed had been
appropriately sanctioned, with no creditor dissenting. Santow J made two
orders. The first order declared that, pursuant to s 1322(4) of the Corporations
Law, the combined meeting of creditors of the two companies, purporting to be
The not pooling options set out the assumptions on which the calculations were made: see Switch Telecommunications (2000) 35 A C S R 172 at 182. 182 Ibid. m Ibid 183.
306
a meeting for the purposes of s 510(l)(b) of the Corporations Law of each
company, was not invalid as a meeting of each company by reason of any
contravention of any provision of the Corporations Law. The second order
declared that, pursuant to s 477 of the Corporations Law, the compromise of
debts constituted by the pooling deed must be approved. Such order, if not
appealed, was to take effect from the date that the period expired under s 510(4)
of the Corporations Law in respect of the arrangement constituted by the said
deed. If there were to be an appeal within the time prescribed by s 510(4) of the
Corporations Law, then such order was to take effect from the date such appeal
was dismissed.185
The liquidators first sought an order under s 447A of the Corporations Law
allowing the pooling and thereby creating a basis for use of the court-approved
compromise or arrangement power in s 477(1 )(c) and (2A), read with the
directions power in s 479(3) of the Corporations Law.1*6 Section 447A of the
Corporations Law provided that 'the court may m ake such order as it thinks
appropriate about how this Part [5.3A] is to operate in relation to a particular
company'. Section 477(1 )(c) of the Corporations Law permitted a liquidator to
'make any compromise or arrangement with creditors' without creditor vote,
while s 4 77(2A) o f the Corporations Lawxequired c ourt approval where the
debt compromised was $20,000 or more. The liquidators requested an order
making Part 5.3 A of the Corporations Law operate in relation to each company
as if the two windings up were court-ordered (compulsory) windings up,
instead of being creditors' voluntary windings up, as deemed by s 446A.
Santow J doubted whether s 447A of the Corporations Law could be utilised to
convert the deemed voluntary winding-up into a deemed compulsory winding-
185 Santow J left open the question whether, where there is minor dissent, a remedial order under s 1322(4) of the Corporations Act could and should be made to allow voting in combination: Switch Telecommunications (2000) 35 A C S R 172 at 173. 186 This was basically the approach followed in BCCI (No 3) both in [1993] B C L C 106 and [1993] B C L C 1490 but without recourse to any U K equivalent of s 447A of the Corporations
Act. 187 Since both companies had passed into liquidation following the appointment of the liquidators as administrators under Pt 5.3A of the Corporations Act, they had to be treated - by operation of s 446A(2) of the Corporations Act-as having been wound up voluntarily.
307
up.188 Even if one assumed that the winding-up could be treated as a deemed
compulsory winding-up, Santow J was of the view that such a route could be
problematic.189 His Honour found that there was a limit on the scope of the
compromise power in s 477(1) of the Corporations Law to bind dissentients.190
It is not clear that the court had the necessary authority by virtue of s 477(1) of
the Corporations Law to approve a compromise not agreed to by all creditors.
On the contrary, there existed Australian authority to the effect that, where all
creditors did not agree to a compromise, a scheme of arrangement should be
used instead.191
On this point Santow J referred to BCCI (No 3)}92 where a very unconventional
approach was adopted. In BCCI (No 3)193 the affairs of the relevant companies
were so intertwined as to make it unrealistic to continue by way of scheme of
arrangement under the United Kingdom equivalent of s 411 of the Corporations
Act. The English Court of Appeal, in what Santow J called 'circumstances of
overwhelming chaos that the court was under enormous pressure to avert',194
decided that in 'special circumstances' where a conventional scheme of
arrangement was impracticable, the compromise power in the United Kingdom
equivalent to s 477(1 )(c) of the Corporations Act was wide enough to bind
dissentient creditors to a pooling arrangement.195 The English Court of Appeal
in BCCI (No 3)1 6 accepted that a departure from the pari passu rule was
allowed w here i t w as ' ancillary t o an e xercise ofanyofthep owers t hat a re
188 Switch Telecommunications (2000) 35 A C S R 172 at 175. In Australasian Memory Pty Ltd v Brien (2000) 172 A L R 28 the High Court held that s 447A orders could be made in certain circumstances, even though a company had passed from administration into liquidation (at 35-36). The High Court pronounced that s 447A(l) of the Corporations Act should not be read down to limit its application to ' some departure from the scheme'. Furthermore, the subject matter with which s 447A of the Corporations Act deals is 'a particular company" and the operation of Pt 5.3A of the Corporations Act in respect of that company, as opposed to 'a particular administration'. This reaffirms the breadth of the section and its capacity to confer powers to make 'orders with future effect, but in respect of past matters or events'. 189 Switch Telecommunications (2000) 35 A C S R 172 at 177-178. 190 Ibid 177. 191 Ibid 178. 192 [1993] B C L C 106; [1993] B C L C 1490. 193 Ibid. 194 Switch Telecommunications (2000) 35 A C S R 172 at 178.
Ibid 178-9. In this regard there was an implicit departure from/?e Albert Life Assurance Company (1871) L R 6 Ch App 381 in Re BCCI (No 3) [1993] B C L C 106; [1993] B C L C 1490. 196 [1993] B C L C 106; [1993] B C L C 1490.
308
exercisable w ith t he s anction o f t he C ourt'.!9? A pproval o f c reditors w as not
required, so long as 'special circumstances' could be proved. Examples of
'special circumstances' included the impossibility of determining the true
debtors of each company and the impossibility of going through the scheme
meeting procedure under the United Kingdom equivalent to Part 5.1 of the i no __
Corporations Act. ° To prove 'special circumstances' something more was
needed than mere inconvenience of implementing a scheme of arrangement.199
Santow J pointed out that the decision in BCCI (No 3)200 seemed at odds with
earlier English authority and the legislative history in respect of compromises in
the Umted Kingdom. His Honour also stated several reasons why Australian — - 0(\0
courts might not follow the decision in BCCI (No 3). First, remedial orders
under s 1322 of the Corporations Law, for which there is no equivalent in the
United Kingdom, might remove the kind of difficulties faced in BCCI (No 3).
Therefore, there might be less pressure in Australia for giving the compromise
power the wide operation recognised by the English Court of Appeal in BCCI
(No 3)?04 Secondly, while in BCCI (No 3)205 it was assumed that the approval
of the court was sufficient to make the compromise binding on dissentients, ss
411(4), 507(3) and 510(1) of the Corporations Law explicitly render a
compromise or arrangement binding on dissentients. This provides a very
good reason, based on the maxim expressio unius est exclusio alterius, not to
rely on s 477 as providing a means to bind dissentients, because s 477 of the
Corporations Act has no express provision that dissentients are to be so
bound.208
197 BCCI (No 3) [1993] BCLC 1490 at 1510. 198 Switch Telecommunications (2000) 35 ACSR 172 at 179. 199 Ibid. 200 p99 3] B C L C 106; [1993j B C L C 149() 201 Switch Telecommunications (2000) 35 ACSR 172 at 176ff. 202 [1993] BCLC 106; [1993] BCLC 1490. 203 Switch Telecommunications (2000) 35 ACSR 172 at 179. 204 [1993] BCLC 1490. 205 [1993] BCLC 106; [1993] BCLC 1490. 206 Switch Telecommunications (2000) 35 ACSR 172 at 179. 207 This maxim is a rule of interpretation and means that the express mention of one thing is the
exclusion of the other. 208 Switch Telecommunications (2000) 35 ACSR 172 at 179.
309
Furthermore, even if the decision in BCCI (No 3)209 could be followed in
Australia, Santow J found that it could not be applied in Switch
Telecommunications210 because the liquidation in BCCI (No 3)211 was a court-
ordered liquidation, not a voluntary liquidation as was the case in Switch
Telecommunications?12 His Honour pointed out that it was possible in Australia
to go through a 'fast-track simplified scheme procedure' under s 510 of the
Corporations Law if orders were made under s 1322(4) of the Corporations
Law so as to allow a similar combined meeting of creditors as had occurred in
that case. Since there was no equivalent to s 510 of the Corporations Law in the
Insolvency Act 1986 (UK), there was a greater need in the United Kingdom to
rely on the compromise power. Accordingly, Santow J found that no order O 1 "5
should be made under s 447A of the Corporations Law.
In the alternative, the liquidators sought an order facilitating an arrangement
under s 510 of the Corporations Law, rendered binding on all creditors by
special resolution. Section 510 of the Corporations Law is applicable to both
creditors' and members' v oluntary 1 iquidations. If the appropriate resolutions
are passed, the arrangement becomes 'binding' on non-voting and minority
dissentient creditors and contributories.214 The court is only involved if a
creditor or contributory appeals to the court pursuant to s 510(4) of the
Corporations Law within three weeks 'after the completion of the
arrangement'.215
Santow J then stated the principles that emerged from the few decisions on s
510 of the Corporations Law in Australia and its equivalent in the United
Kingdom:216
209 [1993] BCLC 106; [1993] BCLC 1490. 210 (2000) 35 ACSR 172. 211 [1993] BCLC 106; [1993] BCLC 1490. 212 (2000) 35 ACSR 172 at 179. 213 Ibid. 214 Ibid 180. 2X5 Ibid 181.
310
• to be binding on non-voting or dissentient creditors, they must be paid pari
passu with the voting creditors;217
• otherwise the non-voting or dissentient creditors need to consent to the
arrangement;
• the concept of 'arrangement' is to be liberally construed and can embrace
any proposal 'such as a reasonable business man might carry out bona fide
in the course of his business';218
• as such, it may include a compromise;219
• the section only applies to voluntary liquidations;220
• but, an arrangement which renders a company solvent so that a winding-up
resolution is not passed, is not covered by the section,221 and such an
arrangement needs to use the scheme provisions in Part 5.1 of the
Corporations Law;
• another way of putting this is that although s 510(1) permits an
'arrangement' between a company and its creditors where the company is
'about to be ... wound up', an actual winding-up resolution is an integral
part of the process;
• the arrangement resolution may be passed before the winding-up resolution,
because of the presence of the words 'about to be wound up', but the
arrangement resolution will have no efficacy unless the winding-up 000
resolution is passed; and
• the voting majority on the resolution of creditors provided for in s 510(l)(a)
of the Corporations Law is, by operation of s 510(2), by value, and by
217 Re Farmers'Freehold Land Co Ltd (1892) 3 BC (NSW) 39 (Manning J). At a meeting convened under s 439A of the Corporations Act, a company's creditors may resolve that the company execute a deed of company arrangement. A deed of company arrangement can override the principle of pari passu: s 444A(5) of the Corporations Act. See also Re Bartlett Researched Securities Pty Ltd (admin apptd); Re Nova Corp Ltd (admin apptd) (1994) 12 ACSR 707 (applied in Hagenvale Pty Ltd v Depela Pty Ltd & Serrada Holdings Pty Ltd (1995) 17 ACSR 139) and Lam Soon Australia Pty Ltd (administrator appointed) v Mold (No 55) Pty
Lfc/(1996)22ACSR169. 218 Re ED White Ltd (1929) 29 SR (NSW) 389 at 391 (Harvey CJ). 219 See Young J in Dean-Willcocks (1997) 24 ACSR 79 at 83 following Re ED White Ltd (1929) 29 SR (NSW) 389 at 391 which is contrary to Re Contal Radio Ltd [1932] 2 Ch 66 at 69. 220 Re Contal Radio Ltd [1932] 2 Ch 66 at 68-69. 221 Ibid; Setco Manufacturing Pty Ltd v Sifa Pty Ltd (1982) 7 ACSR 327 (McLelland J) and Re Robinson & the Trustee Act 1925 [1983] 1 NSWLR 154 (Needham J). 222 Re Contal Radio [1932] 2 Ch 66 at 69.
311
operation of Regulation 5.6.21 of the Corporations Regulations, by
number.223
Santow J added that 'completion of the arrangement' in s 510(4) of the
Corporations Law meant the date of passing the last of the sanctioning
resolutions under s 510(1) of the Corporations Law and not completion of the
implementation steps set out in the arrangement.224 His Honour noted that,
although s 510 of the Corporations Law had the advantage that, if the necessary
resolutions were passed, the arrangement became 'binding' on non-voting and
minority dissentient creditors and contributories, it posed two potential
problems. The first potential problem was the impossibility of isolating the
creditors of each company, although the court could rely on their being
creditors of one company or the other.225 Santow J indicated that this problem
could be overcome as follows. If a resolution of a combined meeting of
creditors w ere p assed, the c ourt, subject t o h earing any objections, would be
minded to make a remedial order under s 1322(4) of the Corporations Law that
the combined meeting of creditors of both companies be treated as a meeting of
creditors of each company, thus complying with s 510(l)(b) of the 00 ft
Corporations Law.
The second potential problem with s 510 of the Corporations Law was that it
had been drafted to cover both creditors' voluntary liquidations and members'
voluntary liquidations.227 In the case of a members' voluntary liquidation there
would n ormally b e a s urplus for c ontributories, t hus g iving t hem t he i nterest
recognised in s 510(l)(a) of the Corporations Law. Section 510(l)(a) of the
Corporations Law, however, could operate to give members a veto power over
an arrangement with creditors although members would have no interest in the
The source of the regulation power was s 80 of the Corporations (NSW) Act 1990. Switch Telecommunications (2000) 35 A C S R 172 at 181-2. Ibid 180.
312
absence of a surplus for contributories in a creditors' voluntary winding up.
Santow J referred to this veto power as 'anomalous'.228
In Switch Telecommunications22* the requirement of a special resolution of
members did not pose any problems, since each company had a sole
shareholder w h o passed a special resolution, making use of s 249B of the
Corporations Law. If the members had not passed the necessary special
resolutions, t he c ourt w ould h ave h ad t o c onsider w hether i t w as p ossible t o
avoid the requirement of a special resolution of members. Santow J did not find
it necessary to decide whether, in the alternative, it would be sufficient for a
liquidator to bind a company utilising the powers under s 477(1), obtained via s
506 of the Corporations Law. In such a case there was no surplus available to
contributories, thus only requiring a resolution of creditors for s 510(1) of the
Corporations Law to become operative.
8.4 Evaluation of position of group creditors
8.4.1 Indirect pooling by the regulator
In light of the watered down Harmer Report recommendations on contribution
contained in s 588V-588X of the Corporations Act, and in the absence of
specific legislative provisions on pooling, ASIC has provided for an indirect
form of pooling in the context of group insolvencies. This they have done by
issuing Class Orders providing for a Deed of Cross Guarantee. Although some
of the deficiencies have been rectified, the operation of the ASIC Deed of Cross
Guarantee h as n ot b een as s mooth a s o ne m ight h ave h oped. As r egards t he
shortcomings of the Deed of Cross Guarantee vis-a-vis creditors, the problem
surrounding multiple insolvencies seems to have been solved by the decision in
Westmex?31 Further, it is conceded that the three conditions imposed by ASIC
229 (2000) 35 ACSR 172. 230 Ibid 180. 231 (1992) 8 ACSR 146, confirmed on appeal in Westmex Operations Pty Ltd v Westmex Ltd (1994) 12 A C L C 106.
313
(namely, lodgement of the deed of revocation with ASIC, public notification,
and no commencement of winding-up within six months) have in all probability
lessened the disadvantage suffered by creditors as far as revocation of the deed
is concerned.
Other deficiencies regarding the Deed of Cross Guarantee vis-a-vis creditors
have, unfortunately, not been solved. In so far as the release of obligations in
the case of a sale is concerned, the Deed of Cross Guarantee remains seriously
flawed in that it does not in these circumstances provide equal access for
creditors of all the group companies involved to all the assets of such
companies. Should the corporate group go into liquidation subsequent to the
sale of a party to the Deed of Cross Guarantee, the interests of some creditors
may be adversely affected. The effect of a Deed of Cross Guarantee is to make
the assets of the company providing the guarantee available to creditors of
another company or companies in the same group. In the case of a sale,
however, the unsecured creditors of the company providing the guarantee may
possibly be prejudiced.
As regards the shortcomings of the Deed of Cross Guarantee vis-a-vis directors,
a subsidiary's execution of a Deed of Cross Guarantee cannot necessarily be
said to be for the latter's benefit, even if the interest of the group as a whole is
taken into account.232 This is illustrated by the decision in ANZ v Qintex?33
Execution of a Deed of Cross Guarantee could therefore be a breach of the
directors' fiduciary duty to act bona fide in the interests of the company and for
a proper (corporate) purpose,234 especially since this duty has been extended to
include creditors. If entering into a Deed of Cross Guarantee is a risk to the
company's s olvency, s uch e ntry m ay c ause d irectors t o b e i n b reach oft heir
duty to take into account the interests of creditors when a company is insolvent
See the discussion in para 8.2.2.1(a) above. 233 [1991] 2 Q d R 3 6 0 .
Hill, 'Corporate Groups, Creditors Protection and Cross Guarantees: Australian Perspectives', above n 25, 352-353.
314
or on the brink of insolvency.235 Furthermore, by deciding to join in the
revocation of the deed, the directors of the subsidiary m a y be in breach of their
fiduciary duty on the basis that the decision to revoke was engineered for the
ultimate benefit of the holding company.236
In so far as the insolvent trading provisions are concerned, concern in the
business community emerged that entering into Deeds of Cross Guarantee
could expose directors to personal liability under s 588G of the Corporations
Act. Although large corporate groups have made extensive use of Deeds of
Cross Guarantee in order to obtain the advantage of not having to prepare, and
have audited, separate financial statements for every wholly-owned • • 0\1
subsidiary, this has caused the relief from the financial reporting
requirements to lose much of its shine.238 Moreover, a possible complication of
the decision in Hawkins v Bank of China139 is that directors must have
reasonable grounds to expect that their company would be able to make good
any liability of the group for which it may become liable under a Deed of Cross
Guarantee.240 If directors do not comply with this requirement, they m a y be
held liable for insolvent trading because it was held that even a contingent
liability could constitute a debt for purposes of the insolvent trading
provisions.241
The m ain o bj ect o f a Deed o f C ross Guarantee has b een s tated asp roviding
creditors of all group companies in insolvency with access to all the assets of all
235 See Ch 5 para 5.3. It should also be noted that the party in whose favour the guarantee had been executed, ie the holding company, could be liable as a constructive trustee. In such a case the guarantee could be set aside: see Rolled Steel Products (Holdings) Ltd v British Steel
Corporation [1986] 1 C h 246 at 298. 236 See the discussion in para 8.2.2.1(b) above. 237 A n empirical study has revealed that almost one third of the top 500 Australian companies listed in 1997 had made use of this opportunity provided by ASIC: see I Ramsay and G Stapledon, Corporate Groups in Australia (1998) at 17ff. 238 R Baxt, 'The duties of directors of public companies - the realities of commercial life, the contradictions of the law, and the need for reform' (1976) 4 A Bus L Rev 289 at 297-8. 239 (1992) 26 NSWLR 562. 240 This is consistent with Norfolk Plumbing Supplies Pty Ltd v Commonwealth Bank of Australia (1992) 6 A C S R 601, where it was held that the principle laid down in a series of cases on voidable preferences should be followed. This principle states that 'own money' of a debtor does not include money that is available by reason of unsecured loans from third parties. 241 See the discussion in para 8.2.2.2 above.
315
the other group companies. This is probably because the effect of a Deed of
Cross Guarantee is to hold a group company responsible indirectly for the debts
of its fellow group companies. However, the better view seems to be that the
rationale behind the introduction of the Deeds of Cross Guarantee is
deregulation.243 O n this view, consolidated accounting and audit relief
arrangements are seen as an administrative attempt to reduce the costs of
reporting obligations that arise from applying the separate legal entity doctrine.
In other words, Deeds of Cross Guarantee were not originally introduced to
protect creditors, or to give them access to group assets, and the main purpose
of these Deeds was not to bring about enterprise liability.
However, when the Deeds of Cross Guarantee remove the boundaries between
the companies forming part of the group for purposes of statutory accounting,
in practice, the boundaries also are removed for purposes of determining
liability to creditors. This brings about enterprise liability. At the same time
each group company m a y act independently and is able, for instance, to revoke
the Deed of Cross Guarantee, thereby adhering to the entity theory. It is thus
fair to say that the scheme of cross guarantees has not been efficient in its
attempt to reverse the vulnerability of creditors and to by-pass standard liability
patterns under the so-called entity theory in the context of corporate groups. It
emphasizes the need for a specific statutory provision for enterprise liability as
set out in Chapter 10.
8.4.2 Indirect pooling by the courts
The traditional potential avenues to pooling pursuant to s 411 (schemes of
arrangement) and s 477 (compromises/arrangements with creditors) of the
Corporations Act are much more low-key than the pooling orders possible
under the Companies Act 1993 (NZ), as appears from Chapter 9. Austcorp
Tiles serves as a reminder that a pooling order along the lines of the one
242 Farrar, above n 45, 192-194. 243 See, generally, H Bosch, The Workings of a Watchdog (1990). See also CASAC Final Report, above n 44, para 2.71. 244 (1992) 10 ACLC 62.
316
granted in the N e w Zealand case of Re Dalhoff & King Holdings Ltd245 is not
currently possible in Australia.
Recently, however, there has been a trend by the courts to endorse pooling that
does not necessarily fall within the ambit of schemes of arrangement or
compromises/arrangements with creditors. This trend is noticeable both in
Australia and in the United Kingdom and has manifested itself in circumstances
where the group structure and invariably the claims are very complex, or where
the creditors recognise pooling as fair while they wish to sidestep unnecessary
administrative c osts. T he n eed for p ooling ore onsolidation a rises m ost o ften
where there has been intermingling of the business affairs of the different group
companies to such an extent that it is difficult, if not impossible, to ascertain the
financial position of the individual companies.
In the context of s 447A of the Corporations Act, Whelan has argued that the
approach followed by Hansen J and Finkelstein J in the D I M group liquidation
is less in conflict with established principles of corporate insolvency law246 than
that followed by Young J in Dean-Willcocks?41 This is because the view of
Young J m a y cause problems in the sense that a new category of arrangement
binding on creditors m a y be imported into Australian law for which the
Corporations Act does not provide and that this is potentially in conflict with
existing legal principles. However, this criticism does not mean that changes to
the Corporations Act to allow pooling would be inappropriate. Indeed, it is
submitted that Whelan is correct when he stated that certain amendments to the
legislation to allow pooling should be welcomed:
Notwithstanding these observations, a statutory power to order pooling in winding up in an appropriate case may be a desirable addition to the law and probably would be seen by the commercial community as reflecting commercial practice. The number of occasions revealed in recent court decisions upon which meetings of creditors have overwhelmingly endorsed pooling suggests that there is support in the business community for such an alternative.
245 [1991] 2 NZLR 296. See further Ch 9 para 9.5 for a discussion of this case, as well as C Chapman 'Cross-guarantees drown in the pool' (1990) IFLR 16. 246 It is also less in conflict with the law on directors' duties: see Whelan, above n 110, 112. 247 (1997) 42 N S W L R 209. 248 Whelan, above n 110, 113.
317
The decision of Santow J in Switch Telecommunications249 shows that pooling
pursuant to the provisions of s 510 of the Corporations Act m a y be preferable
to utilising the provisions of s 447A of the Corporations Act, thereby creating a
basis for the use of the court-approved compromise or arrangement power in s
477 of the Corporations Act. Santow J pointed out the problems with the s
447A approach in respect to pooling, and stated a number of reasons why
Australian courts might not follow the decision in Re BCCI (No 3)?50
Thereafter his Honour noted that the s 447A approach should be left to cases
where there m a y be no other alternative available to achieve pooling.251
Making use of the provisions of s 510 of the Corporations Act to effect pooling
may be more appropriate in a case such as Switch Telecommunications,
where all the creditors consented. It could, however, pose a problem in cases
where this is not the position on the facts. Pooling in this context could
presumably not override the pari passu rule of distribution to unsecured
creditors contained in s 555 of the Corporations Act.
249 (2000) 35 ACSR 172. 250 [1993] BCLC 106; [1993] BCLC 1490. 251 Switch Telecommunications (2000) 35 ACSR 172 at 174. 252 (2000) 35 ACSR 172.
9 CONTRIBUTION AND POOLING: THE CASAC RECOMMENDATIONS FOR A MODIFIED NEW ZEALAND MODEL
9.1 Background 318
9.2 Harmer Report recommendations 320
9.2.1 Contribution 320
9.2.2 Pooling 323
9.3 Legislative provisions relating to contribution and 325 pooling in N e w Zealand
9.4 Case law on contribution in New Zealand 328
9.4.1 'Such other matters as the Court thinks fit' 328
9.4.2 'Just and equitable' 330
9.5 Case law on pooling in New Zealand 334
9.5.1 'As if they were one company' 334
9.5.2 'Just and equitable' 337
9.6 Evaluation of position of group creditors 341
9.6.1 CASAC recommendations 341
9.6.1.1 Contribution orders 341
9.6.1.2 Pooling orders 343
9.6.2 Critique of CAS AC recommendations 346
9.6.2.1 Uncertainty exists also in respect of pooling orders 346
9.6.2.2 Uncertainty exacerbated by confusing contribution and 348 pooling
9.6.2.3 Summary 351
9 CONTRIBUTION AND POOLING: THE
CASAC RECOMMENDATIONS FOR A
MODIFIED NEW ZEALAND MODEL
9.1 Background
Piercing of the corporate veil in terms of the general law has proved inadequate
to protect creditors in the event of the insolvency of one or more of the
companies forming part of a group.1 There are indications from the courts as
well as the legislature that they look favourably upon the adoption of an
enterprise approach in the context of directors' duties. However, this trend by
the courts has not been unequivocally accepted and the relevant statutory
provision, s 187 of the Corporations Act 2001 (Cth),2 was designed to protect
directors. Creditors are only protected indirectly by the proviso that the
solvency of the subsidiary should not be compromised. Various other statutory
measures have also been developed to circumvent the separate legal entity
principle in these circumstances. The most important of these measures are the
insolvent trading provisions contained in ss 588G and 588V of the
Corporations Act and discussed in Chapters 6 and 7 respectively. As appears
from those chapters, however, the insolvent trading provisions are not a
complete solution to the problem that creditors are inadequately protected in
corporate groups because of the application of the rule in Salomon v Salomon &
Co Ltd4
One of the measures closely linked to the insolvent trading provisions and
currently being resorted to in certain countries, notably N e w Zealand, is to
allow the court a discretion to make so-called 'contribution' and 'pooling'
1 See Ch 3. 2 (Corporations Act). 3 See Chh 4 and 5. 4 [1897] A C 22 (Salomon v Salomon).
319
orders in the case of related companies.5 A contribution order entails the
contribution of specific funds by a company not in liquidation to cover some or
all of the debts of a related company that is in the process of being wound up. A
pooling order involves the winding up of different insolvent related companies
as if they were one company. Like the insolvent trading provisions in s 588G of
the Corporations Act, these concepts are out of line with the separate legal
entity principle. They rather acknowledge enterprise liability, where little or no
respect is paid to the legal boundaries between separate companies within a
group.
In M a y 2000 C A S A C published its Corporate Groups Final Report,6 including
Chapter 6 on the liquidation of group companies. CASAC recommended, inter
alia, that the Corporations Law (now: Corporations Act) should not be
amended to introduce any court-ordered contribution power similar to the one
in New Zealand. CASAC recommended, however, that the then Corporations
Law should indeed be amended to allow the court to make pooling orders in the
liquidation of two or more companies along the lines of the New Zealand
pooling provisions. The recommendation by CASAC on pooling orders
involves making it clear that the rights of external secured creditors will not be
affected and that individual creditors will be allowed to bring an application to
have a pooling order adjusted so that their particular circumstances may be
taken into account. The recommendation on pooling orders states that such a
In Australia 'contribution' exists only in the form of the insolvent trading provisions contained in ss 588V-588X of the Corporations Act and 'pooling' has only been recognised indirectly: see
Ch8. 6 (Final Report).
Ibid, Recommendation 21. When the Corporations Law Amendment (Employee Entitlements) Act 2000 was introduced, the Opposition in the Senate moved an amendment to introduce a new s 588YA providing for contribution orders. However, this amendment was defeated in the House of Representatives and was not enacted as part of this Act. See further Ch 5 para 5.2.2 on the Corporations Law Amendment (Employee Entitlements) Act 2000. C A S A C Final Report, above n 6, Recommendation 23. C A S A C also recommended that
liquidators should be allowed to pool the unsecured assets and liabilities of two or more group companies in liquidation with the prior approval of all unsecured creditors (CASAC Final Report, above n 6, Recommendation 22) and that administrators be allowed to pool the administration of several companies, provided that no creditor who attends the creditors' meetings votes against the proposal or the court otherwise approves ( C A S A C Final Report, above n 6, Recommendation 20).
320
provision should be based on the draft provision in the Harmer Report.9 It is
therefore necessary to consider in more detail not only the N e w Zealand
provisions on contribution and pooling, but also the Harmer Report
recommendations.
9.2 Harmer Report recommendations
9.2.1 Contribution
Although as long ago as 1988 the Harmer Report recommended that an
approach to contribution similar to that in N e w Zealand should be followed, the
legislature in Australia has not gone quite so far in its efforts to protect
creditors. One of the recommendations of the Harmer Report in respect of
group consolidation was that the courts should have a wide discretion to make
an order that one company should contribute to the claims of a present or
former related company that is insolvent. This is known as a contribution order.
The courts could make such an order if it was 'satisfied that it is just'.11 The
Harmer Report recommended that this discretion of the courts should be based
on specified factors relating to the extent of control that the related company 1 0
had over the affairs of the insolvent one. These factors were:
• the extent to which the related company took part in the management of the
company;
• the conduct of the related company towards the creditors of the company;
and
• the extent to which the circumstances that gave rise to the winding up of the 1 T
company were attributable to the actions of the related company.
9 Australian Law Reform Commission (ALRC), Discussion Paper No 32 (1987) (AGPS, Canberra), and the A L R C Report, General Insolvency Inquiry, Report N o 45 (1988) (AGPS,
Canberra), (Harmer Report). 10 Ibid para 857. 11 Ibid paras 334-336. 12 Ibid. 13 Ibid para 335.
321
The recommendations by the Harmer Report were opposed by submissions,
principally by the L a w Council of Australia (Council),14 on the following four
grounds:
• Contradicting the separate entity principle
The Council said that it was a fundamental principle of company law that
separate companies were separate legal entities. However, as a matter of policy,
the A L R C saw no reasonable objection to the imposition of liability where a
holding company allowed its subsidiary to incur debts when the latter was
insolvent.15
• Interfering with project financing
The Council argued that financing for large resource and other projects needed
to be done on a limited recourse basis, but the ALRC's proposal would make it
impossible for a holding company to satisfy itself that it would not be liable for
the overall debts of the project. However, the A L R C argued that the fact that
creditors had entered into contracts on a limited recourse basis would be one of
the 'other relevant matters' to which the court was required to have regard.16
• Giving rise to uncertainty
The Council said that the wide discretion proposed for the court would be
undesirable, as it would create uncertainty in commercial dealings. Lenders
would be unable to determine the extent of the liabilities of a holding company
since the court could at a later date order the holding company to make good
the liabilities of any company in liquidation related to it. However, the A L R C
pointed out that lenders of the holding company of a group usually had regard
Ibid para 336. An extended insolvent trading provision was introduced instead: see Explanatory Memorandum to the Corporate Law Reform Bill 1992, paras 34, 1122-1135 and the Public Exposure Draft and Explanatory Paper to the Reform Act, para 1271. C A S A C Final Report, above n 6, para 6.42.
16 Ibid.
322
to its balance sheet and to the consolidated balance sheet of the group and
generally took cross-guarantees or other forms of intra-group security.17 The
A L R C therefore did not accept that its proposal would cause uncertainty.
Furthermore, the A L R C pointed out that liability for the debts of a subsidiary
outside a guarantee would only emerge in the event of the subsidiary's
liquidation.
• Complicating company accounts
The Council suggested that auditors and company directors would have
enormous difficulty in producing accounts that reflected a true and fair view of
the financial affairs of the holding company. However, the A L R C did not
recognise that accounting difficulties were of such magnitude that it would
discourage the imposition of liability on the holding company for allowing its
subsidiary to trade in insolvent circumstances.18
Because of the negative reaction, Parliament rejected the contribution order
proposals in the Harmer Report, which were not implemented in Australia in
their original form. One of the main reasons stated for the rejection was that the
wide discretion of the courts would create too much uncertainty. A s a result the
current regime differs significantly from the Harmer Report recommendations.
Eventually, the Harmer Report proposals relating to contribution were watered
down to the insolvent trading provisions now contained in sections 588V-588X
of t he Corporations A ct.I9 T hese p rovisions w ere discussed i n m ore d etail i n
Chapter 7.
In relation to c ontribution orders CASAC in its Final Report referred to one
commentator w h o suggested that the uncertainty problem and, consequently,
17 Ibid. It should be noted that, although lenders may have access to the financial statements of the group, other creditors of the holding company are not necessarily in this position. 18 C A S A C Final Report, above n 6, para 6.42. 19 See Explanatory Memorandum to the Corporate Law Reform Bill 1992, paras 34, 1122-1135 and the Public Exposure Draft and Explanatory Paper to the Reform Act, para 1271.
323
also the project financing difficulty, could be circumvented. This
commentator suggested that an explicit exception should be introduced to the
court's power to make a contribution order, limiting a creditor's claims to a
nominated company or c ompanies forming part of the group. The suggestion
was that this exception should be invoked in circumstances where the financial
affairs of those group companies had been managed in such a way that their
assets and 1 iabilities w ere c ompletely separated from those o f the rest o f the
companies forming part of the group. The exception should only apply where
the separation was sufficiently documented to allow a liquidator to trace the
assets involved. The commentator was of the view that the problem of
complicated company accounts could also be solved. This could be done by
spelling out the extent of the potential liability of one group company for the
debts of another.
The commentator's recommendation, if adopted, would mean that, in the
context of the liquidation of a corporate group, the separate legal entity
principle w ould i n e ffect h ave t o b e ' purchased' b y a dopting a r ule o f i ntra-
group financial segregation and accounting.21 In other words, the separate legal
entity principle would not automatically apply in corporate groups, as is
currently the case.22 Rather, the abandonment of limited liability would serve as
a quid pro quo for the privilege of being able to operate as part of a corporate
group. Limited liability would have to be 'deserved' before it would apply to
corporate groups. A n express adoption of a rule of intra-group financial
segregation was required before limited liability would apply to a corporate
group.23
9.2.2 Pooling
Another recommendation in the Harmer Report in respect of group
consolidation was that the courts should have the discretion in certain
C A S A C Final Report, above n 6, para 6.43.
Ibid. See further R P Austin, 'Corporate Groups' in R Grantham and C Rickett (eds), Corporate Personality in the 20th Century (1998) at 86-87. The default rule would no longer be limited liability.
324
circumstances t o o rder t hat r elated companies b e w ound u p j ointly.24 T his i s
known as a pooling order. The A L R C proposed that the court should be able to
make such an order in two situations. The first is where is where it appears to
be 'justifiable' to hold one company liable for the debts of a related company.
In this regard the court had to have regard to the same three factors proposed
for contribution orders, namely:25
• the extent to which the related company took part in the management of the
company;
• the conduct of the related company towards the creditors of the company;
and
• the extent to which the circumstances that gave rise to the winding up of the
company were attributable to the actions of the related company.
The second situation where the court should be allowed to make a pooling order
is w here t he b usinesses of t he c ompanies h ave been i ntermingled t o s uch a n
extent that it is convenient from an administrative point of view to wind up the
companies as one. 6
There was no opposition from the A L R C to the pooling proposal. Strangely
enough, however, this recommendation in respect of pooling orders was
omitted entirely from the Corporate Law Reform Act 1992 as well as the
Exposure Draft. Moreover, no explanation was proffered as to why this had
been omitted. One explanation for this omission could be that the so-called
'Hooker amendments' already addressed this problem, at least to some extent.28
23 See further C h 10 para 10.2. 24 Harmer Report, above n 9, para 857. This is similar to the pooling provision in N e w Zealand
discussed in para 9.3 below. 25 Discussion Paper N o 32, above n 9, para 564-5 and Harmer Report, above n 9, para 854-7. Again, this is similar to the N e w Zealand provision. 26 Harmer Report, above n 9, para 855. It may be argued that convenience is too weak a test, and that expediency, difficulty or impracticability would be more appropriate. See, eg, s 89 of
the Trustees Act 1962 ( W A ) . 7 Harmer Report, above n 9, vol 1, para 857. 28 The Hooker amendments (sections 411 (IA), (IB) and (1C) of the Corporations Act) were implemented as a result of the collapse of the Hooker Group of companies. Under these amendments the court has the discretion to order a consolidated meeting of all the group creditors, so that a scheme of arrangement or compromise/arrangement between the group companies and their creditors can be approved. The assets and liabilities of all the group companies are consolidated into the holding company, with the effect that the creditors of the
subsidiaries are treated as creditors of the holding company.
325
Another explanation could be that it was more pressing to reform the area of
insolvent trading than any other area of corporate law, and that it therefore
29
enjoyed priority. Neither of these explanations is convincing.
9.3 Legislative provisions relating to contribution and
pooling in N e w Zealand
The enactment of the contribution and pooling provisions in New Zealand was
the result of recommendations by the MacArthur Report.30 It is interesting to
note that this Report did not analyse the position in detail. It only vaguely
pointed out the problems that could arise where a holding company decided to
abandon its subsidiary. Yet without further discussion or explanation, it
recommended that the court should be granted the power to order that the
holding company should pay all or part of the liabilities of the subsidiary
company to the latter's creditors, or that the holding company and subsidiary
should be wound up as one.31
As a result of the MacArthur Report substantial amendments were made to the
then Companies Act 1955 (NZ) in 1980. Courts were given extensive
discretionary powers regarding the contribution and pooling of assets of related
companies in liquidation. Section 30 of the Companies Amendment Act 1980
(NZ) inserted ss 315A, 315B and 315C into the Companies Act 1955 (NZ),
which became effective on 1 April 1981. Subsequently these provisions were
re-enacted to become sections 245 to 246 of the Companies Act 1955 (NZ) (as
amended in 1993), before current sections 271 to 272 of the Companies Act
1993 (NZ) superseded them.
See further A Nolan, 'The Position of Unsecured Creditors of Corporate Groups: Towards a Group Responsibility Solution Which Gives Fairness and Equity a Role' (1993) 11 C&SLJ 461 at 494. 30 Report on the Reform of Companies (MacArthur Chairman) (1977) (MacArthur Report) para 405. 31 Ibid.
326
Central to liability under these provisions is the concept of a 'related' company.
The definition of 'related' in the Companies Act 1993 (NZ) includes reference
to the definitions of holding company and subsidiary, and to the holding of
majority shares. This is also the position under the Corporations Act. The
concept of 'related companies' in the Companies Act 1993 (NZ), however, is
wider than the definition of a 'related body corporate' in s 9 of the
Corporations Act since the N e w Zealand definition includes the situation where
the businesses have in fact been intermingled. Section 2(3) of the Companies
Act 1993 (NZ) defines 'related' in this context and reads as follows:
A company is related to another if: a The other company is its holding company or subsidiary; or b More than half of the issued shares of the company, other than shares that carry no right to participate beyond a specified amount in a distribution of either profits or capital, is held by the other company and companies related to that other company (whether directly or indirectly, but other than in a fiduciary capacity); or c More than half of the issued shares, other than shares that carry no right to participate beyond a specified amount in a distribution of either profits or capital, of each of them is held by members of the other (whether directly or indirectly, but other than in a fiduciary capacity); or d The business of the companies have been so carried on that the separate business of each company, or a substantial part of it, is not readily identifiable; or e There is another company to which both companies are related; -and 'related company' has a corresponding meaning.
Pursuant to s ections 2 71 and 2 72 o f the Companies Act 1993 (NZ) the New
Zealand courts have a wide discretion to deal with related companies as soon as
at least one of them goes insolvent. In exercising its discretion the court may
make an order that a (solvent) related company should contribute to the assets
available for winding up. In this regard s 271(l)(a) provides that the liquidator,
a creditor or a shareholder may apply to court for an order that a related
company should pay to the liquidator the whole or a part of any claim made
against a company in liquidation. Any contribution payment must, however, go
to the liquidator to use in meeting the overall debts of the company, and not to
the creditor or shareholder who instituted the proceedings. Alternatively, the
court may make a pooling order that the liquidations of two or more companies
proceed together as if they were one company. In this regard s 271(l)(b)
provides that, where two or more related companies are in liquidation, the
liquidator, a creditor or a shareholder may apply to the court for a pooling
327
order.3 Section 271(l)(a) and (b) of the Companies Act 1993 (NZ) reads as
follows:
Pooling of assets of related companies -
(1) O n the application of the liquidator, or a creditor or shareholder, the Court, if satisfied that it is just and equitable to do so, may order that -(a) a company that is, or has been, related to the company in liquidation must
pay to the liquidator the whole or part of any or all of the claims made in the
liquidation; (b) where two or more related companies are in liquidation, the liquidations in
respect of each company must proceed together as if they were one company to the extent that the Court so orders and subject to such terms and conditions as the Court may impose.
The court may, if it is satisfied that it is 'just and equitable' to do so, make a
contribution or a pooling order, as appropriate. Guidelines for orders under s
271 are set out in s 272 of the Companies Act 1993 (NZ). The matters to which
the court is required to have regard are essentially the same as those referred to
by the Cork Report.33 The mere fact that creditors of a company in liquidation
relied on the fact that another company is or was related to the company in
liquidation is, however, not a sufficient ground upon which a court will grant a
contribution order.34 In deciding whether it is just and equitable to make a
contribution order under s 271(l)(a), the court is required in terms of s 272(1)
of the Companies Act 1993 (NZ) to consider the following factors:
(a) the extent to which the related company took part in the management of the company in liquidation; (b) the conduct of the related company towards the creditors of the company in liquidation;
(c) the extent to which the circumstances that gave rise to the liquidation of the company are attributable to the actions of the related company; (d) such other matters as the Court thinks fit.
Very similar considerations play a role when the court has to determine whether
it is just and equitable to make a pooling order under s 271(l)(b). As with
contribution orders, the mere fact that creditors of a company in liquidation
These are the same parties as the ones that may apply for a contribution order pursuant to s 271(l)(a) of the Companies Act 1993 (NZ). 3 United Kingdom: Report of the UK Review Committee on Insolvency Law and Practice, chaired by Sir Kenneth Cork, C m n d 8558 (1982) (Cork Report). See further S Whelan, 'Administration of insolvent groups - the present state of 'pooling" (1998) 6 Insol Law Jnl 107 at 109.
328
relied on the fact that another company - also in liquidation - is or was related
to the company in liquidation, is not a sufficient ground upon which a court will
grant a pooling order.35 In deciding whether it is just and equitable to make a
pooling order under s 271(l)(b), the court is required in terms of s 272(2) of the
Companies Act 1993 (NZ) to consider the following factors:
(a) the extent to which any of the companies took part in the management of the other companies;
(b) the conduct of any of the companies towards the creditors of any of the other companies;
(c) the extent to which the circumstances that gave rise to the liquidation of any of the companies are attributable to the actions of any of the other companies; (d) the extent to which the businesses of the companies have been combined; (e) such other matters as the Court thinks fit.
9.4 Case law on contribution in New Zealand
The fact that the New Zealand provisions are discretionary makes the case law
interpreting these provisions of importance. It is also of particular importance
for purposes of this thesis since it would throw some light on the possible
impact of the C A S A C recommendations. There is, however, scant authority on
even the basic ambit of the N e w Zealand provisions relating to contribution and
pooling. In particular, the N e w Zealand courts have had little opportunity so far
to analyse the provisions dealing with contribution orders. The cases where the
N e w Zealand courts have considered the interpretation of particular phrases
contained in the provisions on contribution and pooling are discussed below in
this paragraph 9.4 and paragraph 9.5 respectively.
9.4.1 'Such other matters as the Court thinks fit'
Reconciling the interests of two sets of unsecured creditors who have dealt with
separate companies seems to be one of the main problems faced by the courts in
34 Section 272(3) of the Companies Act 1993 (NZ).
329
deciding whether to make a contribution order. In this regard Farrar set out
the problem succinctly:37
If the contribution sought from a related company threatens that company's solvency, then the court must consider the equities involved affecting the creditors of that company. These creditors will rely on arguments that they have relied on the separate assets of the company when trading with it and should not be denied a full payout because of that company's relationship with another
company.
The question whether contribution would be allowed if it threatened the
solvency of the related company arose in two cases where the phrase 'such
other matters as the Court thinks fit' had to be interpreted. Both these decisions
were interlocutory in nature. In Re Liardet Holdings Ltd the court stated that it
was questionable whether a contribution order could be made under these
circumstances. O n the facts nothing would have been available to other
claimants after the company had paid its own creditors. This was also the view
adopted subsequently in Lewis v Poultry Processors?9 where Tipping J
commented in respect of the predecessor of s 271 and s 272 of the Companies
Act 1993 (NZ) as follows:40
I doubt very much whether sec 315A is intended to prejudice the position of bona fide unsecured creditors of the related company. If the related company is fully solvent then obviously this sort of problem will not arise. The contrast between sec 315A and 315B suggests that under sec 315A any order made will only run against the balance of assets in the related company's hands after it has satisfied its own bona fide indebtedness.
Thus, in balancing the equities of two sets of creditors who have dealt with two
separate companies, the N e w Zealand courts have held that an order for full
contribution m a y be inappropriate if such an order would place in jeopardy the
solvency of the related company not in liquidation. It follows that in N e w
Zealand a contribution order may only be levied against the balance of the
C A S A C Final Report, above n 6, para 6.38-6.39.
J Farrar, 'Legal issues involving corporate groups' (1998) 16 C&SLJ 184 at 197. (1983) B C R 604.
(1988) 4 N Z C L C 64,508. Ibid 64,513.
330
solvent company's assets after it had paid its own bona fide creditors. This
point is discussed further in Chapter 10 in the Australian context.41
9.4.2 'Just and equitable'
A rare instance for the court to exercise its power to make a contribution order
arose in Rea v Barker,42 where the meaning of the phrase 'just and equitable'
was considered by the High Court of N e w Zealand. Altherm Aluminium
(Auckland) Limited (in liq) (Altherm Auckland) and Altherm Aluminium
(Waikato) Limited (Altherm Waikato) w ere related c ompanies holding rights
under a franchise agreement to deal with aluminium products under the name
'Altherm'. Both companies manufactured the same goods. W h e n Altherm
Auckland w ent i nto 1 iquidation, i ts liquidators j oined A ltherm W aikato i n an
action for relief pursuant to the then s 315A of the Companies Act 1955 (NZ)
requiring the latter to contribute to the debts of Altherm Auckland.43 The
liquidators alleged that a contribution order was just and equitable in terms of
the then s 315C of the Companies Act 1955 (NZ), on two grounds.
The first ground relied on by the liquidators was that Altherm Waikato
procured Altherm Auckland to transfer to it orders for work without payment to
Altherm Auckland, when Altherm Waikato must have known that Altherm
Auckland could not afford to do so. The second ground relied on by them was
that, after Altherm Auckland had been liquidated, Altherm Waikato refused to
purchase t he aluminium s tock (that c ould b e u sed o nly i n A ltherm p roducts)
held by Altherm Auckland. The stock was effectively valueless unless Altherm
Waikato bought it, although there was no contractual obligation on the latter to
do so. Altherm Waikato applied to be struck out of the proceedings.
The question that arose was whether there was an arguable case that a
contribution order should be made. In other words, the issue was whether proof
41 See Ch 10 para 10.2.4. 42 (1988) 4 NZCLC 64,312. 43 Section 315A of the Companies Act 1993 (NZ) was the predecessor of s 271(l)(a) of the
Companies Act 1993 (NZ).
331
of the facts alleged in the statement of claim would entitle the liquidators to an
order that Altherm Waikato should contribute to the debts of Altherm
Auckland. Tompkins J dismissed the application by Altherm Waikato to be
struck out of the proceedings. The High Court of N e w Zealand found that on
both grounds put forward by the liquidators Altherm Waikato could be rendered
liable to contribute to the assets of Altherm Auckland in its winding up. This
was because the conduct of Altherm Waikato could, arguably, be seen as
possible detrimental conduct towards the creditors of Altherm Auckland.
The decision in Rea v Barker44 has been severely criticised, and described as
probably at the outer limit of circumstances in which a contribution order will
be made. 5 The High Court had made a contribution order on rather weak
grounds.46 There was nothing to indicate that, if Altherm Waikato had rejected
the orders for work, Altherm Auckland would have been able to reduce its
debts. It could be argued that the provisions were applied in a way that went far
beyond the legitimate interests of creditors of the insolvent company. This
resulted in an uneven b alance as far as the shareholders and creditors o f the
solvent companies in the group were concerned.47 The facts did not justify the
granting of a contribution order.
The provisions of s 271(l)(a) of the Companies Act 1993 (NZ) were considered
for the first time in HEB Contractors Ltd v Westbrook Development Ltd.4* H E B
Contractors successfully tendered to complete certain subdivision work for
Westbrook Development Ltd (Westbrook Development). After the tender had
been accepted, a second set of tender documents was issued to H E B
Contractors in the name of Westbrook Heights Ltd (Westbrook Heights) rather
than Westbrook Development. H E B Contractors did not notice the change of
44 (1988) 4 NZCLC 64,312. See, eg, A Borrowdale, 'Commentary on Austin' in R Grantham and C Rickett (eds),
Corporate Personality in the 20th Century (1998) at 96-97. 46 See J Farrar, 'Insolvency and Corporate Groups' C L E 1992, University of Sydney, Faculty of Law, 13 March 1992, at 29-33, who states that this judgment may perhaps be explained on the basis that only an 'arguable' case is required in a striking out application.
See, in this regard, J O'Donovan, 'Grouped therapies for group insolvencies' in M Gillooly (ed), The Law Relating to Corporate Groups (1993) 46 at 88. 48 (2000) 8 N Z C L C 262, 256 (HEB Contractors v Westbrook).
332
name when it executed the final documents. H E B Contractors carried out the
work on property owned by Westbrook Development. Westbrook Development
made certain progress payments due under the contract between H E B
Contractors and Westbrook Heights, but failed to pay all the amounts due under
the contract.
HEB Contractors obtained judgment against Westbrook Heights and had the
latter placed in liquidation. Westbrook Heights, however, had no assets. H E B
Contractors sought an order pursuant to s 271(l)(a) that Westbrook
Development should pay to the liquidator of Westbrook Heights moneys
outstanding to H E B Contractors pursuant to its contract with Westbrook
Heights. Salmon J accepted on the evidence available that Westbrook
Development and Westbrook Heights were 'related companies' as defined in s
2(3) of the Companies Act 1993 (NZ).49
In considering whether it was just and equitable to make a contribution order,
the court had regard to the guidelines set out in s 272 of the Companies Act
1993 (NZ). The first guideline considered was the extent to which the related
company, Westbrook Development, took part in the management of the
company in liquidation, Westbrook Heights. Salmon J accepted that Westbrook
Heights had no separate identity. Westbrook Heights, despite being the
contracting party, played no role in the subdivision work. Salmon J found that
Westbrook Development had effectively assumed responsibility for Westbrook
Height's obligations under its contract with H E B Contractors. His Honour also
found that Westbrook Development received all the benefits from the
subdivision work completed by H E B Contractors.50
The second guideline that the court considered was the conduct of the related
company, Westbrook Development, towards the creditors of the company in
liquidation, Westbrook Heights. H E B Contractors was the only creditor of
Ibid 262,259.
333
Westbrook Heights. Salmon J accepted that the following four areas of conduct
were relevant:
• Westbrook Development received the benefit of Westbrook Heights'
contract with H E B Contractors but denied liability for it;
• the conduct of Westbrook Development in forwarding the documents
without g iving a ny i ndication t hat t he n ame o f the c ontracting p arty h ad
been changed or giving any reason as to w h y that was so;
• Westbrook Development, by its conduct, had adopted the contract and
requested that invoices be sent to it or another related company51 - this
induced H E B Contractors to continue with its performance of the contract;
• the directors of Westbrook Development transferred other assets relevant to
the work carried out by H E B Contractors to other companies in which they
had interests, rather than to Westbrook Heights, without disclosure to H E B
Contractors.52
The third guideline taken into account by the court in determining whether a
contribution o rder w ould b e ' just a nd e quitable' w as t he e xtent t o w hich t he
circumstances that gave rise to the liquidation of Westbrook Heights were
attributable to the actions of Westbrook Development, the related company.
Since Westbrook Development managed Westbrook Heights' contract with
H E B Contractors, its failure to fund Westbrook Heights so that it could meet its
obligations to H E B Contractors amounted to circumstances that gave rise to the
liquidation and which were attributable to the actions of Westbrook
Development.
The final guideline that the court took into account was 'such other matters as
the court thinks fit'. The court accepted that Westbrook Development obtained
the benefits of the improvements to the land resulting from the contract, and
that Westbrook Development had been unjustly enriched at the expense of H E B
Contractors. It also accepted that the actions of Westbrook Development gave
51 Ibid 262,260. 52 Ibid. 53 Ibid.
334
the impression of acceptance of liability under the contract between Westbrook
Heights and H E B Contractors. This, in turn, encouraged H E B Contractors to
continue with the subdivision work.54
Although the decision in HEB Contractors v Westbrook55 provides a useful
example of the type of conduct that will cause a N e w Zealand court to make a
contribution order under s 271(l)(a) of the Companies Act 1993 (NZ), it
provides no real analysis of this section. It is noteworthy that application was in
effect made for a contribution order and not a pooling order, as stated in the
head-note to the case report. In a pooling order the liquidations of two or more
related companies proceed together, as if they were one company.56 In this case
only one company was liquidated. The confusion in terminology is rendered
worse by the use of the current heading of s 271 of the Companies Act 1993
(NZ), namely, 'Pooling of assets of related companies', followed by paragraph
(b) of s 271(1) that deals with pooling, as well as paragraph (a) of s 271(1) that
deals with contribution. The relevance of the confusion between the terms
'pooling' and 'contribution' is discussed in paragraph 9.6.2.2 below.
9.5 Case law on pooling in New Zealand
9.5.1 'As if they were one company'
In the context of a pooling order the phrase 'as if they were one company' was
considered in Re Grazing and Export Meat Co,51 where various banks held
debentures over the assets of related companies. This phrase was held to mean
that, after the claims of secured creditors of each group company had been
satisfied, all the remaining assets of the companies under consideration would
form a common pool that could potentially satisfy the claims of unsecured
creditors. A se cured c reditor w hose s ecurity o ver t he a ssets o f c ertain of t he
companies had become valueless was therefore entitled to share in the common
"Ibid. 55 (2000) 8 NZCLC 262, 256. 56 Section 271(l)(b) of the Companies Act 1993 (NZ).
335
pool as an unsecured creditor. Incidentally, it should be noted that this case
arose under the provisions of the Companies (Special Investigations) Act 1958
(NZ) and not the Companies Act 1993 (NZ), but the principle laid down
remains the same.
The meaning of winding up corporate group companies 'as if they were one
company' was also considered in Re Dalhoffand King Holdings Ltd, this time
dealing in detail with the pooling provisions under the then s 315B of the
Companies Act 1955 (NZ).60 The liquidators of three related companies in
liquidation applied to court for pooling orders pursuant to this s ection, s ince
they wished to wind up the companies 'as if they were one company'. A major
shareholder of one of the companies opposed the application. Without the
pooling orders the shareholders of this particular company would receive 28
cents in the dollar as dividend, whereas they would receive nothing in the event
of the assets of all three related companies being pooled.
Although these shareholders would be detrimentally affected by winding up the
companies together and pooling their assets, doing so would improve the
position of the unsecured creditors. Gallen J pointed out that, in respect of an
insolvent company, the rights of creditors generally tended to be of more
importance than the rights of shareholders.61 It was therefore important to
ensure that shareholders did not benefit at the expense of creditors. His Honour
found that it was significant that the creditors in this case would be in a better
position if a pooling order were made and held that the companies should be
wound up together.62
"(1984) 2 NZCLC 99,226. 58 See further RS Nathan, 'Controlling the puppeteers: reform of parent-subsidiary law in New Zealand' (1986) 3 Canterbury L Rev 1 at 15-19. 59 [1991] 2 NZLR 296 (Re Dalhoff). 60 Section 315B of the Companies Act 1955 (NZ)was the predecessor of s 271(l)(b) of the Companies Act (1993) NZ. 61 See further Ch 5 para 5.3. 52 Re Dalhoff [1991] 2 NZLR 296 at 309.
336
A creditor of one of the companies in Re Dalhoff3 argued that an inter
company guarantee that it obtained should be kept intact in the event of a
pooling order being granted. The creditor did not oppose the making of a
pooling order, but argued that it should be made subject to a condition that the
order did not affect the rights that it claimed in respect of two of the group
companies. This would enable the creditor to prove in the liquidation of both
companies involved, up to 100 cents in the dollar. Gallen J rejected this
argument, stating that under a pooling order the obligations as well as the assets
of the related companies were merged.64 It would be incongruous to allow the
creditor to enforce the guarantee, as this implied that, despite the pooling order,
the separate legal identity of two of the companies in the group had been
maintained. Gallen J held that the creditor with the inter-company guarantee
was in the same position as the unsecured creditors.65
On this point the decision in Re Dalhoff6 cannot easily be reconciled with that
in Re Stewart Timber & Hardware (Whangarei) Ltd (in liq) v Stewart Timber &
Hardware Ltd (in liq). 7 In Re Stewart Timber & Hardware6* Doogue J rejected
the liquidators' argument that the order granted by the court to pool the assets
of the related companies also had the effect of pooling their liabilities.69 In
practice the courts have resolved the issue by accepting that pooling can be
interpreted both ways - it m a y include only assets, but it m a y also be
interpreted liberally to include liabilities. It has been suggested, with respect,
correctly, that more certainty will be obtained regarding the meaning of being
wound up as one company if a pooling order entails the pooling of both assets
63 [1991] 2 N Z L R 296. 64 Ibid 311. 65 Ibid. Farrar, 'Legal issues involving corporate groups', above n 37, 197-198 pointed out that it is arguable that it would be inequitable, as a diligent creditor is not rewarded for obtaining additional security and is treated the same as creditors who were not as diligent in arranging then affairs. Cf the decisions in AE Goodwin Ltd v AG Healing Ltd (1979) 7 A C L R 481 and Brown v Cork [1985] B C L C 363 discussed in Ch 8 para 8.3.2.1. 66 [1991] 2 N Z L R 296. 67 (1991) 5 N Z C L C 67,137 (Re Stewart Timber & Hardware). 68 (1991) 5 N Z C L C 67,137. 69 Ibid 67,142. 70 See Farrar, 'Legal issues involving corporate groups', above n 37, 197-198.
337
and liabilities, except in so far as the court lays down conditions to the no
contrary.71 At the same time an equivalent amount of flexibility is retained.
9.5.2 'Just and equitable'
Re Pacific Syndicates (NZ) Ltd (in liq)13 illustrates the usefulness of the court's
power to make a pooling order, and under what circumstances the court will
consider it 'just and equitable' to do so.74 T w o related investment companies
requested funds for contributory mortgages. They set up two contributory
mortgage schemes but failed to incorporate nominee companies to act as
trustees for the scheme investors. The money paid under each of the schemes
was deposited into the same bank account. A director of one of the companies
was granted a mortgage as security for money borrowed from that company's
bank account. The director declared that he held the mortgage on behalf of the
investors in the scheme.
When the companies instituted action for misappropriation of money, a global
sum was paid in settlement of the amount owed. The liquidator of the
companies successfully obtained a pooling order under the provisions of the
then s 315B of the Companies Act 1955 (NZ) for the proceeds of the settlement,
as it was not feasible to apportion the fund between the two companies. All
the parties, creditors and liquidators alike, agreed that pooling w as desirable.
This was a clear case for pooling on the ground that it was impossible to
separate the affairs of the two companies in liquidation. Hardie Boys J
described s 315B of the Companies Act 1955 (NZ) as a valuable remedial
measure designed to facilitate the task of liquidation and the general interests of
72 Ibid. 73 (1989) 4 N Z C L C 64,757 (Re Pacific Syndicates) at 64,767-64,768. 74 CfBullen v Tourcorp Developments Ltd (1988) 4 N Z C L C 64,661 where the court ordered the receivers of one company to be appointed receivers and managers of two related companies, in order to effect an orderly realisation of the assets of each of the companies involved. 75 The claims of the investors in the two companies were thus treated together.
338
all concerned. His Honour justified the making of the order in the following
terms:77
First, there is the pooling of investors' funds in the one account. Secondly, there is the complex and possibly arguable situation of inter-company debt. Thirdly, and related to it, is the intertwined liability of the companies to investors ... Fourthly, there is the impossibility of dividing the Cattle Syndicates fund between the two companies. Fifthly, there is yet another fund which has finally come into the hands of the liquidator, subject to the Court's approval of a compromise ... Sixthly, the investigating accountant has expressed the view that it would be equitable to allocate any final dividend pro rata between all creditors of both companies. If the liquidator were permitted to do this, this protracted liquidation would be brought to a prompt conclusion without further expenditure on what are likely to be futile accounting and legal exercises...
The court in Re Dalhoff* also considered the phrase 'just and equitable' in the
context of a pooling order.79 Gallen J looked at each of the factors set out in the
then s 315C(2) of the Companies Act 1955 (NZ) seriatim,80 although his
Honour acknowledged that it was also necessary to consider the circumstances
as a whole in determining whether it was 'just and equitable' to make the
order.81
'Intermingled management'
The first factor that Gallen J considered was 'intermingled management', or the
extent to which the companies took part in the management of one another.
The evidence revealed that no separate board meetings were held for the
respective companies. Instead, each company's affairs were discussed at one
big 'jubilee' meeting.83 There was no formal closing of a meeting in respect of
one company before the discussion commenced in respect of the following
76 Re Pacific Syndicates (1989) 4 N Z C L C 64,757 at 64,767. 77 Ibid 64,161-64,168. 78 [1991] 2 N Z L R 296. 79 The phrase 'just and equitable' was also considered in Re Home Loans Fund (NZ) Ltd (in group liq) (1983) 1 N Z C L C 95,073 in the context of the Companies (Special Investigations) Act 1958 (NZ). Casey J said at 95,583: 'I think Parliament intended the Court to have the broadest discretion to effect a result which accords with common notions of fairness in all the circumstances, bearing in mind the cardinal principle underlying insolvency administration, that
there should be equality among creditors of the same standing'. 80 The provisions of former s 315C(2) of the Companies Act 1955 (NZ) corresponded with the
provisions of current s 272(2) of the Companies Act 1993 (NZ). 81 Re Dalhoff'[1991] 2 N Z L R 296 at 308. 82 Ibid301.
339
issue relating to one of the other companies.84 Also, there were cross-
directorships to the extent that the directors and secretaries of all three
companies were in essence the same.85 Furthermore, the three companies had
one bank account and were managed substantially as one entity, with
management seeing no particular reason to differentiate between the affairs of
the respective companies.86 Gallen J found the factor of 'intermingled
management' to be a significant but not decisive consideration in assisting
creditors w h o did not single out the particular company with which they had
dealt.
• 'Conduct towards creditors'
The second factor that Gallen J took into account was the conduct of any group
company towards the creditors of any of the other companies. This
consideration was mainly the extent of the confusion of creditors regarding the
particular company that they had dealt with. Gallen J found that the confusion R7
was only partly due to conduct on the side of the companies. Although, on
their own, particular instances of confusion would not be significant, combined
they constituted conduct on the part of the companies that gave rise to concerns QQ
under the pooling provisions. Gallen J found that, in order to justify the
contention that the actions of the company had been such towards its creditors
as to give rise to confusion and to mislead, one had to consider the number of
people confused rather than the amount involved in the confusion.89 It was held
to be a decisive consideration that the companies had induced confusion among
creditors regarding the identity of the company with which they had dealt and
that they had induced the creditors to treat the group of companies as one and to
rely on the group. Because the legal boundaries of the companies were
Ibid. Ibid 301-302. Ibid 302. Ibid 302-303. Ibid 303. /ta/303-304.
340
confused and management encouraged them to treat the group of companies as
one, the creditors were allowed to expect to rely on the assets of the group.90
• 'Actions of one leading to the winding up of another'
The next factor that Gallen J considered was the extent to which the
circumstances that gave rise to the winding up of any of the companies were
attributable to any of the other companies.91 His Honour found that, regardless
of whether it was from interlocking accounting systems, interlocking financial
arrangements or interlocking managements, as a matter of fact the three
companies stood or fell together.92 It appears to have been accepted by the
parties that the failure of one of the companies would cause the failure of the
other two. Gallen J found that, although it was not clear that the action of one
company gave rise to the liquidity problems of one or both of the other
companies, 'as a matter of c o m m o n sense it would seem likely that there must
have been at least some element of this'.93
• 'Intermingled business'
Gallen J also considered the extent to which the businesses of the companies
had been intermingled.94 It appears that creditors did not know about the
separate identities of the companies and also that some confusion existed
among shareholders.95 Apart from the similarities in the names of the three
companies, there were other aspects of significance such as the fact that it was
impossible to ascertain in some cases which companies owned what assets.
This formed part of a general pattern of management, apparently using
whichever company was suitable - as the occasion demanded - to carry out
™ Ibid 305. 91 Ibid. 92 Ibid. 93 Ibid. 94 Ibid. 95 It is interesting to note that Gallen J discussed 'intermingled business' and 'conduct towards creditors' simultaneously - this might be an indication that these two factors belong together.
See the discussion in para 9.6.2.3 below.
341
activities, whether or not the particular company was legally entitled to carry
out such activity.96
• 'Such other matters as the Court thinks fit'
Finally, Gallen J considered the meaning of the phrase 'such other matters as
the Court thinks fit'. A n important factor to be taken into account here was the
situation relating to the inter-company debts between the different group
companies.97 The inter-company debts in this matter were substantial and at
least some of them had arisen as a result of the failure to segregate the activities
of the separate companies and to keep proper record of the transactions among
them. A s a result, considerable doubt existed regarding the validity of the inter-
group transactions or whether particular transactions should be attributed to one
or another of them. This could have a large impact on the amounts available
for distribution in the separate companies at the end of the day.99 In the absence
of a pooling order, legal proceedings would have to be instituted to determine
accurately amounts owing. The result would be that funds that could be used
for distribution to creditors would have to be used to pay for legal costs.100
9.6 Evaluation of position of group creditors
9.6.1 CASAC recommendations
9.6.1.1 Contribution orders
Regarding contribution orders, CASAC in its Final Report101 referred to the
position in N e w Zealand only, because the United States and United Kingdom
96 Re Dalhoff [1991] 2 N Z L R 296 at 306. 57 Ibid. See further the discussion of AE Goodwin Ltd v AG Healing Ltd (1979) 7 A C L R 481 and Brown v Cork [1985] B C L C 363 in the context of inter-company debts in Ch 8 para 8.3.2.1. 98 Re Dalhoff [1991] 2 N Z L R 296 at 306-307. 99 Ibid. 100 Ibid. It should be noted that Hardie Boys J in Re Pacific Syndicates (1989) 4 N Z C L C 64,757 at 64,768 also considered this factor to be relevant in justifying the making of a pooling order. See the quotation earlier in this para 9.5.2. 101 Above n 6.
342
have no equivalent of contribution orders.102 CASAC pointed out that, before
New Zealand courts make a contribution order against a related company not in
liquidation, they have to be satisfied that it was 'just and equitable' to do so.103
To determine whether a contribution order was 'just and equitable' for purposes
of c ontribution, t he c ourt h ad t o t ake i nto a ccount t he factors a s s et o ut i n s
272(1) of the Companies Act 1993 (NZ).104
In its Draft Recommendation 21 CASAC stated that the court should not have a
general power to make contribution orders. In stating this, CASAC took into
account the impact such power would have on the separate legal entity
principle, the uncertainty in applying it, and the possible effect thereof on
project financing, especially for limited or non-recourse financing.105 The
question remained whether specific contribution orders should be introduced on
public p olicy grounds i n p articular c ircumstances, for e xample, a s a p ossible
means of protecting employee entitlements on the insolvency of their employer,
a group company.106
In i ts r esponse t o t he s ubmissions r eceived o n D raft R ecommendation 21, i n
relation to contribution orders, C A S A C reiterated that it did not support a
general court contribution order power.107 As far as employee entitlements were
concerned, C A S A C did not consider it appropriate to recommend court
contribution orders for the benefit of employees in addition to other legislation
specifically tailored to address the issue of employee entitlements.108 C A S A C
C A S A C Final Report, above n 6, para 6.40. 103 Ibid para 6.36. 104 Ibid. See para 9.3 above for the factors set out in s 272(1) of the Companies Act 1993 (NZ). 105 C A S A C Final Report, above n 6, para 6.51. 106 Ibid para 6.53. 107 Ibid para 6.57.
Ibid para 6.59. In this regard C A S A C noted the proposals in the then Corporations Law Amendment (Employee Entitlements) Bill 2000 to extend the provisions of s 588G of the Corporations Act to uncommercial transactions. This Bill has subsequently been passed as the Corporations Law Amendment (Employee Entitlements) Act 2000 (Cth), and introduced the proposed s 596AB on entering into agreements or transactions with the intention of avoiding the payment of employee entitlements as part of Part 5.8A of the Corporations Act. See further Ch 5 para 5.2.2.
343
accordingly recommended that the Corporations Act should not be amended to
give the court power to make contribution orders.
9.6.1.2 Pooling orders
Regarding pooling orders, CASAC in its Final Report110 referred to the position
in N e w Zealand as well as that in the United States. In discussing the N e w
Zealand position, C A S A C pointed out that, before granting a pooling order,
N e w Z ealand courts had to be satisfied that it was 'just and equitable' to do
so.111 To determine whether a pooling order was 'just and equitable' for
purposes of pooling, the court had to take into account the factors as set out in s
272(2) of the Companies Act 1993 (NZ).112
When the factors to be taken into account by the court before a pooling order
will be granted in N e w Zealand are compared to those in the United States,
some overlap is apparent. In discussing the position on pooling orders in the
United States,113 C A S A C referred to Eastgroup Properties v Southern Motel
Association Ltd.114 In this case it was stated that such a remedy is available
where, on balance, 'creditors [will] suffer greater prejudice in the absence of
consolidation than the debtor [companies] (and any objecting creditors) will
suffer from its imposition'. C A S A C pointed out that the United States courts
have ordered pooling in the context of corporate groups in one of the following
two situations:115
(a) Intermingling, where the financial and business affairs of the group
companies in liquidation were intertwined to such an extent that a pooling order
would either be for the benefit for all unsecured creditors or would help in a
reorganisation of the group; or
CASAC Final Report, above n 6, Recommendation 21. 110Aboven6. 111 Ibid para 6.62. 112 See para 9.3 above for the factors set out in s 272(2) of the Companies Act 1993 (NZ).
In the United States pooling is known as 'substantive consolidation'. 114 935 F.2d 245(11th Cir.1991).
CASAC Final Report, above n 6, para 6.69.
344
(b) Reliance, where the unsecured creditors generally reasonably held, and
relied on, the expectation that they were transacting with the companies in the
group as a single economic entity, and did not rely on the fact that any one
company was a separate legal entity at the time when credit was extended to
it.116
In its Draft Recommendation 23 CASAC stated that the introduction of court-
ordered pooling, which would extend the current pragmatic exceptions to the
separate legal entity principle in the context of corporate groups, was
desirable.117 C A S A C conceded that pooling orders could have the effect of
prejudicing creditors of one group company in liquidation if such company had • MR
to 'contribute' ' to the debts of another group company that was also in
liquidation.119 In addressing this issue, however, C A S A C stated that such
'uncertainty problem' already existed under s 588V of the then Corporations 1 0(\
Law. C A S A C was of the view that a clearer balance of interests and reduced
uncertainty in pooling could be achieved by providing that:
• the rights of external secured creditors would not be affected by the pooling
order, and
• the court had a discretionary power to make provision that different
creditors of companies in liquidation receive different levels of return,
where appropriate.121
C A S A C was further of the view that the introduction of court-ordered pooling
could reduce the complexities of certain corporate group insolvencies and be
advantageous to unsecured creditors by providing better returns.122 Moreover,
C A S A C pointed out that pooling orders could be useful in the event of
116 Soviero v Franklin National Bank 328 F.2d 446 (2d Cir.1964), Chemical Bank NY Trust Co v Kheel 369 F.2d 845 (2d Cir. 1966). See also Re Augie Restivo Baking Company 860 F.2d 515
(1988). 117 C A S A C Final Report, above n 6, para 6.91. 118 This was an unfortunate choice of word by C A S A C , as it blurs the distinction between
contribution and pooling. See further the discussion in para 9.6.2.2 below. 119 C A S A C Final Report, above n 6, para 6.92. 120 Ibid. It is submitted that this is not an 'uncertainty problem', but rather an 'unfairness problem', since it is arbitrary by which entity the loss is bome in a particular case. See also the
discussion on fairness in Ch 10 para 10.2. 121 C A S A C Final Report, above n 6, para 6.93. 122 Ibid para 6.95.
345
international insolvencies involving jurisdictions that already permitted pooling
orders.123
The Council was one of two respondents that made submissions commenting
on Draft Recommendation 23. It was in favour of legislation adopting the
provisions proposed in the Harmer Report, subject to any amendments
considered appropriate in the light of any practical problems encountered by the
application of the N e w Zealand legislation. The original Harmer Report
recommendations are virtually identical to the provisions currently contained in
paragraphs (a) to (d) of s 272(2) of the Companies Act 1993 (NZ) (relating to
pooling). However, the Harmer Report does not contain an equivalent of the
provisions currently contained in paragraph (e) of s 272(2) of the Companies
Act 1993 (NZ). This paragraph refers to 'such other matters as the Court thinks
fit'. The Harmer Report contains another paragraph in lieu of par (e), namely
'the extent to which creditors of any of the companies might be advantaged or
disadvantaged by the making of a pooling order'.124
In response to the submissions received on Draft Recommendation 23, in
relation to court-ordered pooling orders,125 C A S A C stated that it continued to
support Draft Recommendation 23, which adopted the principles set out in the
Harmer Report.126 C A S A C accordingly recommended that the Corporations
Law (now: Corporations Act) should permit the court to make pooling orders in
the liquidation of two or more companies.127 It further recommended that such
power should be based on the draft provision in the Harmer Report and:
Ibid. This is true in so far as Australian creditors are concerned, but may not be enthusiastically accepted by foreign creditors. 124 Harmer Report, above n 9, paras 854-857.
In its response to the submissions on Draft Recommendation 22 C A S A C recommended that
the Corporations Law (now: Corporations Act) should permit liquidators, of their own motion, to pool the unsecured assets and the liabilities of two or more group companies in liquidation, where each of these companies had a total debt not exceeding $100,000, with the prior approval of all unsecured creditors: C A S A C Final Report, above n 6, Recommendation 22.
C A S A C Final Report, above n 6, para 6.97.
C A S A C did point out, however, that the effectiveness of court ordered pooling legislation would partly depend on consequential amendments to the taxation law, since, despite pooling, the resource of any net return would have to be traced back to each pooled company: C A S A C Final Report, above n 6, para 6.98.
346
• make it clear that pooling orders do not affect the rights of external secured
creditors, and
• permit individual external creditors to apply to have a pooling order
adjusted to take into account their particular circumstances.128
9.6.2 Critique of C A S A C recommendations
9.6.2.1 Uncertainty exists also in respect of pooling orders
The provisions of s 271 and s 272 of the Companies Act 1993 (NZ) make
inroads upon the principle in Salomon v Salomon129 by allowing a court to
make contribution and pooling orders on broad grounds where a related
company is liquidated. CASAC recommended in its Final Report that the then
Corporations Law should not be amended to introduce a court contribution
power such as in New Zealand.130 CASAC did, however, recommend in its
Final Report that the Corporations Law should be amended to introduce court-
ordered pooling orders in the liquidation of two or more companies based on
the N e w Zealand example.131 One of the reasons proffered by C A S A C for not
being in favour of a court-ordered contribution order, even in principle, was
that its application would cause too much uncertainty.132
Although the equitable basis of s 271 of the Companies Act 1993 (NZ) serves to
counter the wide language used in s 272 to express the power of the court to
intervene, it is acknowledged that the broad language used in the latter
C A S A C Final Report, above n 6, Recommendation 23. 129 [1897] A C 22. 130 Above n 6, Recommendation 21. 131 Above n 6, Recommendation 23. It is interesting to note that C A S A C would not support the introduction of any form of contribution order of the kind used in N e w Zealand, while it had no qualms about adopting the N e w Zealand pooling order, which is arguably a more drastic deviation from the rule in Salomon v Salomon [1897] A C 22. This should be compared, however, with the proposals on contribution in Ch 10 para 10.2.2, where it is suggested that,
even if the holding company is or becomes insolvent, it should contribute in appropriate circumstances. This is more drastic than the N e w Zealand pooling order. 132 This was also one of the main reasons for Parliament's rejection of the similar proposals of the Harmer Report, above n 9, on contribution: see para 9.2.1 above.
347 •
provision is not free from problems.133 It is seen as too wide and as leaving too
much discretion to the courts.134 This causes uncertainty as to the circumstances
that will justify orders being made under these provisions.135 In particular, the
interpretation of the phrase 'just and equitable' has given rise to a lot of
uncertainty.136 Even the weight and ordering of the factors stated in these
provisions are uncertain.137 Despite the guidelines contained in s 272 of the
Companies Act 1993 (NZ) and in the case law, the circumstances in which the
courts will grant the necessary orders on this basis are far from clear.138
It is submitted, however, that CASAC is inconsistent in singling out the fact
that contribution orders along the lines of the N e w Zealand provisions will
cause uncertainty. This is equally true of the N e w Zealand pooling orders.
W h e n comparing the factors to be taken into account for N e w Zealand
contribution and pooling orders respectively, it is clear that they are very
similar. There is only one difference between them. In the case of a pooling
order an additional factor should be taken into account under s 272(2) of the
Companies Act 1993 (NZ), namely, the extent to which the businesses of the
companies have been intermingled.139 This is not stated as one of the factors to
be taken into account under s 272(1) of the Companies Act 1993 (NZ) in the
case of a contribution order.
D Goddard, 'Corporate personality - limited recourse and its limits' in R Grantham and C Rickett, (eds) Corporate Personality in the 20th Century (1998) at 56-57. 134 Cork Report, n 33 above, paras 1947-1950. See further J Dabner, 'Insolvent trading: an international comparison' (1994) 7 Corp &Bus LJ 49 at 100-104, where he points out that the Cork Report criticised the N e w Zealand provisions for their lack of specificity, referring to them as the 'discretionary solution', and cited this factor as a particular obstacle in the way of recommending similar legislation.
Farrar, 'Legal issues involving corporate groups', above n 37, 200. 136 P Blumberg, 'Limited liability and corporate groups' (1986) 11 J Corp Law 573 at 621-622.
Farrar, 'Legal issues involving corporate groups', above n 37, 194.
Ibid 200. See further A Muscat, The Liability of the Holding Company for the Debts of its Insolvent Subsidiaries (1996) at 199 and the authorities referred to there.
C A S A C seems to have omitted this factor inadvertently in its Final Report, above n 6, para 6.86.
348
9.6.2.2 Uncertainty exacerbated by confusing contribution and pooling
The uncertainty that already exists as a result of the wide language used in the
N e w Zealand contribution and pooling provisions is exacerbated by the fact that
the same factors are stated to be taken into account in deciding whether to make
a contribution or a pooling order. Taking the same factors into account (except,
of course, for the extent to which the businesses of the companies have been
combined, which is stated as an additional factor in the case of pooling)140 in
deciding whether to make a contribution or a pooling order, is inappropriate.
The factor of 'conduct towards creditors' is clearly relevant to pooling that
involves inter-mingling businesses and the carrying on of business by different
companies as a single economic unit. Corporate advertising sometimes creates
the impression that the financial resources of the group will be available to
support any subsidiary that runs into financial trouble. A n example of such
advertising is where an individual subsidiary is referred to as 'part of the A B C
group of companies'. This assumption will as a practical matter often not be
misplaced, since it might be damaging to the prestige of a group to allow an
individual subsidiary to fail through lack of adequate financial support.141 O n
occasion, however, the unthinkable does happen, and the holding company
decides not to support its subsidiary in financial distress.
However, it is submitted that two of the overlapping guidelines contained in s
272(1) (relating to contribution orders) and s 272(2) (relating to pooling orders)
are not relevant to pooling. These guidelines, namely, 'intermingled
management' and 'action of one company leading to the liquidation of another',
are considered directly below.
140 See s 272(2)(d) of the Companies Act 1993 (NZ). 141 N C Sargent, 'Through the looking glass: a look at parent-subsidiary relations in the modem corporation', in Today's Challenge to Law, Conference held at Carleton University, C anada, Institute for Studies in Policy, Ethics & Law, 2-3 February 1983, at 73-77.
349
• 'Intermingled management'
The New Zealand legislature itself makes a distinction between two situations.
The first situation arises where one company participates in the management of
another but where the respective companies have their o w n separate businesses
in that they hold separate meetings, have separate bank accounts et cetera
('intermingled management'). The second situation arises where the businesses
of more than one company have been intermingled to such an extent that their
businesses are carried on as one in that the companies do not hold separate
meetings, do not have separate bank accounts et cetera ('intermingled
business'). The factor of 'intermingled business' is expressly stated as a
guideline to be taken into account in the case of pooling. This factor is not
stated as a guideline to be taken into account in the case of contribution. It
makes sense that where the businesses of different companies are carried on as
though they were one, thereby creating an 'intermingled business' where it is
impossible to identify which company was responsible for what actions, the
appropriate order should be pooling. This m a y be seen as an administrative
convenience factor, and automatically takes account of creditors' interests.
The factor of 'intermingled management' is stated as a guideline to be taken
into account both in the context of a contribution order and in the context of a
pooling order. It is submitted, however, that in the context of pooling it is
inappropriate to consider the factor of 'intermingled management', ie the
situation that arises where one company participates (or interferes) in the
management of another. This m a y be illustrated by the facts in Re Dalhoff. The
evidence in that case revealed that separate board meetings were not called for
each company and that the businesses of all three companies in liquidation were
dealt with at single meetings. In this regard Gallen J stated that 'there was one
inter-related group of companies which seems to have been operated by the
management substantially as one entity.'142
Re Dalhoff [ 1991] 2 NZLR 296 at 302.
350
This suggests that the businesses of the companies were combined
('intermingled business'), making pooling appropriate. It does not mean that
one company took part in the management of another company ('intermingled
management'). O n the facts it would have been impossible to identify one
company that was acting in the course of the board meetings.144 The fact that
Gallen J in Re Dalhoff145 did not find the factor of 'intermingled management'
decisive in an application for a pooling order may serve as a further indication
that it is relevant to contribution rather than to pooling. It m a y be contrasted
with the fact that Gallen J found the factor of 'conduct towards creditors' a
decisive consideration to be taken into account in deciding when a pooling
order should be made.
If it is impossible to identify one company that has acted on a particular
occasion, how is it possible to prove that that company took part in the
management of another? The factor of 'intermingled management', where one
company 'interferes' in the management of another, can only be appropriate in
the context of a contribution order. It is therefore suggested that 'intermingled
management' should only be considered in circumstances where contribution,
as opposed to pooling, is appropriate. Accordingly, the recommendation by
C A S A C to enact a section similar to s 272(2)(a) of the Companies Act 1993
(NZ) should be tempered by excluding the factor 'intermingled management' as
a factor to be taken into account in determining whether to make a pooling
order.
• 'Action of one company leading to the liquidation of another'
The guideline of the 'action of one company leading to the liquidation of
another' is also stated as a guideline to be taken into account in the case of both
143 Cf the decision of Gallen J in Re Dalhoff [1991] 2 NZLR 296 at 301 where his Honour discussed the fact that separate board meetings were not called for each company and that the businesses of all three companies in liquidation were dealt with at single meetings under the
heading of 'Intermingled management'. 144 See further Borrowdale, above n 45, at 94-96.
351
contribution and pooling. This factor is clearly relevant to contribution. Just as
the factor of 'intermingled management' endeavours to attribute responsibility
to one company for the management of another, so does the factor of the 'action
of one company giving rise to the liquidation of another'.
As in the case of 'intermingled management', however, it is submitted that the
factor of 'action of one company leading to the liquidation of another' is not
relevant to pooling. Pooling takes place in the context of intermingled business
affairs, where it is not possible to identify which company is responsible for
what actions. Accordingly, the recommendation by C A S A C to enact a section
similar to s 272(2)(c) of the Companies Act 1993 (NZ) should be further
tempered by excluding the factor 'action of one company leading to the
liquidation of another' as a factor to be taken into account in determining
whether to make a pooling order.
9.6.2.3 Summary
In t he 1 ight o f t he s imilarity o f t he factors t o b e t aken i nto a ccount for N ew
Zealand contribution and pooling orders respectively, it is submitted that there
is no justification for C A S A C ' s recommendation that contribution orders
should not be allowed in Australia. Both contribution and pooling orders may
give rise to the same amount of uncertainty. The proposed model discussed in
Chapter 10 suggests that pooling orders should be used only as a last resort,
with contribution orders having a bigger role to play, also being a possibility in
circumstances where the holding company becomes insolvent. This is not
currently possible under N e w Zealand law. The form of contribution envisaged
by the proposed model discussed in Chapter 10 diminishes the uncertainty
problem in contribution orders to a large extent.146
[1991] 2 NZLR 296. See para 10.2.2.
10 PROPOSALS
10.1 Inadequacy of existing law 352
10.1.1 Piercing the corporate veil 353
10.1.2 Directors' duties 354
10.1.3 Insolvent trading 355
10.1.4 Contribution and pooling 356
10.2 Proposed model 358
10.2.1 Pooling: To be used as a last resort 358
10.2.2 Contribution: Presumption of abuse based on control 361
10.2.2.1 Liability based on status versus liability based on fault 361
10.2.2.2 Substantive aspects 364
10.2.2.3 Procedural aspects 368
10.2.2.4 Contribution with a difference 374
10.2.2.5 Advantages of proposed model 378
10.3 Conclusion 381
10 PROPOSALS
10.1 Inadequacy of existing law
As pointed out in Chapter 1, the automatic extension of the separate legal entity
principle and its corollary, limited liability, to corporate groups is
inappropriate.1 In Australia the law has responded to the development of
corporate groups in a random way, applying existing principles of company law
and ad hoc statutory reforms. The varied nature of the techniques available for
the protection of creditors that were considered in the preceding chapters
highlights the absence of a unified legal structure dealing with corporate groups.
Various changes that affected corporate groups in particular were introduced in
the 1990's, including the provisions for making holding companies liable in • • • • 0
certain circumstances for the debts of their insolvent subsidiaries, the
provisions on consolidated accounting, the related party provisions and the
provisions relating to cross-shareholdings. However, while the holding
company continues to be in a comfortable position as a result of the firm
entrenchment of the principle in Salomon v Salomon & Co Ltd,4 the limited
liability principle provides inadequate protection for a subsidiary's creditors
against possible abuse of control by the holding company.
Although it is conceded that control of a subsidiary by a holding company
should not per se be denounced, it m a y pose a real risk of abuse in the context
of insolvent corporate groups. This is the time when creditors need protection
most. The problem arises as a result of the fact that, unlike natural person
shareholders, a holding company in its capacity as shareholder is often in a
position to participate (or interfere) in the management of its subsidiary. Strictly
speaking, the law provides that a shareholder (holding company) is not allowed
to participate in the management of its company (subsidiary), even in a general
'See Chl para 1.2.1. 2 See Ch 7. 3 See Ch 2 para 2.2.
353
meeting.5 A unique situation therefore arises in corporate groups, namely, the
existence of a holding company that invariably participates in the management
of the subsidiary in its capacity as shareholder and, although the law does not
require it, the directors of the subsidiary abide by this state of affairs in practice.
This unique situation often gives rise to the holding company abusing its
position of control, which m a y be particularly prejudicial to creditors of an
insolvent subsidiary.
10.1.1 Piercing the corporate veil
Piercing the corporate veil, as one of the techniques used for the protection of
creditors, was examined in Chapter 3. In line with the traditional entity theory,
piercing of the veil is allowed only in exceptional circumstances. The courts
have become increasingly reluctant to ignore the rule in Salomon v Salomon.6
It appears that the courts are even less willing to pierce the corporate veil to
protect creditors' interests than to achieve other objectives, such as reinforcing
contractual obligations. Furthermore, the indications are that courts are not
prepared to lift the veil to a greater degree where a corporate group exists.7 The
likelihood therefore becomes progressively smaller that the doctrine of
piercing the veil, originally developed to prevent abuse for fraudulent
purposes, will be utilised to cover enterprise liability and expose the assets of
the holding company to the creditors of its insolvent subsidiaries. Very
importantly, it is clear that the application of this doctrine is discretionary and
unpredictable, resulting in irreconcilable decisions and giving little guidance
for future cases. It is therefore submitted that the solution to the problem of
4 [1897] A C 22 (Salomon v Salomon). 5 Automatic Self-Cleansing Filter Syndicate Co Ltd v Cunninghame [1906] 2 Ch 34. 6 [1897] A C 22. 7 IM Ramsay and G P Stapledon, Corporate Groups in Australia (1998) at 20 and I Ramsay and
D Noakes, 'Piercing the corporate veil in Australia' (2001) 19 C&SLJ 250. In this regard it should be borne in mind that the lack of legal certainty was one of the reasons
proffered by the Companies and Securities Advisory Committee (CASAC) for rejecting the idea
of court-ordered contribution orders: C A S A C Corporate Groups Final Report, May 2000
{Final Report) para 6.51. Lack of certainty was also one of the main reasons for Parliament's
rejection of the similar recommendations in the report of the Australian Law Reform
354
the protection of insolvent corporate groups is not to be found in merely
disregarding the corporate veil in certain circumstances.
10.1.2 Directors' duties
The duties of directors of group companies, as a form of protection for
creditors, were dealt with in Chapters 4 and 5. A s far as the directors' fiduciary
duty to act bona fide in the interests of their company in a corporate group is
concerned, there is a definite m o v e by the courts in the direction of an enterprise
approach. In this context the courts have in recent years indicated a willingness
to bend the rule stated in Walker v Wimborne? This involves an objective test to
establish whether directors have complied with their fiduciary duties under
general law. In practice this means that directors will not breach their duty by
failing to consider the interests of their company and instead considering the
interests of the group, as long as intelligent and honest directors could
reasonably have believed that their actions would benefit their particular
company. Although it is clear that enterprise liability is continuing to gain
ground in this context, it should be borne in mind that the courts have only
recognised this in obiter dicta, and the judgment of the High Court in Walker v
Wimborne still stands.
The legislature has also indicated that it is moving towards the acceptance of an
enterprise approach in the context of directors' duties. The introduction of s 187
into the Corporations Act, dealing with the directors' statutory duty to act in the
Commission (ALRC), General Insolvency Inquiry Report No 45 (1988) (AGPS, Canberra),
(Harmer Report) on contribution. See further Ch 9 para 9.2.1. 9 (1976) 137 C L R 1. See the discussion in Ch 4 para 4.2. 10 The enterprise approach enjoys even stronger support in the context of nominee directors: see
Japan Abrasive Materials Pty Ltd v Australian Fused Materials Pty Ltd (1998) 16 A C L C 1172. 11 (1976) 137 C L R 1. 12 Despite the fact that directors' duty of care has not come before the courts very often in group
context, all indications are that the judiciary will follow a similar path as they did in the case of the fiduciary duty to act in the interests of the company. The view that the courts will probably
also gravitate towards an enterprise approach where directors' duty of care is concerned, is
strengthened by the duty of care provisions recently introduced into the Corporations Act 2001
(Cth) (Corporations Act) that all rely on an objective test. These provisions, namely, ss 180, 189
and 190 of the Corporations Act, are discussed in Ch 4 para 4.4.2.
355
ii t _
interests of a company, is significant. Section 187 of the Corporations Act
provides that directors of a wholly-owned subsidiary will in certain
circumstances comply with their fiduciary duty towards their subsidiary even if
they act in the interests of the holding company, provided that the subsidiary's
solvency is not placed in jeopardy.14 Should this provision be extended to
partly-owned subsidiaries, as recommended by C A S A C , it would detract
significantly from the approach in Walker v Wimborne} causing it no longer to
have any practical effect in the realm of solvent companies where there has
been compliance with the provisions of this section.
10.1.3 Insolvent trading
Creditors are protected by the fact that a holding company may be held liable
for the insolvent trading of its subsidiary in two broad instances, discussed in
Chapters 6 and 7 respectively. The first instance arises in its capacity as a
shadow director of the subsidiary. Provision for this is made in s 588G of the
Corporations Act. From Chapter 6 it appears, however, that in practice it may
be difficult to prove that a holding company is a shadow director of its
subsidiary. This difficulty is compounded by the considerable uncertainty that
exists surrounding the elements of the definition of a 'director' in s 9 of the
Corporations Act. The uncertainty has been exacerbated by inconsistent case
law in the various jurisdictions where such a definition is utilised, resulting in
the fact that shadow directorship is a question to be determined on the facts of
each case. Although there seems to be a general trend that the Australian
interpretation of the shadow director provision is somewhat less strict than in
the other jurisdictions discussed, the same problem is encountered as in the case
law concerning the piercing of the corporate veil. Whether a person qualifies as
Also relevant is s 181 of the Corporations Act, the statutory equivalent of the general law duty to act in the interests of a company. The wording of this section is more objective than that
of its predecessors, thereby supporting an enterprise approach.
This section thus accepts the notion of an enterprise in the context of wholly-owned subsidiaries. 15 (1976) 137 CLR 1. 16 See further C h 6 para 6.4.
356
a shadow director is generally decided on an ad hoc basis, making the result
unpredictable.17
The second instance i n w hich a h olding c ompany m ay b e h eld 1 iable for t he
insolvent trading of its subsidiary arises in its capacity as a shareholder of the
subsidiary. Provision for this is made in s 588V of the Corporations Act. As
was pointed out in Chapter 7, however, several limitations exist that make this
provision less advantageous for creditors. Apart from disadvantages that may
result because of intermingling of the affairs of the separate group companies,
the insolvent trading provisions also contain c ertain i nherent 1 imitations. N ot
the least of these is the fact that an expensive investigation of the financial
affairs of the company m a y have to be conducted in an effort to establish
whether the company was insolvent at a particular time.18 The fact that liability
has been made dependent on a debt being incurred further curtails the
usefulness of the insolvent trading provisions - the (incorrect) focus on
'incurring a debt' makes it easier for a holding company (or director) to sidestep
liability.19
10.1.4 Contribution and pooling
The current position in Australia on contribution and pooling, as forms of
creditor protection, was considered in Chapter 8. It appears that contribution as
recommended in the Harmer Report,20 based on the N e w Zealand model, has
01
for the most part fallen by the wayside. The watered-down version of the
Harmer Report recommendations on contribution contained in ss 588V-588X of
the Corporations Act relates to the liability of the holding company for the
17 In addition, on a practical note, the main operational subsidiaries of a listed company will
generally have a substantial amount of autonomy from the board of the listed holding company: see, eg, O E Williamson, 'The m o d e m corporation: origins, evolution, attributes' (1981) 19 J
Econ Lit 1537. It may be the case then that in many instances the listed holding company would
not qualify as a 'shadow director' of these subsidiaries. 18 For other inherent disadvantages see Ch 7 para 7.4.2. 19 See Ch 7 para 7.3.1.1 for the uncertainty surrounding the phrase 'incurs a debt'. 20 Above n 8. 21 See further Ch 9 para 9.2.1.
357
insolvent trading of its subsidiary and is discussed, together with its
disadvantages for creditors, in para 10.1.3 above.22 A s far as pooling is
concerned, it seems as though the rationale behind the introduction of the ASIC
Class Order Deeds of Cross Guarantee was deregulation, and not the protection
of creditors. Although some shortcomings of these Deeds of Cross Guarantee
have been removed or improved upon, the remaining flaws continue to operate 01,
to the prejudice of certain stakeholders, including creditors.
The recent trend by the courts to endorse a form of pooling without reverting to
the traditional expensive and cumbersome scheme of arrangement or
compromises/arrangements with creditors pursuant to ss 411 and 477 of the
Corporations Act respectively, was also placed under the microscope. One of
the main alternative routes by way of which pooling has been endorsed by the
Australian courts is pursuant to the voluntary administration provisions (more
specifically s 447A of the Corporations Act). This provision, however, has its
own shortcomings. Creditors of a particular company m a y be denied the
opportunity to vote for their preferred outcome when meetings of group
companies are consolidated. This is because, by consolidating the meetings, a
person w h o is not a creditor of a particular company m a y effectively be allowed
to vote on a deed of company arrangement that affects the property and
liabilities of that company.24 The seemingly preferable route, pursuant to s 510
of the Corporations Act that involves arrangements under a voluntary winding-
up, has limited application, as it requires the consent of all creditors.
The CASAC recommendations on contribution and pooling were examined in
Chapter 9. In its Final Report C A S A C categorises the limitations of s 588V of
the then Corporations Law (now: Corporations Act) into, on the one hand,
disadvantages as a result of intermingling, and, on the other hand, other
limitations all grouped together. As far as the problem that arises as a result of
For a more detailed discussion of the disadvantages of s 588V of the Corporations Act for creditors, see Ch 7 para 7.4. 23 See Ch 8 para 8.2.1. 24 See further Ch 8 para 8.3.2.2.
358
intermingling is concerned, C A S A C suggests that Australia should adopt the
N e w Zealand pooling order. However, great uncertainty surrounds the N e w
Zealand pooling provisions, which is exacerbated by the considerable overlap
between the factors to be taken into account for contribution and pooling in
N e w Zealand. Although it is conceded that some form of pooling may be
justified in certain circumstances, it is submitted that pooling should be limited
to cases of intermingled business, where administrative convenience and
creditor reliance have a role to play.26 As far as the other limitations of s 588V
of the Corporations Law (now: Corporations Act) pointed out by C A S A C are
concerned, C A S A C does not proffer any kind of solution, or even an analysis or on
discussion. It is submitted, therefore, that its suggestion is flawed or, at best,
incomplete. Instead the model set out in paragraph 10.2 is proposed.
10.2 Proposed model
10.2.1 Pooling: T o be used as a last resort
In Chapter 9 it was pointed out that one of the reasons proffered by C A S A C for
not being in favour of a court-ordered contribution order, namely, that it would
cause too much uncertainty, equally applies to court-ordered pooling orders,
which C A S A C endorses. It was further pointed out that the uncertainty in
relation to the N e w Zealand contribution and pooling provisions is exacerbated
by the fact that the same factors are stated to be taken into account in deciding
whether to make a contribution or a pooling order and that this is inappropriate.
" See Ch 9 para 9.6.2.1. 26 See further para 10.2.1 below. 27 C A S A C Final Report, above n 8, para 6.29 also refers to the two issues identified in the United Kingdom: Report of the UK Review Committee on Insolvency Law and Practice, chaired
by Sir Kenneth Cork, C m n d 8558 (1982) (Cork Report). The first one, ie the one that forms the
subject matter of this thesis, is about liability to external creditors. C A S A C refers to it as 'the
circumstances in which any solvent company in a corporate group should be liable for the debts
of failed members of that group'. It should be pointed out that C A S A C refers to 'solvent' here,
but then only provides an answer in the circumstances where all the companies are insolvent, ie
pooling. C A S A C does not state what should be in the place of the N e w Zealand contribution
order, where the group companies decide not to follow its voluntary 'opt-in' consolidation
suggestion. By implication it is presumed that, in such a case, C A S A C meant s 588 V of the then
Corporations Law to continue to apply unaltered.
359
If the factors of'intermingled management' and 'action of one company leading
to the liquidation of another' are excluded as factors to be taken into account in
determining whether to make a pooling order as suggested in Chapter 9, two
091
factors remain. These are 'conduct towards creditors' and 'intermingled
business'. Arguably the phrase 'conduct ... towards the creditors of any of the
other companies' in s 272(2)(b) of the Companies Act 1993 (NZ) indirectly
incorporates the element that the perception is generated among creditors in
general that they contract with a single enterprise as opposed to a particular
group entity. Intermingled business seems to be objectively ascertainable,
namely, the extent to which the businesses of the companies have indeed been
combined. This could be crucial both in relation to the problem of disentangling
the separate businesses and to the impression created to creditors that the
businesses are one.
Sub-section 272(2)(b) ('conduct towards creditors') and sub-s 272(2)(d)
('intermingled business') of the Companies Act 1 993 (NZ) are similar to the
'reliance' and 'intermingling' criteria, respectively, required in the United
States. Broadly speaking, the United States courts have taken into account
these two factors only, and not additional factors such as 'intermingled
management' and 'action of one company leading to the liquidation of another'
in determining whether or not to grant a pooling order. A s explained in Chapter
9, these last two factors are relevant to contribution rather than to pooling.30 It is
therefore submitted that the United States position on pooling is preferable to
that of N e w Zealand on this point. It is submitted that Australia should follow
this route and only regard 'conduct towards creditors' and 'intermingled
business' as relevant in determining whether or not a pooling order should be
granted.
See Ch 9 para 9.6.2.2.
See further Ch 9 para 9.6.1.2.
See Ch 9 para 9.6.2.2.
360
The submission immediately above is in line with the decision in Re Pacific
Syndicates. This case illustrates that the main purpose of the pooling
provisions is to enable the administration of a liquidation where untangling the
affairs of the companies is almost impossible and would deplete the funds
available to be distributed to creditors.32 Limiting the circumstances in which
pooling orders m a y be granted in this way would not only a void the current
confusion between N e w Zealand contribution and pooling orders as set out in
Chapter 9, but would also place pooling orders on a proper jurisprudential
basis. The effect of this is that pooling orders will be used as a last resort only,
namely:
• where there was intermingling to such an extent that the creditors were
justified in relying on the assets of the group as a whole and would be
prejudiced if their expectations were not fulfilled; and
• where it is virtually impossible (or, at least, prohibitively expensive) to
establish which group company owns what assets.
It is submitted that an additional argument for using pooling as sparingly as
possible i s t o c ounter the problem pointed out by C A S A C and referred to in
Chapter 9, namely, that the loss is arbitrary or random and therefore not
necessarily fair.34
31 (1989) 4 N Z C L C 64,757. This case is discussed in Ch 9 para 9.5.2. 32 Also, in Re Capital Project Homes Pty Ltd (1991) 6 A C S R 310 the court has confirmed that
pooling in a corporate insolvency context is only an option where the intermingling is of such a
nature that it is virtually impossible to unscramble the transactions and all concerned had the opportunity to state their case. Since the difficulty or impossibility of unravelling the affairs of
companies in liquidation is not strictly a criterion that the court should take into account, it
could be stated instead that the court should take into account the extent to which the businesses
of the companies have been intermingled. See further A Borrowdale, 'Commentary on Austin'
in R Grantham and C Rickett (eds), Corporate Personality in the 20th Century (1998) at 94-96. 33 See Ch 9 para 9.6.2. 34 See C A S A C Final Report, above n 8, para 6.92 and Ch 9 para 9.6.1.2.
361
10.2.2 Contribution: Presumption of abuse based on control
10.2.2.1 Liability based on status versus liability based on fault
As stated in Chapter 1, this thesis proceeds on the assumption that the holding
company is the most efficient risk-bearer in the context of corporate groups.35 If
pooling is to be used as a last resort, as suggested in paragraph 10.2.1 above, the
next question that arises is: on what basis should the holding company
contribute to or be held liable for the debts of its subsidiary? Here it is
necessary to distinguish between the two dominant doctrinal avenues of holding
company liability. The first avenue is one where it is sufficient for a holding
company to be held liable for the debts of its subsidiary because of the existence
of the relationship of holding company and subsidiary. In other words, liability
of the holding company for the debts of its subsidiary exists merely because of
its status as a holding company.36 The creditors of the subsidiary only have to
show that this relationship exists to be successful in holding liable the holding
company for the debts of its subsidiary. It is not necessary to prove that the
holding company has acted improperly in any way for it to be held liable for the
subsidiary's debts. Although this first possibility has the advantage of
objectivity, this advantage is offset by the disadvantage of rigidity.37
The second avenue of holding company liability for the debts of its subsidiary is
one where the existence of fault is required on the part of the holding •jo
company. The mere existence of a relationship of holding company and
subsidiary is not sufficient to hold the holding company liable for the debts of
See Ch 1 para 1.2.3. See further K Yeung, 'Corporate groups: legal aspects of the management dilemma' [1997] LMCLQ 208 at 256-263. This may be seen as a form of strict liability.
Also, making a holding company automatically liable for the debts of its subsidiary would
completely negate the use of subsidiaries as risk-shifting techniques. It is submitted that the use
of subsidiaries to provide a degree of protection for a corporate group should not as a matter of policy be proscribed.
See further Borrowdale, above n 32, 96-97, who refers to 'commercial culpability' on the part of the holding company.
362
its subsidiary. The most c o m m o n example of fault used in this context is a
breach of general standards of diligent management. The reason for liability
under this second possible basis for liability is not the existence of the group
structure (status), but rather a pre-determined code of conduct or a policy
devised in response to a particular crisis (fault) on the part of the holding
company. Thus, before the holding company will be held liable for the debts of
its subsidiary, the creditors of the subsidiary need to prove that the holding
company was at fault. While this second possibility is more flexible than the
first, it has the disadvantage of subjectivity.
As far as t he p ro visions ofs 588VoftheC orporations Act a re c oncerned,39
status is required since, for one group company to be held liable for the debts of
another, the companies involved have to qualify formally as holding company
and subsidiary, as defined in the Corporations Act.40 It appears, however, that
status alone is not sufficient and that a pre-determined code of conduct, fault, is
required in addition, before the holding company will be held liable for the
debts of its subsidiary under this provision. Fault is required, since s 588V of
the Corporations Act provides that, for the holding company not to be held
liable for the debts of its insolvent subsidiary, it must prove that it has acted
with the necessary diligence. Fault in the form of negligence, in the sense of not
complying with its duty of care, is therefore required on the part of the holding
company for it to be held liable pursuant to s 588V of the Corporations Act.41
The rationale behind introducing the duty of care into s 588V of the
Corporations Act was probably that the legislature was of the view that holding
company liability on the basis of status alone would be too rigid. The legislature
attempted to model the provisions ofs 588V on the provisions ofs 588G of the
39 Section 588V of the Corporations Act deals with liability of the holding company in its
capacity as shareholder for the debts of its insolvent subsidiary. See further Ch 7. 40 See further Ch 2 para 2.2.1. C A S A C has suggested that the concepts of controlling and
controlled companies should be used instead: see the discussion of CASAC's recommendations
in this regard in C h 2 para 2.3.1.1.
363
Corporations Act, and merely substituted the notion of a holding company for
that of a director.42 However, s 588G of the Corporations Act differs from s
588V in that s 588G deals with directors, while s 588V deals with the major
shareholder. It is trite law that directors owe a duty of care to their company.43
But on general principles of law shareholders owe no such duty towards their
company.44 In a corporate group context this means that, excluding s 588V of
the Corporations Act, a holding company (as shareholder) does not o w e any
duty of care to its subsidiary.45 Under general law a holding company does not
have a duty to monitor the affairs of its subsidiary to ensure that the latter does
not trade while it is insolvent, even where the subsidiary is wholly-owned.46
The removal of limited liability by virtue of the provisions of ss 588V-X of the
Corporations Act effectively imposes a duty of care on holding companies that
are now obliged to ensure that the affairs of their subsidiaries are properly
managed. It is submitted that this is going too far. Such duty is placed on the
holding c ompany simply because of its majority shareholder status. This is a
radical departure from the traditional passive shareholder model underlying
Anglo-Australian corporate law. In other words, imposing a duty of care on the
holding company towards its subsidiary is against the generally accepted notion
that shareholders are allowed to be passive. The provisions of ss 588 V-X of the
Corporations Act apply to all corporate groups, irrespective of whether the
41 Negligence here means that the holding company did nothing to prevent the subsidiary from incurring the debt in question. This is similar to the position under s 588G of the Corporations Act. 42 The guiding principle was stated to be 'as far as practicable [that the Part's operation] mirrors the operation of proposed s 588G, as though the holding company were a director of the subsidiary': Corporate L a w Reform Bill 1992, Explanatory Memorandum (1992) para 1122. 43 The duty to prevent insolvent trading may be seen as an instance of the duty of care. See Ch 4 para 4.4.3 for a discussion of the overlap between the duty to prevent insolvent trading and the duty of care. 44 This is the case even if they are majority or single shareholders. The mere ability of a holding company to control totally a subsidiary does not alter the position.
Under s 588G of the Corporations Act a holding company may, of course, qualify as a
shadow director, in which event it owes a duty of care (as well as fiduciary duties) to the subsidiary. See further C h 6.
A director appointed to the board to manage the affairs of the company has such a duty, but
under general law a shareholder (which includes a holding company) is allowed to be passive if it so wishes.
364
holding company is an active or passive investor.47 It can therefore be said that
there is no general law basis for the introduction of a duty of care (as a form of
fault) into s 588 V of the Corporations Act.
10.2.2.2 Substantive aspects
Proceeding from the argument in the previous paragraph, it is contended that
status by itself should not be sufficient to hold a holding company liable for the
debts of its insolvent subsidiary. Apart from status, an additional requirement
should be complied with before the holding company is held liable. This
additional requirement should not, however, be fault, as provided for in s 588V
of the Corporations Act. A n intermediate way between the two doctrinal trends,
namely, holding company liability on the basis of status, and holding company
liability on the basis of fault, is suggested instead. Unlike the current position
pursuant to s 588V of the Corporations Act, this intermediate model links
liability of the holding company not with status or fault, but rather with
control.4* In deciding whether the holding company should be held liable for the
debts of its subsidiary, the crucial question should be whether the decision to act
in a certain way was made by the subsidiary company autonomously or whether
it was made by the subsidiary while it was under the control of the holding
company.49 Only in the latter instance should the holding company be held
liable for the debts of the subsidiary company. In terms of the suggested model
the holding company should be liable for all the debts of its subsidiary arising
from business decisions made while under the control of the holding company,
but only for those debts.50
47 The liability of a holding company for the debts of its subsidiary under s 588V of the
Corporations Act is discussed in Ch 7. 48 C f C A S A C Final Report, above n 8, para 1.73. 49 JE Antunes, 'The liability of pulj corporate enterprises' (1999) 13 Conn Jlnt'lL 197 at 197. See also Ch 3 para 3.4 where the different outcomes in DHN Food Distributors Ltd v Tower
Hamlets LBC [1976] 3 All E R 462 and Lonrho Ltd v Shell Petroleum Co Ltd [1980] 1 Q B 358
were based on the distinction made by Denning M R between autonomy and control.
365
In the above-mentioned context one should distinguish between the so-called
'general' and 'concrete' approaches.51 In terms of the general approach holding
companies are held liable where the control that they exercise over their
subsidiaries reaches a certain degree of intensity, ie where the group is regarded
as centralised rather than decentralised.52 It is submitted, however, that the
general approach should not be followed, since it is not possible to assess in
advance the degree of centralisation of a specific corporate group. Within a
group control m a y be exercised in different ways. S o m e subsidiaries m a y be
managed at arms' length while others m a y be managed under tight supervision.
Within the same subsidiary some functional areas m a y be under tight control
while others are not. Even within the same functional areas the managers of the
subsidiary m a y make some decisions autonomously, while others m a y be made
under the control of the holding company. Thus, it does not make sense to ask,
as a general question, whether it is a centralised group (where there is tight
control) or a decentralised group (where autonomy is paramount).53
In terms of the concrete approach holding companies are held liable where they
exercise control at the level of the business decision-making area of the
subsidiary that was involved with the debts in question.54 It is only possible to
assert whether the holding company did or did not control a subsidiary in
respect of very concrete situations, by considering the concrete managerial
process that led to a particular subsidiary debt.55 It therefore makes sense to link
holding company liability with actual holding company control and not to
penalise holding companies with a rigid liability system where the debts of the
subsidiary were the result of circumstances beyond the holding company's
JE Antunes, Liability of Corporate Groups - Autonomy and Control in Parent-Subsidiary
Relationships in US, German and EU Law: An International and Comparative Perspective
(1994) ('Liability of Corporate Groups') at 38 Iff 51 Ibid 390ff. 52 Ibid. 531 Ramsay, 'Transcript of Symposium' held at Connecticut in 1998, published in 13 Connect J
Int'l L (1999) 397 at 481-2. For the difference between control and autonomy, see Ch 2 para 2.1. 54 Antunes, Liability of Corporate Groups, above n 50, 390ff. 55 Ramsay, 'Transcript of Symposium', above n 53, 481-2.
366
control. The concrete approach has to be followed if it is sought to link
liability and actual decision-making power.57
In this regard an analogy m a y be drawn with lender liability for environmental co
damage. Justification for the imposition of such liability can be found in the
lenders' capacity to influence the borrower's decisions on environmental
matters and their ability to monitor the borrower's compliance with its statutory
obligations. One of the ways in which a lender can incur liability for
environmental damage is as a 'director' or 'person concerned in the
management' of the polluter.60 In the United States, a distinction has been
drawn between participating in the day-to-day operational aspects of the
contaminated site and participating in the purely financial aspects of the
borrower's operations. While participating in the operational control attracts
liability, participating in the financial control does not. For example, a lender
was not liable under the Comprehensive Environmental Response,
Compensation and Liability Act (CERCLA)61 simply because it monitored cash
collateral accounts, ensuring that receivables went to the proper account, and • f\0
established a reporting system between the borrower and the lender.
Antunes, Liability of Corporate Groups, above n 50, reaches this conclusion after he stated that it is unfeasible to distinguish generally between centralized and decentralized groups. 58 A lender cannot absolve itself of its responsibilities in respect of the environment by simply
lending funds at arm's length to a borrower: J O'Donovan, Lender Liability (2000) at 708. See
also D S Bakst, 'Piercing the corporate veil for environmental torts in the United States and the European Union: the case for the Proposed Civil Liability Directive' (1996) 19 B C Int'l &
Comp L Rev 323 at 345-46. 59 O'Donovan, above n 58, 707. See further K Mfodwo, 'Environmental issues and Australian financial institutions - applicable laws and practical management measures' in Bray and Clarke, Australian Law of Financial Institutions (1996), para 16.13. CfLee, 'The obligations of lenders
to remediate contaminated land - a comparative analysis' (1993) 10 EPU91 at 112. 60 O'Donovan, above n 58, 719-724. Other ways in which a lender can incur liability are in its
capacity as polluter or operator, owner or occupier: see O'Donovan, above n 58, 710-719. 61 (1980) 22 U S C , paras 9601-9657. 62 O'Donovan, above n 58, 721. There are no similar comprehensive principles in Australian
environmental law and there are no actual instances of this form of lender liability in Australia:
see O'Donovan, above n 58, 707. However, the Prosecution Guidelines issued by the N S W
Environmental Protection Authority suggest that the principal factor in deciding whether or not
to prosecute a person concerned in the management of the polluter is 'the person's actual
control over the corporation in relation to its criminal conduct': K Mfodwo, 'Lender liability for
environmental problems: further developments in N e w South Wales' (1992) 9 EPU 61 at 62.
Legislation has been enacted to protect lenders from environmental liabilities where they limited
themselves to their rights to possession or exercised a power of sale: s 98 of the Contaminated
367
The secured creditor exemption under C E R C L A applies to those w h o do not
participate in the management of a facility, as distinct from the management of
the borrower as a whole. In this regard the Court of Appeals in United States v
Fleet Factors Corp63 observed that a lender would not be entitled to invoke the
exemption if it had the capacity to influence the management of waste disposal.
In response to this, C E R C L A was amended on 30 September 1996 to ensure
that secured creditors would not be liable for environmental damage unless they
actually participated in the borrower's activities. Section 101(20)(F)(i) of
C E R C L A n o w provides that the term 'participation in management' means
actually participating in the management or operational affairs of a vessel or
facility. It does not include merely having the capacity to influence or the
unsecured right to control vessel or facility operations.
The imposition of liability on the holding company under a model as set out in
paragraph 10.2.2.2 presupposes the existence of control (generally) as well as
the existence of a causal nexus (concretely) between the control and the specific
losses of the subsidiary, leading to its insolvency.64 The introduction of this
causality requirement means that a holding company will be liable for all the
losses of its subsidiary that were actually the result of the subsidiary's business
decisions which originated from the decision-making power and control of the
holding company. But it will be limited to those losses.65 This is crucial and
means that the holding company will be liable for all those losses that can be
attributed to its own decision-making power, irrespective of whether there was
Land Management Act 1997 (NSW), s 169 of the Protection of the Environmental Operations Act 1997 (NSW), s 183 of the Environmental Protection Act 1994 (Qld), s 129 of the Environment Protection Act 1993 (SA), s 60 of the Environmental Management and Pollution Control Act 1994 (Tas), s 66B of the Environment Protection Act 1970 (Vic), and s 118 of the
Environmental P rotection Act 1986 ( W A ) . S ee, i n g eneral, B aird, ' Liability o f d irectors a nd
managers for corporate environmental offences - recent prosecutions' (1999) 16 EPU 192. 63 (11th Cir 1990) 901 F 2d 1550 at 1557. 54 Antunes, Liability of Corporate Groups, above n 50, 453-454. 65 Ibid 454.
368
fault involved.66 But it also means that, at the same time, the holding company
will be exempted from all the losses that occurred as a result of circumstances
foreign to t he d ecision-making p ower o f t he h olding c ompany orb eyond t he
scope of exercise of its decision-making power.67 Examples of foreign
circumstances would include unpredictable changes in the market environment
or natural catastrophes. Examples of circumstances that are beyond its scope of
exercise would include losses that are incurred as a result of business decisions
taken by the subsidiary company within its own autonomous decision-making
authority.6
10.2.2.3 Procedural aspects
It is very important to note that not only the substantive aspects of this proposed
system of liability but also the procedural techniques are significant. The
importance of questions of proof and especially of presumptions in the area of
corporate groups cannot be overestimated. In this regard Lutter remarked:69
The law enjoys as much authority as the chances of its own implementation permits: the most elegant legal rights are totally useless for the dependent
company, its minority associates and creditors, when they are not and they cannot
be realized in practice.
It should be pointed out that the application of the normal burden of proof in
civil proceedings is inadequate, because the situation of the parties is radically
different as far as the facts relevant to the resolution of corporate group disputes
are concerned. It would generally be extremely difficult for creditors of the
subsidiary (the plaintiffs) to obtain evidence about a corporate decision-making
process of the holding company. Decision-making allocation patterns will often
have been determined by the holding company, which in any event has a large
66 Cythe rationale for imposing liability on a holding company as 'shadow director', namely, its
active involvement in the management of the subsidiary. It is the exercise of power that carries
legal responsibility. 67 Antunes, Liability of Corporate Groups, above n 50, 454.
369
array of techniques at its disposal to establish where a particular business
decision has been taken. Holding companies are therefore in a muc h better
position to place evidence before the court in respect of the circumstances in
which it has exercised control over its subsidiary.70 Moreover, holding
companies are able to provide such evidence at the lowest information cost.
To solve the procedural and evidentiary difficulty for the plaintiffs in obtaining
the relevant information regarding the group companies, there must be a shift in
onus.71 The substantive aspects of the system of liability imputation set out in
paragraph 10.2.2, where liability for each concrete debt is linked with the
decision-making power responsible for it, should be supplemented by an no
applicable procedural system in which the burden of proof is reversed. As
soon as there is the requisite 'control',73 and the controlled company becomes
insolvent, a presumption should arise that the controlling company has abused
its control by acting to the detriment of the subsidiary.74 Unless the holding
company can rebut the presumption, it should be liable to the creditors of the nc
subsidiary, despite the rule in Salomon v Salomon.
* M Lutter, Die zivielrechtliche Haftung in der Unternehmensgruppe, 244ff, 268 (original in German - translation by Antunes, Liability of Corporate Groups, above n 50, 395). 70 Antunes, 'The liability of polycorporate enterprises', above n 49, 227-229. 71 See R A Booth, 'Limited liability and the efficient allocation of resources' (1994) 89 North U
L Rev 140 at 157, where he points out that limited liability shifted the burden in the first place.
There is a second reason for a reversal of the burden of proof, namely, that the holding
company's ignorance about the attributes of its own control over the management of its subsidiary should penalise the holding company rather than excuse it: Antunes, Liability of Corporate Groups, above n 50, 395ff
A n analogy with the German holding company liability model for 'qualified concerns' may be
drawn. Where the interaction between the holding company and subsidiary becomes so intense that they are impenetrable for outsiders, the burden of proof on detrimental effects on the subsidiary shifts to the holding company. Even highly integrated concerns therefore do not have
to give up the basically efficient principle of limited liability. This is different from the situation for the 'integration concern', where holding company liability attaches per se. See further Ch 2 para 2.1.
See Ch 2 para 2.3.2.1 for the suggested definition of 'control'. 74 In the proposed model the holding company is deemed to have acted to the detriment of the
subsidiary where the latter becomes insolvent while under its control. A comparison m a y be drawn between this presumption and the presumption contained in s 187 of the Corporations
Act. The provisions of s 187 imply that the directors of the subsidiary acting bona fide in the
interests of the holding company are only deemed to have acted bona fide in the interests of the
subsidiary if the subsidiary does not become insolvent.
[1897] A C 22. Cf the case 1 aw indicating that in c ertain c ircumstances, where property i s
disposed of on the brink of insolvency, an intent to defraud creditors may be presumed under s
121 of the Bankruptcy Act 1966 (Cth): Freeman v Pope (1870) L R 5 C h A p p 538, accepted in
370
The presumption of abuse of control by the controlling company, so that the
assets of the holding company are available to the creditors of the insolvent
subsidiary, basically follows a pragmatic approach in the context of the debate
between Professors Landers and Posner.76 It is submitted that, not following the
suggestion by Landers, one should not altogether do away with proving that an
abuse occurred. However, it is submitted that the suggestion by Posner that
nothing should be done about abuses since they were not prevalent enough,
should also not be followed. At least, considerable risk exists that a controlling
company will exercise the control that it has in its own interests and to the
detriment of its subsidiary. A middle route seems to provide the best solution.
Thus, where the holding company is in control and the subsidiary has suffered
detriment (that is, it has become insolvent), there is a presumption of abuse of
control, namely, that the holding company acted to the detriment of the
subsidiary, thereby causing its insolvency. This model may be justified, because • 77
the presumption only arises in the context of insolvency and because the
holding company has an adequate opportunity to defend itself against being
7fi
held liable for the losses of its insolvent subsidiary.
Prima facie proof that the required control by the holding company exists will
set in motion the liability of the holding company, thereby indirectly
transferring t he b urden o f p roof c onceming t he c ausal n ature of such control
onto the holding company. In other words, the burden of proof lies on the
holding company to bring evidence as to whether the business decisions in
question have originated from the control of the holding company or whether
Australia in, eg, Noakes v J Harvey Holmes & Sons (1979) 37 FLR 5; Official Trustee v
Marchiori (1983) 69 F L R 290; Pt Garuda Indonesia Ltd v Grellman (1992) 107 A L R 199. 76 Hereinafter referred to as 'Landers' and 'Posner' respectively. See further Ch 1 para 1.2.2. 77 The reason that Posner advanced for stating that Landers was mistaken, is that the latter looked only at cases where insolvency had taken place, and then got a distorted picture. If this is so, then the suggested model will remove this distorted picture, because it only applies in
insolvency. In insolvent situations the abuse is great. 78 Cythe Cork Committee's proposal that a holding company should be presumed (unless the
contrary appears) to be a shadow director of a company, wherever it has been responsible for
the appointment of the company's board or a substantial part thereof, or where the boards of the
371
70
the subsidiary took those decisions as an autonomous entity. In fact, such shift
in onus will remove what is perceived to be the main criticism of such a model,
namely, the alleged impediment in isolating one source that led to the
subsidiary's insolvency.80 To rebut this presumption, the holding company has
to prove that the insolvency of the subsidiary stemmed from circumstances
foreign to its power, or beyond the scope of its powers.
A hybrid system of liability imputation is therefore suggested. It combines the
most fruitful elements of the two dominant doctrinal avenues of holding
company liability, flexibility and objectivity, without falling into their
R7
respective pitfalls, rigidity and subjectivity. Under this system liability for
each actual debt will be linked with the decision-making power responsible for
it. In other words, there must be concrete and actual control exercised by the
holding company over the subsidiary before the holding company will be
visited with liability for the subsidiary's debts. The liability of the holding
company is independent of its formal status as holding company. There must
be a link between the decision-making power of the holding company and its
liability for the losses of its insolvent subsidiary. This m a y be seen as a form of
contribution by the holding company, and it is suggested that it should replace s
588 V of the Corporations Act.
In terms of the proposed model, the substantive and procedural aspects of which
are dealt with above, a holding company would be liable to contribute to the
debts of its subsidiary where:
• the requisite control is established;
two companies consist of substantially the same persons: Cork Report, above n 23, Ch 44 at 437. The U K legislature did not take up this recommendation. 79 Antunes, Liability of Corporate Groups, above n 50, 38 Iff.
Ibid 393ff As long as the decision in question has originated from the control of the holding
company, the fact that there are multiple causes of insolvency is irrelevant - the presumption of abuse of control by the controlling company arises.
Antunes, 'Transcript of Symposium' held at Connecticut in 1998, published in 13 Conn J IntIL (1999) 397 at 464-5. 82 See para 10.2.2.1 above. 83
Antunes, Liability of Corporate Groups, above n 50, 386-7. 84Ibid 391.
372
• the subsidiary is insolvent; and
• the holding company cannot rebut the presumption that it abused its control
by acting to the detriment of the subsidiary (and its creditors), thereby
causing its insolvency.
Accordingly, it is suggested that the current s 5 88V of the Corporations Act
should be repealed and replaced by the following provision:
'WHEN A BODY CORPORATE LIABLE FOR DEBTS OF ANOTHER
(1) A body corporate (the 'second body') is taken to be liable for the debts of
another body corporate (the first body') if:85
(a) the second body controls the first body as contemplated in s 46A; and
(b) the first body becomes insolvent (or an insolvency event occurs in respect of
the first body) during the time that it is under the control of the second body or
as a result of the control exercised by the second body.*6
(2) The second body will not be held liable for the debts of the first body if it
can prove that its action or inaction was not a cause of the first body's
insolvency.'
The suggested replacement of s 588 V of the Corporations Act has a number of
advantages over the current provision. First, 'control' is wider than in the
87
current holding company/subsidiary definition. Secondly, there is no need to
prove that a 'debt' was 'incurred', a phrase that has caused problems since its
inception, which problems have not been solved to date.88 Furthermore, no
duty of care is imposed on the holding company because of its status of holding
In other words, the assets of the second body are taken to be available to the creditors of the first body. 86 'Insolvency event' may be defined in broad terms to include the appointment of a liquidator, administrator or receiver. 87 See sub-s (1) para (a) of the proposed provision and Ch 2 para 2.3.2.1(a). 88 See sub-s (1) para (b) of the proposed provision and Ch 7 para 7.3.1.1.
373
company. Finally, the novel presumption places the onus on the holding
company to free itself from being held liable for its subsidiary's debts where
circumstances would otherwise be regarded as appropriate for imposing
liability on the holding company.90
An objection to the proposed section is arguably that the presumption in sub-s
(2) saddles the holding company with the legal burden of proving a negative in
order to escape liability for the debts of its subsidiary. In the context in which
the presumption will arise, the presumption is not only commercially fair, but
such objection is unsustainable. In certain circumstances there may be
difficulties in proving a negative.91 However, there are numerous instances in
which a party has the legal burden of proving a negative.92 The difficulties that
may present themselves in proving a negative are countered by the application
of the maxim that 'all evidence is to be weighed according to the proof which it
was in the power of one side to produce, and in the power of the other to have
contradicted'.93
The effect of the application of the above-stated maxim is that the burden of
proof that is required to satisfy a negative onus is not usually difficult to
discharge, particularly where the other party has greater means to produce
evidence that contradicts the negative proposition. Provided the onus-carrying
party has tendered some evidence from which the negative proposition may be
inferred, the other party carries a tactical or evidentiary burden to adduce
evidence of any matters with which the first party will have to deal in the
discharge of its legal burden of proof.94 Thus the operation of the maxim will
ensure fairness, both procedurally and commercially. This is the case even in
See sub-s (1) para (b) of the proposed provision and para 10.2.2.1 above. See sub-s (2) of the proposed provision.
91 JD Heydon, Cross on Evidence (2000) at 207. 92 Ibid.
Apollo Shower Screens Pty Ltd v Building and Construction Industry Long Service Payments Corporation (1995) 1 N S W L R 561 at 565.
Ibid 5 64. For a discussion of the difference between a legal and evidential burden, see eg
Purkess v Crittenden (1965) 114 C L R 164 and G Roberts, Evidence, Proof and Practice (1998) at 79-87.
374
the unlikely situation of the holding company not being in a better position to
place evidence before the court regarding the business decisions which
adversely affect the subsidiary and the circumstances in which it has exercised
control over the subsidiary.
10.2.2.4 Contribution with a difference
One important aspect regarding the operation of this proposed model of
contribution should be pointed out. This aspect relates to the solvency of the
holding company that is potentially liable to contribute. A s stated before, a
form of contribution derived from the Harmer Report recommendations is
contained ins 5 88V-588Xofthe Corporations Act. Nothing is stated in the
Corporations Act itself about the solvency of the holding company in this
context, and no case law exists to give an indication of whether the courts will
order contribution under this provision if its effect will be that the holding
company becomes insolvent. As far as the position in N e w Zealand is
concerned, there is also nothing in the Companies Act 1993 (NZ) expressly
providing for this contingency, but the N e w Zealand courts have held that
contribution orders are available only where the holding company remains
solvent. The N e w Zealand courts have not been prepared to grant a
contribution order if this meant that the solvent holding company would also
become insolvent.95 If this issue were to come before the Australian courts,
they would in all likelihood follow the N e w Zealand example and not be
prepared to make an order that the holding company should contribute if such
action would cause the latter's insolvency.
It is submitted, however, that the New Zealand model should not be followed
in this regard, since it does not have a proper basis in law. The N e w Zealand
courts have interpreted the contribution order to entail that, where it is fair, you
can take from an entity if it can afford it to pay out the creditors of another
95 See Re Liardet Holdings Ltd (1983) BCR 604 and Lewis v Poultry Processors (1988) 4
NZCLC 64,508, discussed in Ch 9 para 9.4.1.
375
entity w h o cannot afford payment. But even where it is fair, you cannot take
from an entity if it cannot afford such contribution. It is submitted, however,
that whether or not the holding company's assets should be available to the
creditors of the insolvent subsidiary should not depend on the solvency of the
holding company. It should depend on whether the holding company was
responsible for the insolvency of the subsidiary, regardless of the state of
solvency of the holding company itself.96 The creditors of the holding company
should not be in a better financial position than the creditors of the subsidiary
where the holding company had the requisite control and cannot prove that it
did not cause the subsidiary's insolvency. Contribution by the holding company
should therefore not be seen as something that is possible only in
circumstances where the holding company remains solvent. Thus, under the
proposed model, the holding company should be liable for its insolvent
subsidiary's debts, regardless of whether the holding company itself becomes 07
insolvent because of such act.
The main reason that the N e w Zealand courts have not made contribution orders
where it would cause the holding company to become insolvent is to ensure that QQ
creditors of the holding company do not suffer prejudice. Creditors of the
holding c ompany m ay b e p rejudiced b ecause such creditors assumed that the
holding company was a separate legal entity and relied on its assets without fear
of competing claims from creditors of an insolvent subsidiary.99 It is submitted,
96 When a company has to 'contribute' its creditors are potentially worse off- whether under a
contribution or a pooling order. It does not make any sense - as C A S A C suggests - to have a pooling order but not a contribution order on the ground that the creditors of the company making the contribution will be worse off - this equally applies to the company making the bigger 'contribution' under the pooling order. If both companies are insolvent, and can still be identified, the proper question is whether one company can be held responsible for the other's
insolvency. If so, a contribution order is appropriate, even if both companies are insolvent. If
not, no order should be made. 17 Cf the group consolidation proposal by C A S A C that would impose liability for contractual
claims on all companies in the consolidated group, regardless of whether a particular company within the consolidated group was insolvent or not. See further Ch 2 para 2.3.1.2 and V
Priskich, ' CASAC's proposals for reform of the law relating to corporate groups' (2001) 19
C&SL/360at361. 98 Borrowdale, above n 32, 96-97.
'9 Since it is the holding company that participated in or interfered with the management of the subsidiary, the creditors of the subsidiary may claim against the assets of the holding company,
376
however, that as long as there is adequate disclosure to creditors of the holding
company that its assets are available to the creditors of the subsidiary where the
latter becomes insolvent while under the control of the holding company, this
potential prejudice to them could be overcome. In order to protect creditors of
the holding company by way of disclosure, the following is suggested. It is
proposed that the words 'Controlling Company' or ('CC') should appear in
brackets directly after the name of any company that is taken to control another
body corporate as contemplated by the newly-proposed s 46A in Chapter 2
paragraph 2.3.2.2. This should appear on all public documents and on the
ASIC database. This is to notify or warn creditors that they cannot rely on the
separate entity doctrine and that the presumption of abuse applies in the event
of the insolvency of any of the holding company's subsidiaries, unless the
controlling company can rebut it.102 The default rule in the event of a
subsidiary's insolvency is thus that the assets of the holding company are
available to the creditors of the subsidiary. Creditors would have no claim that
the doctrine interfered with their contractual expectations, as their expectations
would have been developed against this standard.103
In practice, in order not to deter creditors/lenders, the holding company m a y
give a written undertaking to a particular creditor, stating that the holding
company does not control the subsidiary and will therefore not be liable for the
debts of its subsidiary if the latter becomes insolvent.104 If the holding company
but not vice versa. See Ch 9 para 9.6.2.2 for a discussion of interference, and the fact that 'intermingled management' means that contribution (and not pooling) is relevant. 'Intermingled
business', relevant in the context of pooling, does not play a role here. 100 This may be compared with the recommendation in the C A S A C Final Report, above n 8, that
'all companies that choose to be in a consolidated corporate group should be required to
disclose on all public documents and on the ASIC database that they are members of that
group'. 101 This is a modified version of CASAC's recommendation that all companies that choose to be
in a consolidated corporate group should be required to disclose on all public documents and on
the ASIC database that they are members of that group. See the discussion in C h 2 para 2.3.1.2. 102 The potential liability for the debts of a subsidiary should be disclosed as a note in the
holding company's financial statements. The extent to which this should be done may be
determined by statute. 103 See also C W Frost, 'Organizational form, misappropriation risk, and the substantive
consolidation of corporate groups' (1993) 44 Hastings LI 449 at 452. 104 This is similar to limited liability and a guarantee.
377
provides such an undertaking and it proves to be untrue, then the creditor would
have no difficulty in holding the holding company liable on the basis of
misrepresentation,105 or on the basis of misleading and deceptive conduct.106 If
the holding company refuses to provide such an undertaking, it is for the
creditor to decide whether it wishes to enter into the proposed agreement or not.
If a company becomes a holding company after the contract had been entered
into, the new holding company should be required to inform the creditor of its
change in status and the creditor should have the right to decide whether or not
to continue with the contract at that stage.
Contribution orders despite the insolvency of the holding company may be
justified on the following basis. A holding company that is in control m a y run
the affairs of its subsidiary according to its o w n business interests. A holding
company (including its shareholders and creditors) therefore enjoys all the
advantages of managing the business of its subsidiaries, even where this is to
the detriment of the subsidiaries' affairs, except where the subsidiary is or 1 f\n
becomes insolvent. The holding company may, for example, call on the
subsidiary to make loans to it without paying interest, or to purchase assets of
the subsidiary at bargain prices. Although this is not illegal, there is a price to be
paid (a quid pro quo). The price is that, once the holding company enjoys this
power of control over its subsidiary's affairs, it must pay the price of unlimited
liability for losses of those subsidiaries where the subsidiaries become
insolvent.108
Cf Re Augustus Bamett & Son Ltd [1986] B C L C 170. 106 See s 52 of the Trade Practices Act 1974 (Cth) and s 42 of the Fair Trading Act 1987 (NSW); s 12 of the Fazr Trading Act 1992 (ACT); s 11 of the Fair Trading Act 1985 (Vic); s 14 of the Fair Trading Act 1990 (Tas); s 56 of the Fair Trading Act 1987 (SA); s 10 of the Fair Trading Act 1987 (WA); s 38 of the Fair Trading Act 1989 (Qld); s 42 of the Consumer Affairs and Fair Trading Act 1990 (NT). 107 In such a case Walker v Wimborne (1976) 137 CLR 1 and Ring v Sutton (1980) 5 ACLR
546 are applicable and s 187 of the Corporations Act is not. See further Ch 5 paras 5.3.4 and 5.4.2 respectively.
C/the German model. See in this regard Antunes, 'Transcript of Symposium', above n 81, 477-8.
378
10.2.2.5 Advantages of proposed model
The suggested model overcomes the inherent limitations of the current s 588V
of the Corporations Act as described in C A S A C Final Report}09 namely,
(1) the notion of 'holding company/subsidiary' is replaced with the notion of
' controlling/controlled company';'' °
(2) there does not have to be an expensive investigation to ascertain the
financial position of the company in order to establish whether it was insolvent
exactly when the specific debt was incurred;
(3) it will also cover debts incurred by the subsidiary while solvent, but which
are still outstanding; and
(4) it covers asset-stripping so that, even if the insolvency of the subsidiary is
caused only eventually, it means that the holding company can be held liable.
CASAC mentioned one other 'limitation' ofs 588 V of the then Corporations
Law, namely, that it does not extend to the assets of other group companies. It is
submitted, however, that this should not be seen as a limitation. The model
proposed in paragraphs 10.2.2.2 to 10.2.2.4 should not extend to group
companies other than the controlling company. It is exactly because these
companies are not in control that they should not be held liable.
Apart from overcoming the shortcomings of the current s 588V of the
Corporations Act, the proposed model also has the advantage of certainty over
the N e w Zealand example. In Australia the main reason for the Government not
to adopt the Harmer Report recommendations on contribution was stated to be
uncertainty. Like pooling based on the N e w Zealand model,111 contribution
109 See C A S A C Final Report, above n 8, para 6.28 and Ch 7 para 7.4.2. 110 While the C A S A C Final Report, above n 8, recommended that the definition of 'holding
company' and 'subsidiary' should no longer be used in the then Corporations Law, it was
suggested earlier in this thesis that the holding company/subsidiary test should in principle be
retained as part of the general control test. See further Ch 2 paras 2.3.1.1 and 2.3.2.1. 111 See Ch 9.
379
based on the N e w Zealand model is very uncertain.112 Section 272(2) of the
Companies Act 1993 (NZ), providing for contribution orders, has been stated to
be too generally expressed, leaving much too much to the discretion of the
court. One could argue that using the N e w Zealand contribution model is
tantamount to allowing the courts to lift the veil on the basis that it is 'just and
equitable'. Under the proposed model, however, concrete control (as opposed to
general control) is required before a holding company will be held liable for the
debts of its subsidiary, so that uncertainty is reduced, if not avoided altogether.
A further advantage of the proposed model, especially if compared with the
current position, is fairness. Section 588V of the Corporations Act imposes a
duty on the holding company to ensure, actively, that its subsidiary's creditors
are not prejudiced, even where the holding company has not participated in or
interfered with the management of the subsidiary.114 This seems unfair. It is the
proper role of the subsidiary's directors, who themselves are under a statutory
duty to avoid insolvent trading, to take adequate steps to protect the interests of
the subsidiary's creditors.115 It is suggested that, instead, the holding company
should be held liable, based on the presumption that its control of the subsidiary
was abusive, resulting in the latter's insolvency. Thus, if an Australian
subsidiary becomes insolvent for a reason beyond the holding company's
control, or outside its scope, the holding company will have no difficulty in
rebutting the presumption. Because the holding company m a y rebut the
presumption, the loss is borne by the right entity and its creditors.
Cf Cork Report, above n 27, para 1937, stating that contribution orders are not necessarily uncertain. In the countries where contribution orders are allowed, such as the United States and
N e w Zealand, there has not been undue uncertainty and it also has not discouraged entrepreneurial activity.
D Goddard, 'Directors and Corporate Groups - the N e w Zealand experience', paper delivered at the C orporations L aw W orkshop, p resented b y t he B usiness L aw S ection o f t he
Law Council of Australia, 27-29 August 1999, Fairmont Resort, Leura, N S W , 31 at 61-63.
There is no positive duty on the holding company to be an active investor. The instance in which the holding company should be held liable for the subsidiary's insolvency is if it participated in or interfered with the latter's management. 115 See also Yeung, above n 35, 256-263.
380
The fairness of the suggested model becomes even more apparent when
compared with s 588G of the Corporations Act. Under the suggested model the
presumption applies, with the effect that the holding company is deemed to be
liable if the potential of the holding company to control its subsidiary is
objectively established.116 The presumption can be rebutted if it is shown that
the holding company did not in fact cause the subsidiary's insolvency. Under s
588G of the Corporations Act a holding company would only be liable as a
shadow director if the directors of the subsidiary were accustomed to act in
accordance with the instructions or wishes of the holding company. Although
the holding company would only be a shadow director if actual control of the
subsidiary can be proved, actual control of the particular transaction that caused
the insolvency is not required. The particular instance may be that a less
ingenious business decision taken by the board of the subsidiary caused the
latter's insolvency. It might have had nothing to do with the holding company,
but the holding company could be liable just because the latter generally gave
instructions to the subsidiary that it followed. Indeed, it could happen that, in
the particular instance where the subsidiary company took its own autonomous
decision, which decision then led to its insolvency, the subsidiary ignored the
holding company's warnings or contrary advice. It seems unfair to hold the
holding company liable in these circumstances.
The suggested model is also very flexible because holding companies impliedly
have a choice whether they wish to respect the separate legal status of their
subsidiaries (both in financial and managerial terms) or whether they wish to
ignore effectively the separate legal status of the subsidiary.117 In the latter
instance the holding company is free to become integrated in the affairs of the
subsidiary on the financial and managerial level, but it would then incur
liabilities towards certain stakeholders, for example, creditors of the
116 See Ch 2 para 2.3.2.1(b). 117 Cf the suggestion by C A S A C , discussed in Ch 2 para 2.3.1.2, that wholly-owned corporate
groups should have a choice whether to 'opt in' to form part of a consolidated group governed
by single enterprise principles. Hadden refers to these regimes respectively as a separate status
regime and an integrated regime: T Hadden, 'Insolvency and the group - Future developments'
in R M Goode (ed), Group Trading and the Lending Banker (1988) at 101-108.
381
subsidiary.118 It thus makes provision for cases where the group structure is
centralised, but also where it is decentralised and subsidiaries manage their own
affairs.
10.3 Conclusion
The proposals set out in paragraph 10.2 above admittedly encroach on the
principle of limited liability. It is proposed that the entity theory should not be
strictly followed where the insolvency of corporate groups is involved. This
means that limited liability should not automatically be applicable to group
companies. It is not proposed, however, that one should see as a blanket
solution the liability of the holding company or the corporate group. This would
be adhering to enterprise liability. It would be overly simplistic and unrealistic
to expect that either entity liability or enterprise liability can be universally
applied. Both these concepts have merit, and the appropriateness of each of
them should depend on the extent of the interrelationship of the related
companies and the policy objectives in a particular context.119 It is therefore
submitted that the answer lies somewhere in-between the entity and enterprise
approaches.120
There is no easy way to devise company legislation so that limited liability is
allowed where it is regarded as desirable, but prohibited where it is regarded as
undesirable. Limited liability is and should remain a fundamental rule of
Cf the E E C proposed Ninth Directive, that gives a controlling company the option to manage
its subsidiaries as part of an integrated group. The controlling company then becomes liable for
the debts of the subsidiary unless it could show that these did not result from the controlling company's action or inaction.
S K Miller, 'Piercing the corporate veil among affiliated companies in the European
community and in the US: a comparative analysis of U S , German, and U K veil-piercing approaches' (1998) 36 Am Bus U 73 at 148-149.
Although Grantham and Rickett concede that these principles clearly require some
refinement, they warn against a so-called 'root and branch' attack on them and point out that, in fine-tuning the content of our corporate law, we should not destroy the very concept that we
seek to perfect: see R Grantham and C Rickett 'The bootmaker's legacy to company law
doctrine' in R Grantham and C Rickett (eds), Corporate Personality in the 20th Century (1998) at 7.
382
company law. A part from t he fact t hat i t i s s uch a n e ntrenched p recept o f
company law today, there are other reasons also for not getting rid of limited
liability altogether. A n important reason is that, if the holding company does not
enjoy limited liability, desirable but risky ventures m a y not be undertaken.122 It
is therefore 'economically efficient'.123 Also, other companies would have an
advantage over holding companies if holding companies did not have limited
liability. It m a y furthermore be said to result in a 'fair distribution of risk
between shareholder and creditor'.124
If the goal is to get rid of the abuse often associated with it, all that needs to be
done is to place limits on limited liability for group companies.125 The solution
does not lie in prohibiting 1 imited liability itself, but rather in preventing the
abuse flowing from it, or at least in ensuring that such abuse is more difficult to
achieve. T herefore, o ne s hould d eal w ith a ny c onsequences o f incorporation
that are considered undesirable by dealing with the offending conduct, not with
the vehicle that is merely an instrument of such conduct, namely, the corporate
form. As Professor (now M r Justice) Austin has said:126
By limiting the reform to liquidation and providing an exception for financially segregated subsidiaries, the law would address the liquidator's administrative nightmare while allowing the principles of Salomon's case to continue to operate in the cases where, historically, it has proved so important.
121 IM Ramsay, 'Allocating liability in corporate groups: an Australian perspective' (1999) 13
Conn J Int 7 L 329 at 329. 122 See also C L Villanueva, 'Restatement of the doctrine of piercing the veil of corporate
fiction' (1993) 37 Ateneo LJ 19 at 20. 123 S Fridman, 'Removal of the corporate veil: suggestions for law reform in Qintex Australia
Finance Ltd v Schroders Australia Ltd' (1991) 19 A Bus L Rev 211 at 214. 124 Ibid 215; F Easterbrook and D Fishel, 'Limited liability and the corporation' (1985) 52 Univ Chicago LawRev 90; P Halpern, M Trebilcock and S Turnbull, 'An economic analysis of
limited liability in corporation law' (1980) 30 UT Faculty LR 299. 125 See A Muscat, The Liability of the Holding Company for the Debts of its Insolvent
Subsidiary (1996) 193. 126 R P Austin, 'Corporate groups' in R Grantham and C Rickett (eds), Corporate Personality in
the 20th Century (1998) 71 at 89.
383
SUMMARY
The automatic extension of the separate legal entity principle and its corollary,
limited liability, to corporate groups is inappropriate. In Australia the law has
responded to the development of corporate groups randomly, applying existing
principles of company law and ad hoc statutory reforms. The varied nature of
the techniques available for creditor protection highlights the absence of a
unified legal structure dealing with corporate groups. However, while the
holding company c ontinues to be in a comfortable position as a result of the
firm entrenchment of the rule in Salomon v Salomon, the limited liability
principle provides inadequate protection for a subsidiary's creditors against
possible abuse of control by the holding company.
A model is proposed whereby the holding company should be liable for all the
debts o f i ts s ubsidiary arising from b usiness d ecisions m ade w hile u nder t he
holding company's control. It presupposes the existence of control as well as
the existence of a causal nexus between the control and the specific losses of
the subsidiary, leading to its insolvency. The holding company will be liable for
all losses attributable to its own decision-making power, irrespective of fault.
But the holding company will be exempted from all losses that occurred as a
result of circumstances foreign to or beyond the scope of exercise of its
decision-making power.
The substantive aspects of the system of liability imputation should be
supplemented by an applicable procedural system in which the burden of proof
is reversed. A s soon as there is the requisite 'control', and the controlled
company becomes insolvent, a presumption s hould arise that the controlling
company h as a bused i ts c ontrol b y a cting t o t he d etriment o f t he s ubsidiary.
Unless the holding company can rebut the presumption, it should be liable to
the creditors of the subsidiary.
384
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3M Australia Pty Ltd v Kemish (1986) 10 ACLR 371
3M Australia Pty Ltd v Watt (1984) 9 ACLR 203; [1984] 2 NSWLR 671
Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq 461
ACN 007 537 000 Pty Ltd, Re (1997) 15 ACLC 1,752
A Company (No 005009 of 1987); Ex parte Copp, Re [1989] BCLC 13
A Company, Re [1985] BCLC 333
Adams v Cape Industries pic [1991] 1 All ER 929
AE Goodwin Ltd v AG Healing Ltd (1979) 7 ACLR 481
AG v Equiticorp Industries Group Ltd [1996] 1 NZLR 528
Albert Life Assurance Company, Re (1871) LR 6 Ch App 381
Anderson v Abbott 321 US 349 (1944)
Androvin v Figliomeni (1996) 14 ACLC 1,461
Anmi Pty Ltd v Williams [1981] 2 NSWLR 138
ANZ Executors & Trustee Co Ltd v Qintex Australia Ltd (1990) 2 ACSR 307;
[1991] 2 Q d R 360
ASC v AS Nominees Ltd (1995) 18 ACSR 459
ASC v Gallagher (1993) 11 W A R 105
ASIC v ABC Fund Managers Ltd (2001) 39 ACSR 443
Atlas Maritime Co SA v Avalon Maritime Ltd, The Coral Rose (No 1) [1991] 4
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Augie Restivo Baking Company, Re 860 F.2d 515 (1988)
Augustus Bamett & Son Ltd, Re [1986] BCLC 170
Austcorp Tiles Pty Ltd; Re Global Marble Pty Ltd; Austcorp Quarries Pty Ltd
(in liq), Re (1992) 10 ACLC 62
Australasian Memory Pty Ltd v Brien. (2000) 172 ALR 28
Australian Growth Resources Corporation Pty Ltd v van Reesema (1988) 6
ACLC 529
Australian National Industries Ltd v Greater Pacific Investments Pty Ltd (in
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385
Australian Securities Commission v Forem-Freeway Enterprises Pty Ltd (1999)
17 ACLC 511
Australian Securities Commission v Marlborough Gold Mines Ltd (1993) 177
CLR 485
Automatic Self-Cleansing Filter Syndicate Co Ltd v Cunninghame [1906] 2 Ch
34
A WA Ltd v Daniels (trading as Deloitte Haskins &Sells) (1992) 10 ACLC 933
Balmedie Pty Ltd v Nicola Russo, unreported, F ederal Court, Ryan, Whitlam
and Goldberg JJ, 21 August 1998
Bamford v Bamford [1970] Ch 212
Bank of Australasia v Hall (1907) 4 CLR 1514
Bartlett Researched Securities Pty Ltd (admin apptd), Re; Nova Corp Ltd
(admin apptd), Re (1994) 12 ACSR 707
Beach Petroleum NLv Johnson (1993) 11 ACSR 103
Benchmark Building Supplies Ltd v Jackson (2001) 9 NZCLC 262,612
Bennetts v Board of Fire Commissioners of NSW (1961) 87 W N (Pt 1) (NSW)
307
Bentley Poultry Farm Ltd v Canterbury Poultry Farmers Association (1989) 4
NZCLC 64,780
Berkey v Third Ave Ry 244 N Y 84, 155 NE 58 (1926)
Berlei Hestia (NZ) Ltd v Fernyhough [1980] 2 NZLR 150
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Foss v Harbottle (1843) 2 Hare 461
Francis v United Jersey Bank 432 A 2d 814 (1981)
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Hay's Settlement Trust, Re 1982 1 W L R 202
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In re White and Osmond (Parkstone) Ltd, unreported (30 June 1960)
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JN Taylor Holdings Ltd (in liq) (No7), Re (1991) 6 ACSR 187
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Levin v Clark [1962] N S W R 686
Lewis v Cook (2000) 18 ACLC 490
Lewis v Poultry Processors (1988) 4 NZCLC 64,508
Liardet Holdings Ltd, Re (1983) BCR 604
Linter Group v Goldberg (1992) 7 ACSR 580
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McMahon v Pomeray Pty Ltd (1991) ATPR para 41-125
McPhail v Doulton [1971] AC 424
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Mendes v Commissioner of Probate Duties (Vic) (1967) 122 CLR 152
Mentha v GE Capital (1998) 16 ACLC 1,032
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ABBREVIATIONS
A Bus L Rev
AIB
AU
AU
Am Bus U
AmJofSoc
Ateneo U
Austl B Rev
Austl Com Sec
AIJ
Aust Jnl of Corp Law
BCInt'l & CompL Rev
Butt Co & Sec L Bull
Butt Comm L Bull
Butt Corp LB
Bond L Rev
Bus Law
C&SLJ
Can Bus U
Canterbury L Rev
Cardozo L R
CBU
CU
Co Dir
Co Law
Columb Lrev
Com Fin & Insolv LR
Comm Law Assoc Bull
Comm LQ
Conn J Int'l L
Australian Business Law Review
Australian Insolvency Bulletin
Australian Insolvency Journal
Australian Law Journal
American Business Law Journal
American Journal of Sociology
Ateneo Law Journal
Australian Bar Review
Australian Company Secretary
Australian Insolvency Journal
Australian Journal of Corporate Law
Boston College International & Comparative Law Review
Butterworths Company and Securities Law Bulletin
Butterworths Commercial Law Bulletin
Butterworths Corporation Law Bulletin
Bond University Law Review
Business Lawyer
Company and Securities Law Journal
Canadian Business Law Journal
Canterbury Law Review
Cardozo Law Review
Corporate and Business Law Journal
Cambridge Law Journal
Company Director
Company Lawyer
Columbia Law Review
Company Financial and Insolvency Law Review
Commercial Law Association Bulletin
Commercial Law Quarterly
Connecticut Journal of International Law
417
Conn L Rev
Cornell L Rev
Corp & Bus U
Deakin LR
Delaware J Corp L
EPU
Fed L Rev
Griffith LR
Harv L Rev
Hastings LJ
IBFL
ICLQ
Insol Law Jnl
Insolv Prac
InsL&P
IFLR
Int 7 Law
IntJSocLaw
Iowa J Corp L
J EconLit
J Corp Law
JBFLP
JBL
JIBL
LMCLQ
LQR
LSI
Mich L Rev
MLR
Mon ULR
MULR
Connecticut Law Review
Cornell Law Review
Corporate and Business Law Journal
Deakin Law Review
Delaware Journal of Corporate Law
Environmental and Planning Law Journal
Federal Law Review
Griffith Law Review
Harvard Law Review
Hastings Law Journal
International Banking & Financial Law
International and Comparative Law Quarterly
Insolvency Law Journal
Insolvency Practitioner
Insolvency Law & Practice
International Financial Law Review
The International Lawyer
International Journal of the Society of Law
Iowa Journal of Corporate Law
Journal of Economic Literature
Journal of Corporation Law
Journal of Banking and Finance Law and Practice
Journal of Business Law
Journal of International Banking Law
Lloyd's Maritime and Commercial Law Quarterly
Law Quarterly Review
Law Society Journal (NSW)
Michigan Law Review
Modem Law Review
Monash University Law Review
Melbourne University Law Review
418
North Car J Int L & Comm
North UL Rev
NZU
NZULR
OJLS
OrLR
South Cross ULR
THRHR
Torts U
Univ Chicago Law Rev
UT Faculty LR
Univ of Toronto U
U ofPitt L Rev
UNSWU
UWALR
VandLRev
Waikato L Rev
YaleU
North Carolina Journal of International Law and
Commercial Regulation
Northwestern University Law Review
New Zealand Law Journal
New Zealand Universities Law Review
Oxford Journal of Legal Studies
Oregon Law Review
Southern Cross University Law Review
Tydskrifvir Hedendaagse Romeins-Hollandse Reg
(Journal for Contemporary Roman Dutch Law)
Torts Law Journal
University of Chicago Law Review
Univ of Toronto Faculty of Law Review
University of Toronto Law Journal
University of Pittsburgh Law Review
University of New South Wales Law Journal
University of Western Australia Law Review
Vanderbilt Law Review
Waikato Law Review
Yale Law Journal